It’s so trendy and hip for VCs to scoff at the thought of investing in enterprise software that some of the smart VCs are beginning to, get this, invest in enterprise software! Choosing to zig while everyone is zagging is often a smart move. My take is that this move will pay off for those that make it. Here’s why.
At the highest level, the software content of everything we buy – be it bananas, plane tickets or cell phones – is increasing. Smart (i.e. surviving) enterprises are using software to automate and to optimize research, design, manufacturing, logistics, customer support, and demand creation as well as to enhance technology products.
So, why then is enterprise software dead? It’s the traditional model of enterprise software that is dead. What is dead for certain for most of the industry is the traditional model of building software, throwing it over the fence to a sales force that flies the globe to show their wares to inattentive prospects worldwide. Slowing demand for software is not the cause of death. Instead, the drivers are in the changes in levels of risk that large enterprises and decision-makers are willing to make.
Capital Model Has Changed (Trade-Off Between CapX and OpX)
The first dramatic change in the software industry was the erosion of capital budgets for software acquisition in the Global 3000 customer base. In the past, automation was seen as a trade-off between balance sheet and income statement. Companies use significant balance sheet capital in order to acquire expensive software that automates processes and make expensive labor much more productive, thereby lowering operating costs (on a per-unit basis). Software technology has been a major drive of labor productivity and enterprise profitability. Thus, the balance sheet is leveraged in return for higher profitability. The software was seen as a one-time capital cost and the productivity improvements would be achieved for years.
This trade-off made sense in the past. First, the high cost of ERP and CRM implementation merited attention from senior management based on cost controls alone. Second, operating managers didn’t want to be penalized with the cost of software in their P&L. Operating managers had the benefit of corporate capital but were measured on operating group profitability. They were motivated to automate even if the capital costs provided only modest ROI to the enterprise. The software provided great ROI to them.
As companies began to tighten their capital budgets, buying decisions got pushed out to business units who had to shoulder all the costs of automation and other forms of software. This forced operating executives to start pushing back on the high costs of software.
Risk Models Have Changed (Financial Risk, Execution Risk, Job Risk)
In addition to the capital costs, the risks associated with large software installations have also been historically high. As decision-making has been pushed out into the organization, the risk of those decisions has followed down the org chart to business managers. Complicating matters are the large number of ERP systems that are purchased but not in “production.”
As a result, decision makers face financial risk, execution risk, and even job risk. There is financial risk that the value accreted through optimizing high-priced workers (e.g. a sales force) will not outweigh the cost of utilizing other high-priced and scarce workers (i.e. IT staff). There is also execution risk that implementations will not meet time frames or will fail outright. Finally, for those business managers now making these decisions, there is the job risk inherent in making the purchase decision in the first place. The hurdle for buying managers has gotten too high to overcome with the traditional sales model.
Death of a Salesman
As an industry we have for years held our selling processes in higher priority than customer buying processes. Software sales executives like big pipelines; software buyers like to get educated by software companies. This combination results in expensive sales people educating unqualified buyers months, quarters and even years ahead of budgets and decisions.
Additionally, our model in the software industry is to sell “value.” And as an industry, in aggregate, we do deliver value. We were willing to make the bet that enough of our long sales cycles and low-probability leads would result in large million-dollar purchases to make it worth our while. In this game of software roulette, the law of large numbers works for the software vendors (many customers) but not for the buyers.
Enter Software Subscriptions, A First Step
While many companies and sales people were successful with that model, and in fact many Global 3000 customers also flourished buying software, there is now a lower risk model that is taking form. It is a model that provides the same probabilistic expectation of sales with better quality leads, lower ASPs (average selling prices) and higher probability of close. Software companies can achieve this model by:
- Eliminating financial risk of purchase via trial (try-before-you-buy)
- Eliminating cost of selling prior to engagement in customer buying process
- Enabling qualified leads to aggregate and self-select
And as an industry in 1999, we tried just that – and created a short-lived industry of “ASPs” of a different sort – Application Service Providers. ASPs were hosting companies that sold you ERP and other complex software hosted on their premises and purchased on a leased model. The problem with that solution is that it only eliminates the capital risk. The software still required expensive and scarce IT personnel to implement systems. The advantage was that they weren’t your expensive and scarce personnel. In the same year Salesforce.com (and others) came along and a new model was truly born.
SaaS: Business Models that Align Product, Price and Operations
Salesforce got it right. If you think about it, they should never have existed. There were literally hundreds of SFA vendors already selling to corporate America. But Salesforce.com did one thing that no other company achieved at the time, and that few have achieved since. They built an entire company around perfect alignment of product, pricing and sales.
- Product – online, self-service, easy-provisioning service with no deployment cost (as a first approximation)
- Pricing – free trial, low entry cost, costs that scale perfectly with users and usage, known costs
- Sales – low cost telesales who can work against highly-qualified (already in trial) prospects who self-select and actively identify themselves (via trial) to the company
All three elements were critical to success. And at that time, it was not entirely obvious.
You could pay Corio or other hosting companies to host your Siebel application on their premises, or you could try the scaled down Siebel version, sales.com. These solutions proved ineffective, providing subscription pricing but no reduction in deployment complexity nor sales costs. A Harley Davidson motorcycle and a Schwinn bicycle are not interchangeable regardless of the fact that they are both “bikes.” The same can be said for the large enterprise applications and lighter-weight SaaS applications. Most enterprise applications were not built for multi-tenant, self service, pay-as-you-go service that Salesforce.com implemented from scratch. A billion dollars per year in revenue later, Salesforce.com has made it look so very obvious.
Conclusions
Enterprise Software as a category is alive and well. Like electricity, software is a basic necessity of corporations. It’s the old enterprise pricing, sales and delivery models that collectively are suffering outside of a few large software vendors. For the rest of us, software has morphed into something we try before we buy, we buy on subscription and we don't need anyone to install.
Reach into your pocket, pull out your cell phone and think about those cell phones in the early 1990s – large, heavy, and unreliable. Salesforce.com is the iPhone of enterprise apps. Other SaaS and cloud computing companies are rapidly advancing. So far, however, very few others have it “dialed in."
