The late 1990s marked a turning point in the enterprise software industry. Forecasts of a Y2K disaster, Internet-driven hype and gangbuster corporate profits allowed both vendors and customers to embark on a spree of untethered spending that led, inevitably, to a restructuring of the software industry over the subsequent decade. All industries mature over time, and software is no different. But the economic repercussions of the late 1990s shaped the traits and business models that work today for the most successful entrepreneurial software companies.
Looking back to the late 1990s, a present-day software vendor would find an almost unrecognizable industry. Customers made all-or-nothing decisions to invest millions of dollars in large enterprise systems, with no ability to invest incrementally as business value proved out. Industry analysts and the media were beating the drum on terms like e-procurement, CRM and enterprise content management. As a result, companies feared they would be left behind unless they embarked on their own enterprise IT program. In this environment, large software vendors were able to convince customers to make seven- and eight-figure license purchases.
The volume of money flowing into enterprise IT licenses, combined with the shortage of expertise on how to derive business value, led to the mushrooming of systems integrators and consulting houses—all of whom benefited from the complexity and adoption challenges to drive billable hours. Once software was purchased, the software vendors’ profits were achieved, and the obligation of customer success was handed off to the integrator. Vendors would rely on customer habit to drive high-margin maintenance renewal—whether or not the software was delivering its promised business value. The system guaranteed product complexity, which was necessary to keep the channel in business. This complexity made it difficult for customers to scope a proof of concept, which helped vendors and integrators create an illusion of value to justify high price points. Giant companies grew and crashed on this model, some of which were household names during that era.
A self-fulfilling cycle evolved, with customers, vendors and channel participants reinforcing one another’s worst tendencies. When the inevitable bust occurred, it left an industry in need of transformation. If the starting principle of the late 1990s software industry was the C-level fear of being left behind in the much-hyped IT race, the starting principle in recent years has been a countervailing rise of extreme buyer skepticism.
Ultimately, the project failures and expenses of the late 1990s left customers with a mistrust of software vendors. This buyer skepticism has redefined the software business models that work today. Though there are always exceptions, for the most part, the entrepreneurial software companies that have achieved the greatest success in recent years have adopted one of four business models:
1. The Commoditizer
Commoditizers identify a market with rich profits and incumbent vendors with relatively high-cost and slow-to-iterate distribution and product development models. They build a product with comparable capabilities to incumbent products, but narrow down the feature sets to the essential elements to keep out the bloat. Most of all, they focus on ease-of-use, ease-of-install and ease-of-purchase. They must make excellent products because word-of-mouth and prospect self-identification are critical to selling efficiency at Commoditizer price points. Commoditizers are ruthlessly focused on eliminating friction points in all aspects of their business, but particularly in customer adoption and product usage. They effectively expand the number of addressable seats in a market, while compressing the average price per seat in the market. All “freemium” companies are fundamentally commoditizers. Google is an aggressive Commoditizer in the productivity application and operating system markets.
2. The Incrementalist
Incrementalists know they have good products that deliver fast ROI. They are confident that once an individual or department starts to use the product, it will be easy to sell to other employees or departments within the same company. Incrementalists typically adopt telesales models to drive “land and expand” behavior. They have highly productive and cost-effective product development operations that frequently pump out new products, which the telesales team can sell back into a satisfied installed base. Salesforce enjoyed much of its early success by employing an Incrementalist model.
3. The Specialist (often the Cost-Saver)
Specialists generally identify a seemingly narrow or complicated problem, often within the ecosystem of a larger software vendor or between different layers of the IT stack. For vendors that address problems within a larger ecosystem, the problem itself often seems small to the large software vendor, but it causes pain that customers will pay to solve. Addressing the pain often entails not just technical understanding, but also a deep understanding of the workflows and behavior of an everyday user. Often, the Specialist takes advantage of slower product cycles from an incumbent software vendor whose product complexity and requirement for back-integration with prior versions slows development cycles.
If the problem is not specific to one vendor’s ecosystem, it often involves an understanding of different elements of the IT stack. The Specialist almost always delivers rapid ROI through cost-saving—either time, headcount or capital dollars. Doing so makes it easy for customers to make an incremental investment on top of one they have already made. VMWare is an example of a company that understood a problem that incumbent operating system and hardware vendors had little incentive to solve. By understanding the hard problems at both the server operating system and hardware layers, VMWare built what may be the most disruptive software company of the last decade. Summit Partners portfolio companies like GoldenGate Software and SafeBoot have used Specialist models to build large and valuable businesses by focusing on a problem where neither the operating system nor the hardware vendor had a strong motivation to solve it.
4. The Continuist
Continuists set up their business model to deliver ongoing value to the customer—typically by off-loading the obligation of hosting and supporting the application or by providing ongoing application updates and information. If they fail to perform well, the customer will be in a difficult spot, as it’s often hard to switch vendors. However, because Continuists generally make a substantial investment to acquire customers on the presumption of customer longevity, slight increases in customer churn rate have a powerful effect on profitability and the net present value of the business. The Continuist and its customer both understand the potential for “mutually assured destruction,” and this keeps the vendor committed to doing a good job for its customers. All SaaS and Cloud Computing companies use the Continuist model, as do many security software companies that must deliver continuous adaptation to emerging threats. Summit Partners has invested in companies like Cloudmark, LiveOffice, PeopleAdmin, Postini, RightNow, Sybari, and WebSideStory, which use Continuist models to build large and valuable businesses.
The categories above are rough groupings and certainly do not describe a number of successful companies. Perhaps the common thread is that buyer skepticism has forced most enterprise software companies to take a page from the direct marketing industry rather than the old-school enterprise software industry. Rapid product iteration, low-cost distribution models, products focused on ease-of-use and continuity programs—these are the traits that now work in the software industry. The result is that customer success and vendor success may be more tightly coupled than they have been in the history of the software industry. For the next generation of great software companies, maximum success depends on rebuilt trust between customers and vendors.