Software's new economic drivers

I just reread this great piece by Rick Sherlund about new economic drivers in software. While it was fascinating to read that IT now comprises the single largest component of enterprise capital spend at 40%. I couldn't help but think that there are interesting ramifications to this as the industry moves to a subscription pricing model thereby taking a large chunk of capex and moving it to operating expense, assuming of course that this is a broad-based evolution.

Sherlund also makes the point that the days of landscape changing shifts in technology are gone, a point that every established vendor is well aware of. However, I wonder if the legions of software startups looking to capitalize on cheap infrastructure and low cost sales and delivery models really believe that. One could argue convincingly that the overwhelming majority of enterprise software startups in the business are selling layered products that go on top of an SAP or Oracle infrastructure, and you would be right of course. Other companies, like Workday, are looking, possibly, to displace existing vendors and if they are successful then we have seen a landscape shift.

While tech continues to benefit from "mini-waves" of technology shifts (e.g., wireless),
there are not the rapid, landscape-changing shifts that drove feverish
growth in the 90s. In addition, many of today's technology trends
actually serve to reduce aggregate IT spending.

Sherlund also makes some interesting points about software margins and the fact that they have actually increased over the last couple of years. I think there are two factors that have contributed to margin expansion, fewer competitors and improved productivity among software companies. It's no surprise that there are fewer competitors in the market, a dynamic that always improves pricing power, but the other component of this is that there is a security premium customers are willing to pay to do business with a company they know will be around for the long haul.

The productivity factor is the most interesting, basically the companies in this business have vastly improved their operating economics. We sell smaller deals profitably because we're no longer "rolling up in the bus" with huge sales teams, we're doing more remotely, our customer service procedures are not only more effective but they are less expensive to staff (offshoring). Software development is still an expensive endeavor but thanks to mature infrastructure technology and extensive staff resources that understand infrastructure and application development, we're increasing the amount of product that developers turn out.

Read the rest of the piece, Sherlund makes some really good points in his predictions.

technorati tags: sherlund software economics

Comments

[Woodrow]

Jeff,

When Rick published this back in September, I remember thinking..."he's right, but what does that say about software investing?" Obviously in your purview that's not germane to the conversation directly but Sherlund's main constituency [i.e., we fund managers] have to sit back and wonder what to make of a universe where the lead thought-leader [Rick has been II-ranked in the category every year I can remember] basically paints a case for stymied innovation [or at least stymied INVESTMENT OPPORTUNITY via innovation.]

If you overlay his comments with a look at Bill Burnham's recent post regarding the to 10 software stocks of 2005, it really crystallizes just how much rationalization the industry has to go through before it's a sector many fund managers feel compelled to 'overweight.'

[viinnie mirchandani]

Rick only looks at the mega s/w vendors - the public ones at that. He has a vested interest in talking about them. But look at how much custom development continues to happen in financial services, look at the SaaS in CRM and other areas in the mid market, look at the BPO in mortgage processing, maintenance going to 3rd parties. Last time I checked companies Like Infosys, saleforce.com, and several others were growing much faster than SAP or Oracle. You may not consider them competition but buyers do and start ups and other companies continue to find plenty of niches around SAP and Oracle

[Jason Wood]

Vinnie,

That's not really a fair assessment of Rick's purview. He put out one of the most comprehensive pieces on salesforce.com and the SaaS CRM space this year I've seen from the sell-side or 3rd party research groups.

[viinnie mirchandani]

Jason - you are right, and BTW I like Rick - I think he knows more about Microsoft than any other outsider - but he does not cover open source, private software companies, offshore vendors etc...lots going on there too in s/w development and maintenance..in the end Rick is paid to cover the mega s/w vendors...