Starting a New Chapter for the Software Industry

Just came back from a venture capital conference hosted by Longworth Ventures in Boston, all in all it was a very good experience and having the opportunity to sit on a panel featuring fellow Irregulars Rod Boothby, Ismael Ghalimi, and Zolie Erdos was a highlight, especially considering that the panel was moderated by newly minted Irregular Andrew McAfee (aka “Probie”).

In my discussions with the Boston area venture capitalists I was left with the impression that this whole “2.0” thing is something that isn’t widely grasped outside of the Valley. At the risk of not making the best of friends with some VCs that I will actually have to sit on the other side of the table from and convince them to fund my new company, allow me to expand.

Of course I am making a generalization here because clearly there are VCs like Brad Feld and Fred Wilson that clearly get the impact of web 2.0 both on the consumer and enterprise sides of the industry and they aren’t located in Palo Alto, and to be fair I think there are quite a few VCs in the Valley that either don’t get it or don’t believe it’s meaningful to the degree that I do. However, what I am trying to suggest is that the volume of the conversation is a much more amplified where I live and work, which is reflected in the fact that all 4 panelists were from Palo Alto, and it would have been 5 if Ross Mayfield didn’t have to cancel at the last minute. Think about that for a minute, a panel discussion at a Boston VC conference and all the panelists are from the other side of the country.

I left SAP recently with a couple of observations that I am using to inform my decisions about where my new company goes:

1) Direct enterprise selling sucks, is highly inefficient, and makes you do unnatural things in your product strategy in order to drive higher deal sizes

2) Large enterprise software vendors are not the future. The whack-a-mole selling model where a handful of vendors (172 public companies in hardware and software) are fighting it out over approximately 50,000 business customers just can’t be the future! There are 38 million businesses in the U.S. alone that have less than 10 employees, there just has to be a way to grow our collective markets by appealing to these business users and I’m pretty confident in saying that it isn’t going to come from SAP, Oracle, or IBM.

3) The SOA-ification of big enterprise products has attacked a technical dimension, not an economic or business model one. In a somewhat bizarre turn of events, the historical strength of market leading business applications, the integrated suite approach, is being turned from an advantage into a liability. It’s like if you went into the Gap and wanted to buy a pair of jeans but because of the way the Gap was structured and how they merchandised, they would only sell you a pair of jeans, socks, underwear, shirt, jacket, and a hat… and when you told the salesperson that you just wanted a pair of jeans they said “but we are selling you a pair of jeans”.

4) Big enterprise software has historically been a product driven development process, not a user driven approach. Just look at the fact that all these companies have applications “products” and “modules” and “components” instead of something more logical, like “process portfolios” that map to what people actually do in their jobs. Furthermore, there is a big disconnect between what users do and what vendors build for the simple reason that no vendor except Salesforce.com (more on that later) is selling to people who actually use their software, they are selling to people who buy and implement software for other people in the organization. Traditional enterprise vendors will tell you very convincingly that they are all about process, buuuuttt what do they actually sell you? Applications.

5) Lastly, and most importantly, there are no new big killer apps that are going to be built for today’s enterprise. Global business has spent the last 40 years automating every corporate function that is worth automating, and then they automated it again through “process reengineering” and once more when that didn’t work out quite like everyone thought. Today’s enterprise software market is about finding gaps and filling them, linking products in new ways, and leveraging more value out of IT investments that have already been made. I think the consumer side of the business is a fantastically rich opportunity landscape and if I were building a company today the company my team is building will straddle both worlds.

So getting back to the Boston area VCs, the reason I felt a disconnect with this group is that they were still thinking in the enterprise 1.0 mindset while fully acknowledging that most of the artifacts of the 1.0 version are antiquated. It takes a massive jump in mindset to believe that a company can exist by:

1) Building applications from other people’s stuff (OPS). There is a proliferation of web services being driven by all players in the market but they are largely looking at this as the mechanics for how to build and manage their own products. I look at the growing repository of web services and see a company that exist to package these services as components for new “meta-apps” or applications that users themselves are creating and publishing.

2) The “departmental sell” strategy is thrown around as essentially a downsized version of the traditional enterprise sell. In reality, the departmental sell is all about selling to people who use your software, actually use it in the sense of sitting down in front of it and really using it. This is one half of the substantial innovation that Salesforce.com brought to the market, the other half being that they figured out how to do this with profitable unit economics.

2a) The closed loop process of seeing and hearing from actual users can inform a product development roadmap in ways that the traditional approach never could. As an added benefit, seeing in realtime what people are using, in terms of functionality, means that you can strip out the crap that didn’t work to your user’s satisfaction and wasn’t adopted. Wow.

3) Living on top of the idea that a software service can be built by and for it’s users featuring services that are built and supplied through other vendors, and sold through a channel(s) that doesn’t feature a bag carrying salesperson.

It’s an incredibly frightening thing to leave the safety of a very large company like SAP for a company that doesn’t qualify for a Cogenz beta account (Niall said he’s take care of us!), but I am comforted by the fundamental belief that the enterprise software industry is undergoing radical change that has little to do with technology alone. In other words, the company may not succeed but I know that the principles that we are building on put us in the very forefront of where this business is going and we will all be better off for it. My big concern at the moment, aside from delivering a product, is finding the right investor syndicate that not only believes in what we do but is capable of putting aside a lot of historical experience while we all learn how to do business at the beginning of a new chapter.

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Surviving In the Software Economy

Over the last 10 years there is just one hardcopy article that I have guarded and taken with me in every role I have had. The article in question is from the March/April 1996 issue of Upside magazine (remember them?) titled “Surviving in the Software Economy” by Ted Lewis.

Surviving in the Software Economy is a treatise on something called software economics and what “FutureBusinesses” would be required to do to succeed in the future:

“Software economics does adhere to certain principles: driving prices to commodity levels, setting standards at nanosecond intervals, targeting special interest groups, identifying shooting ranges (and shooting), and appealing to tribalism. These techniques are already being successfully used by such companies as Intel Corp., Microsoft Corp., Netscape Communications Corp. and Qualcomm Inc.”

It’s easy to read the excerpt above and cringe because after all these are not what you would refer to as the cutting edge companies in our industry, but remember this article came out in 1996 and the simple fact of the matter is that all but one of these companies are fantastic successes and the one that failed did so for reasons other than what are discussed here… in fact, you could reasonably argue that Microsoft used the very principles that Netscape was dependent upon, and detailed in this article, against them.

“Microsoft’s great success in the PC world started with a simple idea: the more market share you have, the more you get.”

How true it is… who could argue against the idea that the reason YouTube is getting so much uptake is that they have such a large community, or that Digg doesn’t get more people submitting and voting than for the simple reason that they already have so many. Even in the enterprise space this holds true, Salesforce.com accelerates customer acquisition and partner development as they add share.

What is even more amazing about the above is that Lewis uses positive feedback mechanisms as an example of how entrenched applications extend their value, and by extension of that how learning curves result in decreasing cost as production/deployment rates rise. Amazing because if you look at the graphic of learning curves being applied to software versus hardware industries you realize that Lewis is talking about “the long tail”.

There is one section in this paper that does fail to hold up, in my opinion, and that is the section on mainstreaming and free products.

“Now, all FutureBusinesses are stampeding to the Internet to give away their products! A recent op-ed piece in an industry publication suggested that the next step is to pay consumers to use a new product. Once hooked, of course, the consumer is levied upgrade fees.”

This is the one thing that doesn’t hold up over time, companies are not giving away their products with the intention of becoming the crack dealers of the internet, quite the opposite really because the switching costs are so low that there is no incentive for users of free products to stay with those vendors if they do impose fees. What is happening is that companies are using free as a mechanism for lowering their sales and marketing expenses, converting customers into paying customers by establishing premium service offerings that their customers are willing to pay for, not necessarily because they have to but because they want to. Another aspect of this that Lewis, nor anyone else for that matter, is that you could get someone else other than the person using your service to pay for it… Google proved this pretty definitively.

The concepts of “markets-of-one” and “tribalism” are two things that I do very much agree with. The idea here is simply that mass marketing is dead and businesses must adapt to reaching out to individuals as niches, not really markets of “one person” but clearly very small niche markets that have requirements and determiners that are both similar and very different from other markets that company serves.

Tribalism is simply the phenomena that Mac users are quite different than Windows users, but today we can obviously point to more examples of this, even though the Mac vs. Windows piece still holds water. I think that what Lewis is talking about when he refers to tribalism is that partner ecosystems matter more than ever. In order to establish a partner system a business today needs to employ all of the elements that Lewis references. I would sum it up as saying a company has to lower the bar for getting into the tribe, create opportunities for the tribal members to establish rank and social status in the tribe, and lastly but most importantly, for tribe members to improve their economic position in the tribe and that of the tribe as a whole. All of the objectives above not only increase the success of the tribe in the market but also attract new members from competing tribes, which serves the ultimate goal of growing the tribe at the expense of competitors.

The last point about growing the tribe at the expense of competitors is something that becomes very meaningful when you apply it to the New Lanchester Strategy.

“So what is the ideal market share? When a company’s goal is to dominate, it usually attempts to gain at least 50 percent of the market. The New Lanchester Strategy, however, suggests that only a 41 percent market share is necessary. The gap in profitability between the leader and its rivals widens when the leader’s market share exceeds 41 percent but is less than 73.9 percent.”

Indeed, look at Google and Ebay for proof positive examples of the New Lanchester Strategy, or Oracle in databases. SAP is actually an interesting example to watch going forward because their market share in global ERP markets is approaching the magic threshold, but in my opinion they won’t necessarily benefit to the same level as others because they have not fully embraced the other principles referenced here. It’s not a bad thing, but this should be considered leading indicators for what the company should be investing in at an increasing rate going forward.

The New Lanchester Strategy also references shooting range theory pretty heavily, and quite honestly I am of mixed opinion as to whether or not this still applies, although the concept of finding and targeting a weakness in an opponent, which is called finding the shooting range, is certainly nothing to be dismissed lightly. The part about shooting range theory that I have an issue with is the sizing part:

“Any company whose market share size is within 1.7 (or the square root of three) times the size of a second company’s market share is within the shooting range of that company.”

Hmmm…. not so sure I agree with this for the simple reason that there are two shooting ranges, the economic one versus the perception range. Perhaps the reason why I am not quick to agree with this is that the example used to expand on this is America Online vs. CompuServe vs. Prodigy, and we all know how that turned out. Very often it is not the competitor you know that does you in. The very small companies, those out of the shooting range, are the most dangerous to incumbents.

The final section of this article talks about a lot of concepts that in 1996 were pretty new and disruptive, however today we would pretty much refer to all of it as search engine marketing and that is rapidly evolving itself as the social media space has exploded in recent years.

It’s too bad that Upside Magazine itself was unable to adopt the principles that Lewis detailed in his piece, because if that were the case Upside might still be with us. Technology businesses are in constant change and convergence, but the strategies are pretty solid in spite of tactics that are constantly accelerating and increasing in scope and scale.

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