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Wednesday, March 15, 2006

Matt Miller On Enterprise Software Investment Trends

Matt Miller of Walden has an excellent post in Sandhill delineating the issues around investments in enterprise software. He brings forth the point the much hyped opensource and SaaS, seen by many as the new innovative blocks in the enterprise software industry finds few takers or requires super scale to surivive. As he sees it,the last investment "bubble" funded plenty of strong small and mid-sized vendors who are still waiting to be acquired with many stagnating. Perpetual license models are a slowly dying business model, but the much-hyped Software as a Service (SaaS) model is still more conjecture than reality in the core software sectors. He finds that VC’s tend to think as a group today in contrast to the late 80’s & adds that software companies have become more "capital efficient." The cost structure of the industry has changed for the better - from a budget of $7 - $10 million to build a product in yesteryears, today software companies can leverage open source components and offshore development to decrease development budgets significantly. Result : a decent piece of enterprise software can be built for $5 million or even less. On the marketing side, from 10%-15% marketing spend of its gross revenues in the past, it has now come down significantly. Other key points:

- With opensource, the barriers to entry are quite low that anyone can start an open source software company – so the scale needed to have a successful open source company is dramatic. See my related article –“ open source : where’s the business model? An open source startup might need 100,000s or millions of users to generate meaningful revenue on maintenance. Needless to say, few open source companies can quickly achieve the scale needed to be successful.
- Action on SaaS is only at the press level and even CIO’s tending to agree that the perpetual license model is dead, have not committed any big dollars to subscriptions. Aside from Salesforce.com, there are no other successful companies that we could come across. I wrote about this several months back –“ SaaS & : Overwhelming issues coming in the way of adoption , concluding that not a very easy path lay to embrace Software-as-a-Service model.
- VCs do have an increasing preference for later stage investments, which now account for one-third of all deals and nearly one-half of all dollars invested. That's why areas like open source databases are looking extremely popular with investors this year. The area is ripe with early adoption and strong contenders. I also wonder how this would affect the rest of the constituents in the ecosystem - professional service providers with globally distributed delivery models and new model consulting firms, information advisors - all of them need substantial support to facilitate growth of the industry.Wonderful piece full of insights - worth reading again and again.

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