The Enterprise Software Industry : Broken Model

Erik Keller writes a seminal article where he points out that the enterprise-software industry business model is broken. The mega players - IBM, Microsorft, Oracle and SAP hardly represent the diversity of functional solutions, vertical and niche markets, innovation and business processes that are fulfilled by a growing base of companies. Yet most small companies are struggling for their survival today. By examining the financial results of "Enterprise 11" as well as that of SAP and Oracle, he brings out interesting facts. (The Enterprise 11 companies are Aspen Technology, BEA, IBS, Indus, Hyperion, Manhattan Associates, PTC, QAD, Software AG, SSA and Vignette). His review of the data shows up interesting information. :
- The E11 has greater G&A spending than either Oracle or SAP yet generates a half or less revenue than either.
- The E11 spends much more on S&M as a percentage of total revenue than do either SAP or Oracle.
- The G&A spending of the E11 nearly equals their corporate profits.
- SAP and Oracle are much more alike than either would like to admit
Clearly the E11 is significantly more inefficient than either SAP or Oracle thus facilitating consolidation as well as the emergence of new business models. The Enterprise software overhead-to license ratios defy logic – in early 1990’s typically over two thirds of total revenue were new software license sales. Today due to changing realities, only one third of total revenue is from software licenses. In the meanwhile companies mostly have not flipped their overhead model to accommodate for this change in revenue mix. The fact that on average smaller software companies spend nearly two-thirds more in overhead for every software license dollar than their larger brethren puts them in a race that will be difficult to win as a publicly traded company. To succeed in the future small software companies must throw out the old play book and start with a new one.

Can SaaS change this – unlikely as it looks - Salesforce.com and RightNow Technologies, two of the most well-received companies with a SaaS delivery and revenue model, both spend nearly 50 percent of their total revenue on software sales and marketing. It is also far from clear how far and deep SaaS can be extended into buyer organizations. Co-ops look like an interesting model. Rather than pushing products out to the market, a new generation of companies is beginning to pull customers in via a combination of open source or "free" basic products that can be downloaded over the web as well as "for-charge" enhanced products and support. He thinks that is likely that a combination of SaaS, open-source offerings, overhead efficiency, group selling and enhanced services will become the core of the future enterprise-software business model. Indeed a very interesting article. Vinnie thinks that the state of the industry is such that its as if The red cross spends just ten percent on charity. As I wrote earlier, a careful examination shows that well evolved industries move towards a decentralized/tiered model – currently the enterprise software industry is highly integrated vertically and its ecosystem is not well set today. In this changing world, going beyond the packaged solutions, extend the idea a bit – enter the idea of SOA & Composite applications - the applications can be mashed up in multiple ways to create new frameworks that can be assembled as & when needed to make business in an always ready-to-respond mode towards changing external conditions. The composite applications address more complex business scenarios by combining discrete functional applications or service modules and encompass business processes that typically cross departmental silos synchronizing in the process varied information for effective functioning of the enterprise. BPM, Portal applications – early entrants of such frameworks inside enterprises and these core technologies will continue to act as the forerunners for adoption of composite applications. Application as a concept neatly disappears with SOA. I also see that composites can bring about a huge change in the setup of the ecosystem – we can see leading edge applications coming in from mega vendors & startups alike. Product engineering too shall also see a positive influence - facilitating development of software in modular pieces, enabling rapid delivery of new functionalities. Several independent developers could start writing specialized programs that plug into the composite apps framework. Professional services, sales network can begin to take a different shape far different from the vertically integrated model that we see today. The partnership between the product vendors and system integrators shall also change – the emerging equation may put more demands on the integrators and force product vendors to spend more on developing vertical solutions. Composites will potentially change the landscape –of enterprise market and the dominant business model (form & structure included) of the enterprise software industry will change as well. Please read the full note here.