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The Rise and Fall of Enterprise Software
W.H. Janeway, Ph.D
Cambridge University/Warburg Pincus
Business of Software Conference
22 May, 2018
Once upon a time…
“Through the 1990s, as exemplified by VERITAS and BEA, there was no
better place for VCs to invest in the broad world of information
technology than enterprise software. In retrospect, several factors
contributed to the historic attractiveness of enterprise software as an
arena for entrepreneurial investment.”
(Janeway, Doing Capitalism, p. 144)
Profiles of Two Bubbles
New York: 1929 and 1999
3
Standard Platforms
“A succession of standard platforms established a stable target
environment: first, IBM’s System 360 architecture; then, the canonical
client–server architecture of smart Windows clients interacting with
relational database servers running UNIX; and on to the fully
distributed, web architecture with the application server written in Java
at its core.”
Declining Cost of Hardware
“A second factor was the persistent and exponential decline in
hardware costs, enabling value to migrate upward through higher and
higher levels of abstraction into software, broadening the scope for
algorithms to capture and automate a seemingly limitless range of
business processes, from the first generation of general ledgers to
comprehensive enterprise resource planning (ERP) systems to
specialized processes unique to particular subsectors like banking or
logistics.”
Smart Customers
“Third, an external and internal ecosystem of customer-supporting
systems management and application development resources evolved
to build and deploy software to automate customer-specific processes:
systems integration firms became less important as corporate IT
departments matured with a vastly increased supply of software
engineers.
“So enterprise application and enterprise infrastructure software
companies co-evolved in symbiosis, the latter enabling the frontier for
standard applications to move out continuously while rendering it
easier for corporate customers to build their own non-standard
applications.”
The Revenue Model: THEN
“But no factor was more important from an investment standpoint
than the unique revenue model with which the enterprise software
industry was endowed by a benign providence: the “perpetual,
nonexclusive license” to run purchased software, bundled with an
annual maintenance fee typically priced at 20 percent of the license as
compensation for the vendor ensuring that the software would
continue to run as the operating environment evolved.”
The Revenue Model: NOW
“Salesforce.com was launched in 1999, just as the Bubble reached its apogee, with
a novel approach: Software as a Service (“SaaS”) transformed the customer’s
purchase decision from a capital investment to a recurring operating expense. A
product sale now generated cash flow to be collected in the future….
“For the vendor it eliminated the high-risk, lumpy quarterly license challenge (and
with it the temptation to cheat by holding the books open for the license sale that
would make the quarter). But, while the SaaS model made it radically easier to
sell software and to forecast reported revenues as contractual payments were
made over time, it came with a cost. Salesforce.com was the first enterprise
software company characterized by sound operating execution to consume more
than $100 million of funding to reach positive cash flow. Now the poor start-up
was in the role of financing the rich customer.”
8
State of the Software Industry Today:
Open Source and Cloud
“The maturation of the open source software movement complemented by the adoption of “agile,’
iterative development methodologies, radically less risky than legacy linear ‘waterfall’ methods but
requiring a fundamentally different mindset on the part both of developers and managers;
“The emergence of “the Cloud” as an abstracted computing environment for development and
deployment….
“…[T]ogether, [these] mean that the absolute and, even more, the risk-adjusted cost of launching a
new offering has been radically reduced. With software tools available for free and computing
resources available for rent, the upfront cost of building enterprise-class software has declined by
a decimal order of magnitude….And agile development of programs that have been broken down
into discrete deliverables radically increases the likelihood that what is being coded will actually
work and satisfy the target customer’s expectations. Moreover, cloud-hosted business software
requires minimum friction in deployment and lends itself to the delivery of rapid bug-fixes,
performance improvements and incremental functionality without the technical and marketing risks
to customers and vendors alike of major, discrete releases delivered after intervals of a year or
more. Above all, of benefit to suppliers and users alike, only one version of the software exists at
any time.”
9
Bill Janeway (Partner & Senior Advisor, Warburg Pincus) - The Rise & Fall Of Enterprise Software
Amazon Web Services: Machine Learning
Microsoft Azure: AI and Machine Learning
Google Cloud: AI
The State of the Software Industry Today:
The Entrepreneurial Challenge
“[T]he cost of building a business…has hardly declined at all. So a Darwinian explosion of “hopeful
monsters” is followed by the intensely competitive process of market selection applied through a
much longer ramp to positive cash flow. While those who do get to scale enjoy an extremely
attractive cash flow profile, the time and money needed to reach scale can be daunting. The
emergence of Amazon and Microsoft, with Google following…[means
that]…[f]unctionality…traditionally sold to the enterprise customer is now delivered as a component
of an increasingly comprehensive and progressively “thicker” bundle: “Infrastructure as a Service”
becomes “Platform as a Service”…. The Cloud providers are preempting market space that was once
served by independent infrastructure software companies.
“[And] within the enterprise client there is no longer a capable IT customer charged with
delivering application solutions to the business units ….BEA sold an application platform to the
enterprise IT customer who in turn would deliver an array of functional systems to complement or
extend the more or less packaged, standard enterprise applications. No more.”
14
The Cloud is Becoming the Platform
“The disappearance of the internal enterprise IT department as the
customer for software means, in the first instance, that attempting to
sell a new general-purpose “platform” to the enterprise – emulating
the enormous success of Oracle in the market for database software or
BEA in the market for application server software – is quixotic. There is
nobody home when the salesman calls. Instead, the technology must
be fashioned into a “solution” relevant for and appealing to the distinct
business unit customer. Now the problem is that there are too many
homes on whose doors to knock.”
Consumerization of IT
“The evolution of the competitive environment is accelerating across
industries with the “consumerization” of IT: “bring your own device” to
work and with it the expectation that interactions both with and within
the enterprise will be as seamless and transparent as with Facebook or
Instagram. The enterprise “customer” is now fragmented into multiple
customers: the disparate business units where the need and budget are
to be found . . . but not the technical capacity to deploy or manage
complex code. And the cost of building a channel to those distinctive
and distributed customers is typically greater than to the centralized IT
department, even as the cash flow generated from each successful sale
has been spread out over time.”
Decline of US IPO Market
“Finally, given that SaaS-driven start-ups need at least five times as
much risk equity to reach positive cash flow, the post-bubble decline in
the US IPO market has differentially affected enterprise software
ventures. When the SaaS model was new and its business appeal was
apparent, a few new companies managed to execute IPOs early and
fund their growth to positive cash flow with cheap public equity. But
enterprise software companies address market spaces that are trivial in
scale compared to the digital giants, who target markets of consumers
numbered in the billions, which today dominate the consciousness of
investors.”
BUT: the Unicorn Bubble?
The State of the Software Industry Today:
The Entrepreneurial Risks
“Given that SaaS-driven start-ups need five times as much risk equity to reach
positive cash flow, the post-Bubble decline in the U.S. IPO market has differentially
affected enterprise software ventures….
• Technology Risk: “When I plug it in, will it light up?”
• Market Risk: “Who will pay to buy it if it does work?”
• Financing Risk: “Will the capital be there to fund the venture to positive cash
flow?”
• Business Risk: “Will the team manage the transition from start-up to sustainable
business, especially given the challenge of building an effective channel to the
market?”
19
The State of the Software Industry Today:
From IPO to “Do We Sell Now”
“Given the much extended path to self-sustaining positive cash
flow from operations, the responsible entrepreneur and VC are
charged with asking themselves the same question at each step
along the way:
• The technology does “light up” – do we sell now?
• We have three credible customers who will testify that they
have bought our offering and will buy more – do we sell now?
• We have access to another round of capital but it will be
dilutive and Business Risk looms – do we sell now?
For venture investors in this domain, the default definition of
success has come to be represented by a timely trade sale
rather than by a successful IPO and subsequent exit by
distribution or sale of shares into a vibrant public market. 20

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Bill Janeway (Partner & Senior Advisor, Warburg Pincus) - The Rise & Fall Of Enterprise Software

  • 1. The Rise and Fall of Enterprise Software W.H. Janeway, Ph.D Cambridge University/Warburg Pincus Business of Software Conference 22 May, 2018
  • 2. Once upon a time… “Through the 1990s, as exemplified by VERITAS and BEA, there was no better place for VCs to invest in the broad world of information technology than enterprise software. In retrospect, several factors contributed to the historic attractiveness of enterprise software as an arena for entrepreneurial investment.” (Janeway, Doing Capitalism, p. 144)
  • 3. Profiles of Two Bubbles New York: 1929 and 1999 3
  • 4. Standard Platforms “A succession of standard platforms established a stable target environment: first, IBM’s System 360 architecture; then, the canonical client–server architecture of smart Windows clients interacting with relational database servers running UNIX; and on to the fully distributed, web architecture with the application server written in Java at its core.”
  • 5. Declining Cost of Hardware “A second factor was the persistent and exponential decline in hardware costs, enabling value to migrate upward through higher and higher levels of abstraction into software, broadening the scope for algorithms to capture and automate a seemingly limitless range of business processes, from the first generation of general ledgers to comprehensive enterprise resource planning (ERP) systems to specialized processes unique to particular subsectors like banking or logistics.”
  • 6. Smart Customers “Third, an external and internal ecosystem of customer-supporting systems management and application development resources evolved to build and deploy software to automate customer-specific processes: systems integration firms became less important as corporate IT departments matured with a vastly increased supply of software engineers. “So enterprise application and enterprise infrastructure software companies co-evolved in symbiosis, the latter enabling the frontier for standard applications to move out continuously while rendering it easier for corporate customers to build their own non-standard applications.”
  • 7. The Revenue Model: THEN “But no factor was more important from an investment standpoint than the unique revenue model with which the enterprise software industry was endowed by a benign providence: the “perpetual, nonexclusive license” to run purchased software, bundled with an annual maintenance fee typically priced at 20 percent of the license as compensation for the vendor ensuring that the software would continue to run as the operating environment evolved.”
  • 8. The Revenue Model: NOW “Salesforce.com was launched in 1999, just as the Bubble reached its apogee, with a novel approach: Software as a Service (“SaaS”) transformed the customer’s purchase decision from a capital investment to a recurring operating expense. A product sale now generated cash flow to be collected in the future…. “For the vendor it eliminated the high-risk, lumpy quarterly license challenge (and with it the temptation to cheat by holding the books open for the license sale that would make the quarter). But, while the SaaS model made it radically easier to sell software and to forecast reported revenues as contractual payments were made over time, it came with a cost. Salesforce.com was the first enterprise software company characterized by sound operating execution to consume more than $100 million of funding to reach positive cash flow. Now the poor start-up was in the role of financing the rich customer.” 8
  • 9. State of the Software Industry Today: Open Source and Cloud “The maturation of the open source software movement complemented by the adoption of “agile,’ iterative development methodologies, radically less risky than legacy linear ‘waterfall’ methods but requiring a fundamentally different mindset on the part both of developers and managers; “The emergence of “the Cloud” as an abstracted computing environment for development and deployment…. “…[T]ogether, [these] mean that the absolute and, even more, the risk-adjusted cost of launching a new offering has been radically reduced. With software tools available for free and computing resources available for rent, the upfront cost of building enterprise-class software has declined by a decimal order of magnitude….And agile development of programs that have been broken down into discrete deliverables radically increases the likelihood that what is being coded will actually work and satisfy the target customer’s expectations. Moreover, cloud-hosted business software requires minimum friction in deployment and lends itself to the delivery of rapid bug-fixes, performance improvements and incremental functionality without the technical and marketing risks to customers and vendors alike of major, discrete releases delivered after intervals of a year or more. Above all, of benefit to suppliers and users alike, only one version of the software exists at any time.” 9
  • 11. Amazon Web Services: Machine Learning
  • 12. Microsoft Azure: AI and Machine Learning
  • 14. The State of the Software Industry Today: The Entrepreneurial Challenge “[T]he cost of building a business…has hardly declined at all. So a Darwinian explosion of “hopeful monsters” is followed by the intensely competitive process of market selection applied through a much longer ramp to positive cash flow. While those who do get to scale enjoy an extremely attractive cash flow profile, the time and money needed to reach scale can be daunting. The emergence of Amazon and Microsoft, with Google following…[means that]…[f]unctionality…traditionally sold to the enterprise customer is now delivered as a component of an increasingly comprehensive and progressively “thicker” bundle: “Infrastructure as a Service” becomes “Platform as a Service”…. The Cloud providers are preempting market space that was once served by independent infrastructure software companies. “[And] within the enterprise client there is no longer a capable IT customer charged with delivering application solutions to the business units ….BEA sold an application platform to the enterprise IT customer who in turn would deliver an array of functional systems to complement or extend the more or less packaged, standard enterprise applications. No more.” 14
  • 15. The Cloud is Becoming the Platform “The disappearance of the internal enterprise IT department as the customer for software means, in the first instance, that attempting to sell a new general-purpose “platform” to the enterprise – emulating the enormous success of Oracle in the market for database software or BEA in the market for application server software – is quixotic. There is nobody home when the salesman calls. Instead, the technology must be fashioned into a “solution” relevant for and appealing to the distinct business unit customer. Now the problem is that there are too many homes on whose doors to knock.”
  • 16. Consumerization of IT “The evolution of the competitive environment is accelerating across industries with the “consumerization” of IT: “bring your own device” to work and with it the expectation that interactions both with and within the enterprise will be as seamless and transparent as with Facebook or Instagram. The enterprise “customer” is now fragmented into multiple customers: the disparate business units where the need and budget are to be found . . . but not the technical capacity to deploy or manage complex code. And the cost of building a channel to those distinctive and distributed customers is typically greater than to the centralized IT department, even as the cash flow generated from each successful sale has been spread out over time.”
  • 17. Decline of US IPO Market “Finally, given that SaaS-driven start-ups need at least five times as much risk equity to reach positive cash flow, the post-bubble decline in the US IPO market has differentially affected enterprise software ventures. When the SaaS model was new and its business appeal was apparent, a few new companies managed to execute IPOs early and fund their growth to positive cash flow with cheap public equity. But enterprise software companies address market spaces that are trivial in scale compared to the digital giants, who target markets of consumers numbered in the billions, which today dominate the consciousness of investors.”
  • 18. BUT: the Unicorn Bubble?
  • 19. The State of the Software Industry Today: The Entrepreneurial Risks “Given that SaaS-driven start-ups need five times as much risk equity to reach positive cash flow, the post-Bubble decline in the U.S. IPO market has differentially affected enterprise software ventures…. • Technology Risk: “When I plug it in, will it light up?” • Market Risk: “Who will pay to buy it if it does work?” • Financing Risk: “Will the capital be there to fund the venture to positive cash flow?” • Business Risk: “Will the team manage the transition from start-up to sustainable business, especially given the challenge of building an effective channel to the market?” 19
  • 20. The State of the Software Industry Today: From IPO to “Do We Sell Now” “Given the much extended path to self-sustaining positive cash flow from operations, the responsible entrepreneur and VC are charged with asking themselves the same question at each step along the way: • The technology does “light up” – do we sell now? • We have three credible customers who will testify that they have bought our offering and will buy more – do we sell now? • We have access to another round of capital but it will be dilutive and Business Risk looms – do we sell now? For venture investors in this domain, the default definition of success has come to be represented by a timely trade sale rather than by a successful IPO and subsequent exit by distribution or sale of shares into a vibrant public market. 20