According to Mark Benioff, the founder of Salesforce.com, the future of software is no software. It's a catchy slogan (Salesforce.com's phone number is 1-800-NO-SOFTWARE) but sticking to such a statement might make Benioff a modern day Henry Ford (who once declared that customers can have any color as long as it is black).
Most of us have already experienced the future of software - and it looks like iTunes, not Salesforce.com (who doesn't have an iPod these days?). But before explaining, let's do a quick review of how we got here.
As the technology industry evolved, it has served wider and wider audiences. Decades ago, it was engineers making products for each other - like HP's engineers making products for the guy sitting at the next bench. The next wave was driven by businesses, culminating in Y2K (even Netscape, the company which helped kick-start the whole Internet revolution, made most of its money from businesses). In the latest wave, consumers are driving the tech industry. When Benioff started Salesforce.com, his inspiration was Amazon.com and eBay not Oracle or SAP.
However, over the past few years, we've seen hackers and entrepreneurs pushing exciting new frontiers and the more I think about it, the software industry will be taking its cues from iTunes, not Salesforce.com.
As Yogi Berra says, it's deja vu all over again. At first, we started with big servers connected to dumb terminals, then we had client-server computing, and then web based computing (i.e. back to thin clients). Now it's back to fatter clients (again).
Well, it depends on the application. Hackers are just too creative to be tied down with the "no software" model. Clever hackers working on Google Maps blew away Mapquest using AJAX which makes supporting different browsers and operating systems a whole lot more complicated. But the increased trouble is worth it, from a user's perspective.
However, this is just the first step. We have been seeing an incredible array of new plug-ins, widgets, toobars, and applications which require new downloads and installations. The real developers are back - over-paid script editors can step aside. Companies with talented developers will have serious competitive advantages over Web 2.0 companies that are long on hype but short on technology.
With broadband, multi-megabyte pieces of software can be easily downloaded, installed, and updated and, if done right, they will drive faster adoption and more stickiness. For example, in Korea, PandoraTV (one of our portfolio companies) started by providing a YouTube-like video service. They are now also connecting to proprietary client software on PCs as well as cell phones to millions of users. They are quickly moving up the traffic rankings and were named company of the year (the founder was also named entrepreneur of the year by the Korean tech press).
But wait, there's more - much more!
The real inspiration for this article was not "more software" vs. "no software", but new business models being developed by clever entrepreneurs. It's the combination of hacker creativity AND business model innovation which will revolutionize the software industry.
In the past, high prices for software were required to cover sales and distribution costs. It was like the old door-to-door salesmen selling encyclopedias. (High margins for encyclopedias were needed to cover sales costs, not the marginal costs of updating and printing encyclopedias - which, like software, is relatively low).
Salesforce.com's on-demand, recurring revenue model is better than the outdated perpetual, per-CPU licensing models of SAP and Oracle. However, most SaaS (software-as-a-service) companies are still stuck with per-user or per-seat licensing models which are bound to get blown away by new, more innovative (and disruptive) business models.
To explain the second half of the new software revolution (the business model revolution), let's go back to the iTunes example.
iTunes is free.
The concept of free software is nothing new to proponents of open source software - but the new software revolution has little to do with it. We will see hundreds of new "free" software companies that do not participate in the open source community. The way that Apple makes money from iTunes is through the use of its software and the ecosystem built around it. To date, Apple has sold over 2 billion songs. Not bad considering you can still download those songs from P2P networks for free. They've also sold 50mm TV shows and, within the first few months of launch, they sold over a million movies even though only 100 movies were available. iPods are great (the 100 millionth unit will be sold this year) but what gets customers hooked is the software.
Pulling another example out of Asia, there are dozens of game developers that make millions (sometimes hundreds of millions) of dollars giving away free Internet games. What they charge for are "virtual goods" sold to millions of addicted users. Virtual goods include virtual clothing, music or game elements (such as an upgraded car in a racing game) which help improve game play or one's chances of beating competition.
Buy the song, not the album.
The biggest winners will figure out how to make money through smaller and smaller increments of value. Google's model of charging pennies per click is a good example. The bottom line is pricing must be low (i.e. not vulnerable to disruption) and it must be more directly aligned with value. A great example is Vertical Response, a bootstrapped and profitable email marketing software company, which charges based on the number of emails sent. An enterprise can have an unlimited number of users - the price is the same. Their model is more rational - and highly disruptive to companies selling software the old way.
Content is king.
In the old days, maybe software was more product oriented. For example, tools, operating systems, Word or Excel didn't include knowledge or content - users supplied it. Then as applications became more sophisticated they possessed embedded knowledge or "domain expertise" (examples include QuickBooks, SAP, or Salesforce.com). iTunes takes it a step further.
In the future, software's value may be so linked to content (and data), that it won't be clear which is more valuable - the software or the content? Going forward, software companies will look more like content companies and content companies will have to develop more software (or partner with software companies) to monetize their proprietary content more effectively. iTunes and Google are good examples. So is Xignite, one of our portfolio companies, which provides tools and Web services that stream financial data into applications and websites (they were also bootstrapped and profitable without VC funding).
Xignite doesn't just provide tools for developers. They offer content from their own databases as well as serve as a conduit (and new distribution channel) for a growing list of content partners. You can think of them as a next generation Bloomberg. However, unlike Bloomberg, most of their customers are not from the financial services industry (which is yet another sign of disruption - new users who could not or would not pay for Bloomberg terminals are becoming customers).
Another example from our portfolio is DemandTec, an on-demand software company which analyzes POS (point of sale) data from retailers and makes recommendations on pricing and promotions of products. They combine knowledge gleaned from transactions with market research data (from partners like Nielson) to provide unique insights. They also connect networks of retailers (like Safeway) and manufacturers (like P&G) to solve cross-organizational issues like the thorny out-of-stock problem on retail shelves (DemandTec's massive server farms analyze over $250 billion dollars of transactions from thousands of stores per year on behalf of their customers).
Get better faster.
The next generation of software connects developers directly with customers (not just through PCs but through all sorts of devices and gadgets). There will be no such thing as shelf-ware. If the software doesn't deliver value, software and service providers won't get paid (based on new pricing models). If new software does deliver value, it will be used and usage data will prove to be very valuable to developers. They can do market research everyday or every hour. Doing A/B testing is common practice at companies like Amazon.com and Google. Software companies that follow their lead will get better faster than their competition.
Over time, the usage data itself can become killer content. One of our companies, Instill, started by enabling restaurants to buy supplies online. Now they also make millions of dollars selling market research data (about the food services vertical) to manufacturers such as Coca-Cola. Likewise, if Apple stays alert, they should be able to monetize the data collected from the iTunes network.
I do have to give some credit to Mark Benioff in that he is experimenting with new business models (i.e. they have a 10% revenue sharing program on App Exchange). But Salesforce.com's problem is that they are addicted to a core-business model which is vulnerable to disruption. Most software models are subject to disruption because marginal costs are essentially zero. (I have already seen some start-ups switch away from Salesforce.com to cheaper alternatives). That is why examples like iTunes, Google, and the other companies I've mentioned (that demonstrate new ways of monetizing software) are so interesting.
Ironically, Salesforce.com is a victim of its own success. They can't change their core business model because their whopping $4.5 billion dollar market cap depends on it. This is the trap (and treadmill) that Netscape fell into after their hot, hot, hot IPO. They grew spectacularly (faster to $100 million than any software company since Lotus, which grew faster than even Microsoft). But they were hooked to a business model vulnerable to disruption (when Microsoft decided to give away browsers). If Netscape had been a bit more patient and kept their burn rate under control, rather than ramping up a loser model, they might have been able to figure out other ways to monetize - they could have been a Yahoo or Google (a decade ago, Netscape had more traffic than any website on the planet).
For entrepreneurs as well as venture capitalists, this is all great news. We don't have to be addicted to old business models. We can experiment and try new ones and we can afford to not only survive but thrive on much smaller revenue streams (if we keep burn rates low!). The Salesforce.coms of the world will have a very hard time switching models just as the companies before them found it difficult to switch away from their entrenched business models and practices.
In summary, as we evaluate new software investments, our firm looks for the following characteristics:
- Easy to use (the bar is getting set much higher, must deliver compelling user experience, not fancy unused features. Solve real problems - duh!)
- Easy to try (if download is required, should be easy to install and update)
- Easy to buy (transparent pricing, terms and conditions. No hassle purchase - self-service option, no negotiation necessary)
- Business model innovation (monetization in smaller increments, through actual use and value. No shelf-ware!)
- The melding of software, content, and service (usage data can also be very valuable)
- Increasing efficiencies and value through network effects (scale leading to snowballing competitive advantages)