Posted by andy@assembla.com Sat, 15 Apr 2006 13:22:00 GMT

Less than a year ago I wrote an article titled “Is the Enterprise Software Licensing Business Dying�. It was originally posted on IT Managers Journal, but it got picked up by Slashdot and various bloggers and podcasters. It pointed out that enterprise buyers had stopped buying software licenses – the mainstay of the software industry. This caused years of misery for software professionals, years during which software was a bad business to be in. But the light at the end of the tunnel was apparent even then, in the form of new packaging and revenue models. Faster than I imagined, the prospects for the software industry have been transformed. We now have a wonderful alignment of good fundamentals – increasing demand, declining costs, and rapid innovation.

Any industry with increasing demand, declining costs, and rapid innovation has got to be a great place to invest time and money.

INCREASING DEMAND

I recently did some research into market size for Assembla’s business plan, and what I was interested in was “on-demand softwareâ€? or “software as a serviceâ€? – traditional enterprise applications packaged as subscription online service. Almost every company that I looked at was growing at more that 50% per year. This accounted for more than $3B in revenue. So while the overall enterprise software market may be flat, there are big categories inside it where business is better than ever – better than in the 90’s boom. Revenue is actually growing faster, from a bigger base. That’s the macro view. The micro view is that globalization has doubled the pool of available programmers in five years, and we’re already running out of them.

DECLINING COSTS

At a presentation about social software at Harvard Business School, one of the questions the presenter asked was “why now?� Why are we seeing big, free social wikis, networking sites, blogging sites, classified markets, spaces? Why now and not 5 years ago? His answer was: because the basic costs are a lot lower now. The servers, server software, and network bandwidth are cheap enough to give away. That’s why people can support bigger communities. That’s why businesses give away free online services instead of hiring salespeople. It’s cheaper.

The cost of making the applications to run on this platform has declined even more. I estimate that my cost of building and launching an application is about 25% of what it was six years ago. Labor is much less expensive because we now shop globally. The productivity of that labor rises continuously as we adopt better tools and processes. We have more open source components to draw on, which has a big impact because studies show that code re-use is the single biggest contributor to increasing developer productivity.

Inside established software companies, lower costs mean higher margins. The margins rise faster if companies take a pro-active approach to moving customers to lower cost software as a service platforms – or as a friend of mine dubs it, “lift, shift, and maximize�. Software investors have some challenges and some opportunities. One opportunity is to look at software as a cash producing business, doing LBO’s, giving up on growth, and paying down debt and dividends with the cash not spent on new sales, marketing, and launch activities. A new generation of entrepreneurs is figuring that out. A challenge for software VC’s is to figure out how to participate in a market with shrinking deal sizes. In theory, that means they can do more deals, and give another bump to innovation.

RAPID INNOVATION

We’re in the middle of a rapid burst of innovation that I call Wetware. Wetware is open source, globalization, Web 2.0, and user-generated-content. It’s the smart node in the stupid network. It’s people working together. Inevitably, they will accomplish great things.

Wetware is a relatively obscure burst of innovation because it is new. We used to follow Hardware. When computers first became big business, we measured innovation by the rate of new hardware introduction. Software was an obscure component. Then came software. We created Moore’s law for hardware, and software became a more interesting business. We followed platform launches and browser wars and client server and software as a service. We’re still in that phase. Here comes Wetware. We can’t measure units of human innovation, and we don’t measure the speed of organizational reconfiguration. But we should, and we will. It’s coming fast.

Max Planck said “science advances one funeral at a time,� and so it is with this innovation. Today’s teenagers live their life in global networks, and spend a lot less time hanging out in parking lots than my contemporaries did. They’re going to take over the workforce, one retirement at a time.