Software is Evolving Out of the Tar Pits of Consolidation

This piece was originally published on Venture Beat (8/3/2013)

Massive consolidation of the software industry seemed inescapable. This trend is reversing with the rapid development of best-of-breed companies that can leverage the advantages of the cloud.  Software-as-a-Service (SaaS) leads to a richer ecosystem, where focus trumps scale and where independent companies can grow and thrive.

After consuming nearly the entire ecosystem of client-server software providers, the dominant business software companies have turned their attention to SaaS.  Within the last year, the big incumbents have made multiple, billion-dollar SaaS acquisitions, including SuccessFactors, Ariba, Eloqua, Taleo and Right Now.  These acquisitions include some of the pioneers of SaaS, market leaders that grew from startups to independent public companies.

With the flurry of recent large SaaS acquisitions, you might wonder if the era of independent SaaS companies will be a footnote in the annals of software. Are we witnessing the continued consolidation of business software? Will the giants keep getting bigger, gobbling up any prey large enough to satisfy their voracious appetites?

The driver behind the consolidation of client-server software was simple: Customers were drowning in the costs of the huge integration projects needed to link together all the stovepipe applications they needed.

Integration costs were five to 10 times the cost of the software itself.  The largest providers saw a grand opportunity: buy adjacent applications, integrate them and sell them as a suite. Customers had limited choice, but were happy that someone was supporting their mission critical applications. They had only one throat to choke and could avoid the uncertainty and cost of a massive integration project.

Because of the integration burden, software buying power was concentrated within IT departments.  IT buyers were the “king makers of software,” who were wined and dined by software sales executives.  The biggest vendors controlled access to CIOs with their hefty sales forces. Few small companies could match their reach.

SaaS: A better breed of software

Today, the prevailing winds have changed.  Luckily, evolution, i.e. startups, favors brains over brawn and nothing is smarter than the intelligence of the cloud, in that it finally gives companies access to highly affordable, on-demand and always-updated software. There are limits to the advantages of scale, and the landscape is shifting from bloated dinosaurs to a flourishing ecosystem of smaller, nimbler and diverse species of software companies. The nature of the cloud has made earlier software challenges almost obsolete.  Integration is no longer the hurdle that it once was.

The open nature of cloud architectures makes integrating disparate applications much more manageable.   Modern SaaS companies make their APIs readily available, encouraging other SaaS vendors to link up across the web. Integration work is done once and then serves all customers.  Lightweight integration-as-a-service providers, such as SnapLogic, MuleSoft, Jitterbit and others offer standard connectors that serve the most common integration requirements.

With cloud integration, independent SaaS category leaders such as Marketo, Cornerstone On Demand and Intacct offer the advantages of a suite with simple integrations to other leading SaaS applications.  Pre-packaged suites from a single vendor are less compelling when companies can assemble their own by picking and choosing from best-in-category applications that fit their business processes. The “patchwork environment” becomes a competitive advantage when it is simple, flexible and optimized for the unique size and configuration of each customer.

For instance, The Knowland Group, a high growth provider of analytics to the hospitality industry based in Washington DC, built its own best-of-breed cloud financial suite optimized for its specific business needs. The company connected Intacct’s financial management and accounting systems to a set of top-tier point solutions: Adaptive Planning for budgeting, Sererra’s fixed assets and collections applications, ADP’s human resources system and TPro’s credit card processing application.

The cloud also changes the dynamics of software purchasing, as it is no longer controlled by a single department.  Today, each critical function in a business buys software, which allows a best-of-breed vendor to outsell a giant company by specializing on the needs of a particular buyer or business process. Online sales and marketing techniques allow small companies to target distinct roles in the business without a massive sales force and is more effective and dramatically cheaper than in-person meetings and calls; small vendors can outsell a huge, distributed sales force.

We are starting to see the emergence of SaaS suites, a logical choice for some companies that can compromise functionality.  These offerings lack the significant cost advantages of earlier suites and will not dominate the application landscape. Newly powerful Salesforce.com has joined the SaaS buying frenzy, spending billions of dollars on Radian6, Buddy Media and ExactTarget, in an effort to build its own SaaS sales and marketing suite. The company is even partnering with Oracle to integrate their clouds. However, focused SaaS solutions are continuing to thrive, and best-of-breed applications are the right choice for most companies:  IT directors are giving up the onerous tasks of software integration and infrastructure management and seeking the flexibility of choosing the best tools for every job or department, which is what the business has always desired.

The new software ecosystem resembles the real world we live in today, not the barren landscape of the Dinosaur Age.  The dynamic software ecosystem encourages evolution, and size is no longer the dominant characteristic of survival.  Startups have learned to fly high above the entrenched mammoths, selling into opportunities not visible before.  Investors are eager to fund entrepreneurs with innovative, low cost applications and cheaper routes to market.  We have truly evolved to a new era, where we can thrive by developing our wings or our fins or our brains.

Brian Jacobs is a founder and general partner at Emergence Capital Partners, a leading Silicon Valley venture capital firm focused on enterprise cloud businesses.  He currently sits on the boards of Intacct, Hightail, Bill.com, InsideView, Janrain, and Donuts.