6 reasons enterprise software companies are dying.

What was once a $1 million deal is now a $200K deal. Buyers are now looking for value first. Whereas before the sales decisions were made by CIOs or the top tech position, more and more they're being handled by the business unit GMs. Their focus is on the business side, how much will it cost, how much will it save, what resources do we need to use the software etc. Add on top of that the fact that businesses have already automated a significant part of their operations and you get a dried up marketplace.

Buyers are going for software as a service (SaaS, "pay as you go") and are focused on hosted service. This is good for them because it switches much of the risk back to the vendor, and switches the costs of server upgrades, hosting and maintaining back to the vendor. Salesforce.com and Rightnow.com have been very successful in riding on this trend. I also heard the VP of Ops of WebEx (prior to the Cisco acquisition) state that their biggest asset was their hosting infrastructure and that it took a lot of effort to get it right. He also went on to state that given their pricing model where they (Webex) incurred most of the upfront risk (given the cost of customer acquisition), they absolutely had to nail the hosting infrastructure issues.

Here's a secret of the enterprise software business. You demonstrate high double digit revenue growth (that's why you need those million dollar sales guys) for the first few years with a 90% gross margin and then you are ready for an exit. The investors and the executives make a boat-load of money and everybody is happy (except the software guys pulling all those all-nighters). Note that phrases like "ROI" and "customer value" were not left out of this equation by accident. So these companies bail (err... I mean exit) before someone finds out that the stuff doesn't really work. If you miss this window for an exit, you will end up in a death-spiral where these companies will chase their own tails in getting their software to deliver some real-value.

With the average deal size down for the vendor (lower revenues) and the cost of hosting software switched to the vendor (higher expenses), the net margins & PE ratios are low. Additionally these companies have to now demonstrate some real value (gasp!) to their customers before any hope of an exit. Software companies' valuations today make them look like traditional brick-and-mortar business and so it is harder to make a quick buck. This has scared away most of the VC crowd who typically like a quick exit.

Plain and simple, you now need to be a big player to compete in the market. The Big Guns (Oracle/Microsoft/IBM/Computer Associates/SAP), after snatching up and/or killing off any competition, now have such a large sales infrastructure that no new company could hope to compete.  Oracle alone has made over $20 B in acquisitions (whatever happened to Craig Conway :-) ) in the last few years. Each of these companies has a dedicated sales rep who camps out in each of the large enterprise accounts. A sales team is too expensive to build and the sales cycle is too long to be up and selling quickly enough. Also buyers perceive purchases from the Big Guns as another form of risk-aversion.

For over a couple of decades, software companies got away with a hit-and-run strategy where they would close large multi-million dollar deals that didn't deliver any real value. Most of this software never even got deployed properly while the sales crew got rich on commissions and the executives got rich on stock options! The jig is up, as they say.  Nobody is going to pay a big lump sum to one company (and pay repeatedly for licensing), then pay monthly fees to a consulting company to implement the software. Buyers are very savvy now and want to see value up-front. They also want the vendors to share a big chunk of the risk.

While the ASP (average selling price) has dropped to $200K, the length of the sales cycle continues to be 9-12 months. Just because the ASP has declined, it doesn't mean that the bureaucratic decision making process within enterprises has disappeared. With the heavy burden of a direct sales team, this presents an interesting challenge for any CEO. You can't really scale the business rapidly in a profitable way and you will end up buying the business.

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