Software is eating itself

The software paradox – the rise and fall of the commercial software market

Steven O'Grady
Rise and fall image via Shutterstock

Software is more important than ever today and yet its commercial value is steadily declining. Microsoft, for instance, has seen its gross margins decrease for a decade, while startups and corporations alike are distributing free software that would have been worth millions a few years ago. Welcome to the software paradox.

This is an excerpt from The Software Paradox by Steven O’Grady, an O’Reilly publication available here.

The past few decades have, in general, been good ones for software. Once an afterthought, software became not just a means to an end but an end in and of itself. Trillions of dollars of wealth were created by software vendors and the markets they created and owned. The ascension of software was perhaps best described in a now-famous Wall Street Journal op-ed by Marc Andreessen on August 20, 2011, “Why Software Is Eating the World.” In the piece, the man whose fortune was made in part by the $2.1 billion IPO of the software company Netscape described the present state as the following:

More and more major businesses and industries are being run on software and delivered as online services—from movies to agriculture to national defense. Many of the winners are Silicon Valley-style entrepreneurial technology companies that are invading and overturning established industry structures. Over the next 10 years, I expect many more industries to be disrupted by software, with new world-beating Silicon Valley companies doing the disruption in more cases than not. — MARC ANDREESSEN

By the time Andreessen wrote those words, there were few who would disagree with the core thesis. Those who would were most likely to be employed by industries in the process of being actively disrupted by software. Software was, and still is, the new reality for most industries. Much as Amazon is now more appropriately described as a technology company than a retailer, so too are an increasing number of businesses in an ever-widening number of industries.

A curious thing was happening while software was hungrily consuming the world, however. Even as it was becoming more and more vital and disruptive, software’s commercial value was declining. Software that would have once generated billions in revenue per quarter is increasingly made available for free. Companies that once battled each other and struggled to differentiate similar proprietary products now collaborate with each other on a common platform, competing on implementations and service. Developers that solve interesting problems with software see more benefit than cost to making it available for free than attempting to charge for it.

This is the Software Paradox: the most powerful disruptor we have ever seen and the creator of multibillion-dollar net new markets is being commercially devalued, daily. Just as the technology industry was firmly convinced in 1981 that the money was in hardware, not software, the industry today is largely built on the assumption that the real revenue is in software. The evidence, however, suggests that software is less valuable—in the commercial sense—than many are aware, and becoming less so by the day. And that trend is, in all likelihood, not reversible. The question facing an entire industry, then, is what next?

The software paradox

According to Bloomberg Businessweek, since the year 2000, an information technology company was counted among the world’s five largest businesses every year but two, 2007 and 2008. Microsoft was by far the most successful, serving as the industry’s representative on that list eight years out of the decade beginning in 2001. It hasn’t made the list since 2010, however, even as 2013’s list included both Apple and Google. This changing of the guard perfectly symbolizes the transition currently underway in the industry, one leading away from software as revenue and toward revenue using software.

It is a paradox that the economic value of software is falling even as its strategic value rises, and paradoxes are by definition challenging to accept. But look no further than Microsoft’s absence for confirmation of the risks. Even as the business continues to print money with its two most popular software franchises, it is retooling itself to compete in a very different landscape, and its new leadership reflects that.

Because the software industry has generated so much wealth historically, because it continues to today, and because software really is eating the world, it can be difficult to accept the idea that its intrinsic commercial value is in decline. But the evidence is both broad and conclusive. When large, successful incumbents are having difficulty growing license volume, margins, revenue, or all of the above, and new emerging players are releasing as open source assets that would have been worth millions a decade ago, it’s safe to say that a new pattern is emerging. Software has never been more important than it is today, but software producers expecting to match the performance of years past are setting themselves up for disappointment. There are exceptions, but in the majority of cases, the realizable revenue and margins of traditional standalone software businesses are trending downward, and there is no reason to expect a recovery. From startups to big businesses, enterprise to consumer, it’s simply getting harder for businesses to make money selling software by itself.

The silver lining is that the slope of the decline is mild, which means that there is time to adapt—assuming organizations can acknowledge that there is a problem in the first place. Open source and the rise of the developer kingmaker have altered procuremen fundamentally and permanently, but enterprise buyers at least have three decades of conditioning telling them that they must pay for software. Many buyers, frankly, will keep paying for software not because they have to but simply because it’s routine. Intelligent, adaptive organizations will therefore use whatever software runway they have left to subsidize the generation of new complementary or even replacement lines of revenue. Their less-progressive competitors, meanwhile, will be left to fight over a budget pool that will grow smaller every year. Once upon a time, an entire industry knew that the economic value wasn’t in software, when in fact it was. Today, we know the economic value is in software licensing, when in fact it increasingly is not. With history unequivocal on the outcomes for those who know what the value is versus those willing to question it, everyone producing software should be considering what the Software Paradox means to them.

Steven O'Grady
Stephen O'Grady is a co-founder of the developer-focused technology analyst firm, RedMonk. Regularly cited in publications such as the New York Times, BusinessWeek, and the Wall Street Journal, Stephen's work revolves around understanding developer needs and trends and working with businesses to help them work more effectively with the New Kingmakers. Although his birth certificate says New York City, Stephen is a Red Sox fan, born and raised. A graduate of Williams College, Stephen lives in Midcoast Maine with his wife.

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