One of the most common misinterpretations of the Software Paradox to date has been the assertion that traditional software license models are a binary, on or off switch. Many who read the book, or at least the title, come away with the impression that it’s arguing that it is impossible to generate revenue from software today. This is not, in fact, the argument being made. Not least because it’s very difficult to build the case that you can’t generate money from traditional software licensing when one company alone is generating double-digit billions of dollars in revenue from the sale of what is effectively two software products.
But more problematically, this simplistic interpretation obscures the reality that it remains very possible to generate revenue with software, it’s simply that the economic model for its monetization is evolving. One of the most common adaptations is to operate software as a service, and sell it in that fashion. This model has obviously been extant in the market for years; Salesforce, for one, went public in June of 2004. Over the past few years, however, we’ve seen a dramatic expansion in the availability of infrastructure software, rather than packaged applications, operated and sold as a service.
One of the latest examples of this is Amazon’s Aurora RDS flavor. Originally announced at its annual conference in November and made generally available last week, it is a bid to offer customers the performance of high end commercial databases in a MySQL compatible database. It is, in other words, a service whose addressable market theoretically includes both traditional Oracle customers and the volumes of MySQL users worldwide. Which makes it one of the more interesting arrows in AWS’ quiver, but just one for all of its engineering. AWS already had the ability to sell to both MySQL and Oracle customers, as well as PostgreSQL and SQL Server.
While AWS may be the poster-child for infrastructure software-as-a-service disruption, however, it doesn’t actually tell us much about the market direction. AWS is, after all, explicitly and solely a services-based business, so its focus on and attention to that model is no more surprising than Salesforce/Heroku’s efforts with respect to offering PostgreSQL in similar fashion. Services businesses, in other words, should be expected to provide service products. More telling with respect to testing the Software Paradox hypothesis would be traditionally on-premise software companies embracing service-oriented models. Which is what we’re seeing.
Most recently, IBM acquired the Y Combinator graduate Compose. At the time of aquisition, the company formerly known as MongoHQ provided services for Elasticsearch, MongoDB, PostgreSQL, Redis and RethinkDB. Compose adds new functional capabilities and experience to IBM’s portfolio, as well as additional expertise in running these datastores as services. Not that Compose is directionally new for IBM; a year and a half prior, the company picked up Cloudant, the CouchDB-derived database offered as a service. And this is on top of the services push the company is making with its Cloud Foundry-based Bluemix platform, which itself offers software such as Hadoop or Spark as a service.
The acceleration of IBM’s move towards services-business, from databases to application development, is understandable in the wider context of its financials. Over the last four years, here is IBM’s software revenue growth: 2011 (9.9%), 2012 (2.0%), 2013 (1.88%), 2014 (-1.9%). Whether or not one believes the Software Paradox to be true more broadly, then, two facts about IBM cannot be argued. First, that it is getting harder for the company to sell software. Second, that the longtime technology incumbent is investing heavily in software-as-a-service businesses across the board. The presumption here is that these two facts are not unrelated.
Some might argue that the struggles of an IBM or Oracle to reliably sell new licenses of on premise products is nothing more than a function of their particular markets. Relational databases, for example, are a mature market that should be expected to see minimal growth, particularly as it’s disrupted by various newer non-relational alternatives.
This argument makes sense on the surface, but ignores the reality that many of the would-be disruptors are eyeing services themselves as an additional growth channel, a means of hedging against the various trendlines that indicate traditional software monetization mechanisms are under pressure, or both. As a halfway step towards becoming more of a SaaS-type business, many commercial open source vendors are actively looking at their monitoring and management software as a potential step towards that model. The core software itself is sold in the traditional manner, but SaaS-style recurring revenue is the goal from the software – frequently proprietary – that manages and monitors the core open source asset.
Other startups are being even more proactive, however, and building or acquiring the resources necessary to spin up a legitimate SaaS product in-house, rather than relying on partners or partial-products like the aforementioned monitoring systems. ElasticSearch, for example, may have acquired Found in part for the short term impact from the acquisition’s ability to package up Elasticsearch-as-a-service into containers deployable on premise. But over the longer term, the new ability to operate and run Elasticsearch as a public service is likely to be far more material to Elastic’s bottom line.
More importantly for Elastic, they timed the move well. As we move forward and see more service-oriented acquisitions like Compose or Found, the price for similar startups is only going to rise. Because the precedent for exits and escalating valuations is being established, but more importantly because on-premise only organizations are increasingly going to require the ability to offer customers not just a given software asset, but the ability to operate and maintain that software for them. Expect more SaaS startups and acquisitions, then, at higher prices.
None of which should be taken as a binary statement, again. On premise businesses have today and will continue to have the ability to generate both revenue and profits from traditional models. Some SaaS businesses, in fact, are effectively reverse commuting, taking their SaaS offerings, sealing them in a proprietary image, and selling it to customers that insist on on-premise deployments. GitHub has done this for years, and when we spoke with CircleCI last week on premise deployments were a growing opportunity for the SaaS company.
But even as on premise remains an opportunity, it is becoming more difficult to monetize efficiently. Selling software as a service is a very reasonable adaptation, but the window for adapting your on premise organization to the new reality will not remain open forever. Like it or not, the SaaS transition is underway.
Disclosure: Amazon, Elastic, IBM, Oracle and Salesforce are RedMonk customers. CircleCI and GitHub are not currently RedMonk customers.