As the pendulum swings—back to enterprise software?

As the pendulum swings—back to enterprise software?

We’ve been dazzled in recent years by consumer-oriented software that is simple to use, designed for mobile devices and gaming consoles, and takes advantage of Internet advances for storage, remote processing and high-bandwidth communications. Successful consumer software companies have demonstrated explosive growth, reaching millions of consumer users and making their founders hugely wealthy, often in very short periods of time.

Young developers dream of creating the next big consumer success story, but their market knowledge is often limited to their personal experiences as consumers of social media, gaming, digital media and related software and online services. As such, they often aim to make what they themselves would buy. It is easy to forget that, as judged by revenue, most software is not actually sold to individuals, but is rather sold to enterprises—mostly companies and governments.

Enterprise software is very different from consumer software and companies that develop and sell enterprise software operate in completely different ways, too. But the enterprise software market is huge: US$285 billion in 2012 and growing to US$304 billion, according to Gartner. There are many opportunities in a market of nearly one-third of a trillion dollars!

Over the last two decades, investors have alternatively favoured either consumer or enterprise software companies. Recent evidence suggests that the pendulum is beginning to swing back to favour enterprises; however, targeting the enterprise software market requires significant time, money and expertise.

A recent article by Ben Sesser published on PandoDaily—titled “Memo to this year’s YC class: It’s damn hard to build an enterprise company”—reviewed the characteristics of companies that recently went public (IPO) and that operate in the software-as-a-service segment. This segment is the fastest growing enterprise segment; Gartner predicts it will grow from US$13.5 billion in 2013 to US$32.8 billion in 2016.

Ben’s findings were sobering.

  • The median time from founding to IPO was nine-and-a-half years and the median was eight years.
  • The companies had between three to six rounds of financing after seed rounds, averaging 4.45 rounds with a median of four.
  • Total funds raised prior to IPO averaged US$109 million, with a median of US$74.2 million.
  • The companies in this cohort averaged 532 staff at IPO.

So why do enterprise companies need to raise so much money? It’s primarily to support the enterprise sales process. At the time of their IPOs, one-third of the staff in these companies were in sales and marketing; on average, sales and marketing accounted for 45% of expenditures. Enterprises buy after meeting face-to-face with salespeople, often many times over protracted periods. Those salespeople often travel extensively and command high salaries. This is a very different model than consumers finding out about a product through social media and downloading it on a whim.

The other primary use of funds is for product development. As Ben summarizes: “If you just spend 9.5 years raising $110 million dollars across five rounds of funding, and hire 530 employees, including a sales and marketing team of 160 people, while building a world-class product that can win in the hyper-competitive enterprise software business, to reach $70 million in annual revenue, you can create a high margin business with predictability.”

Ben’s examples are all companies that were founded a decade ago when the enterprise was last in vogue.

Will the lessons still apply this time?

Some experiences from today’s consumer software sector are directly relevant to enterprise software. It is clear that enterprise software users are tired of non-intuitive, hard-to-use software. They have experienced modern consumer software and want the same user experiences at work—especially the interface and mobility.

A focus on delighting the user first might win in an enterprise and obviate the need for a top-down expensive sales-and-marketing model, as Peter Fenton suggested in a Forbes interview last year: “What we discovered is you can take product-driven entrepreneurs and back them in the enterprise market and achieve orders of magnitude more scale than you could with a sales-driven model.”

Perhaps, but this approach will be countered by the enterprise chief information officer unless there is a smart business model that he or she can back. You must have the CIO onside to sustain penetration of an enterprise, making your application “sticky” and supporting durable revenue, no matter how you make your first sale.

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