Special Feature
Part of a ZDNet Special Feature: Enterprise Startups: Risk vs. Reward

Enterprise odyssey: How B2B startups made it back to center stage

Over the past few years, enterprise startups have risen to prominence in tech circles. Here's what's behind the B2B startup comeback.

This is the common room at Box, one of the premier enterprise startups. Image: Box

The mid 1990s are often referred to as the golden age of enterprise software. For the first time, on-premise software touched almost every point of an employee's workflow and the computer was coming into its own as the premier tool for knowledge workers.

However, interest in enterprise software slowly began to wane and the startups that propelled it fell off the map almost completely. Sure, a few companies popped up here and there, but the enterprise market as a whole was fading. Technological advancements were creeping forward in the enterprise, but risky innovations seemed to halt.

Then, in the early 2010s, enterprise startups came roaring back to life. All of a sudden, enterprise technology was sexy again. New tools and a receptive market made it easier than ever to build a B2B technology company and startups flourished.

If startups trends can be described as waves, the enterprise market rose and crashed, and is on its way to crest again. Here are the factors that contributed to this startup surge.

Background

Enterprise software companies in the early days often took massive amounts of capital to grow. This was due, in part, to the excess of the dot-com era, but it was also due to the fact that software was expensive to build in the 1990s. It was even more expensive to market and distribute.

"It started to get very expensive to start enterprise software companies. The reason was, the cost of sales and marketing had gone up," said Larry Augustin, CEO of SugarCRM. "People were buying differently and trying to reach the customer became a major challenge."

According to Augustin, Goldman Sachs analyst Rick Sherlund began tracking the ratio of license revenue to sales and marketing costs, and saw it get close to 80% before he stopped tracking it. At that point, its easy to argue that those companies stopped being technology companies, and became sales and marketing companies.

This is a main reason why VC firms stopped investing in enterprise technology at that time -- the go-to market plan was almost impossible. A few companies were actually able to raise a lot of money and survive, because they had the resources to spend on sales and marketing, but they were the exception and not the rule.

This was around the time that the dot-com bubble burst. When that happened, IT spending slowed and traditional IT vendors had to reconsider their strategies moving forward.

"When you're in a market that is flat to shrinking, you optimize differently than when you are in a market that is growing," Augustin said.

So, the big vendors optimized for cash flow and to maintain market share, Augustin said. While that's the right decision to make in that situation, it halts spending on investing in or acquiring startups.

Just when the enterprise tech economy seemed like it was coming back around in the late 2000s, America experienced the 2007/2008 economic recession and the uneasiness set back in. Needless to say, there wasn't a lot of new and interesting technology available in great quantities for some time.

Consumerization of business model

The same time that enterprise innovation was declining, consumer technologies were continuing to advance. Computer hardware was more accessible to everyday users and had more use-cases in the home.

"Most people began to have their own higher-end computers at the time, in that late 90s period," said Steve Herrod, a partner at General Catalyst. "That's when the web was exploding and you could actually get access to things that would help you personally, not just at work."

In the mid-to-late 2000s, consumer companies took off. These companies didn't have the sales and marketing costs associated with enterprise software, in part due to viral adoption. The products were accessible and easily finding success, leading to many copycats in the consumer space. However, it also led to some enterprise innovators to take note of the success of consumer products.

According to Mike Krupka of Bain Capital Ventures, enterprise founders looked at the consumer products and saw four aspects of building consumer technology products that they wanted to replicate in an enterprise product.

  1. Build it cheaply.
  2. Host it so you don't have to deliver on-premise.
  3. Low-cost sales model.
  4. Quick implementation with client.

These founders thought that, if they could scale an enterprise customer as fast as they could scale a consumer company, they could potentially make a lot of money, Krupka said.

So, they imported the business model and ran with it. But, they also brought many of the consumer innovations into the enterprise with them. The collaborative aspect of social media began to infiltrate ERP and CRM applications and enterprise companies began to leverage the accessibility of mobile and Wi-Fi -- both consumer products that forced their way into the enterprise.

According to New Enterprise Associates' partner Scott Sandell, this consumerization wasn't really something that was possible before the first wave of SaaS applications like Salesforce enabled business users to start buying IT products directly.

"Once business users could start buying stuff directly from companies, and not have to go through their IT department, then the buying patterns shifted and these technologies no longer had to be vetted by the IT department," Sandell said.

By now, it was the around the early 2010s and the economy had leveled out enough to encourage IT departments to seek out new products and services. As they began to examine their options in the market, it became apparent that many legacy IT vendors couldn't match the agility or innovation that was coming from these new enterprise startups.

Traditional IT vendors were smart to play it safe in the 2000s by allocating less of their budgets to innovation, but it quickly became a problem for some of them. It's very difficult for traditional IT vendors to change their business models to compete with startups as they have bigger price points and a slower time to market.

"It doesn't take long before scale and process overwhelms your ability to be agile," Krupka said.

This has created three specific opportunities for enterprise startups. The first opportunity is the most obvious, sell their products to the enterprise customers who are willing to part ways with their incumbent provider -- disrupt the old guard.

The second and third opportunities allow enterprise startups to exploit the problem they created for the incumbent providers. The big vendors are not agile enough to invest in the type of R&D needed to compete with most of these startups. Because of this, many corporate technology companies are running sponsored startup incubators and accelerators, giving them a first crack at the new technologies produced there.

These programs provide funding and mentorship to help founders develop their offering, but they also help carve out a path for the final opportunity presented to them -- acquisition.

"The big IT vendors are looking to, now, buy their way into R&D," Augustin said.

We've seen this in the surging M&A market, and we will, likely, continue to see increased activity around the M&A market. If you can't beat them, buy their company and capitalize on their IP.

Consumerization of attitude

According to Herrod, the combination of new, cheaper computer hardware and the internet rising in earnest also began changing consumer behavior in ways that would later translate to the enterprise.

As consumer products advanced in the home, consumer users began to expect their products to "just work." This lack of patience led to a need for automation and products that could quickly be updated, spurring the arrival of SaaS tools and products like AWS.

The next change is that company leaders began to realize that design and usability matter. Consumer products were designed to be intuitive to drive adoption, which is part of the reason for virality. As they carried this into idea back to work, enterprise startups had to create products to fit this attitude.

"Business users started to first use consumer apps on their phones and on their iPads and on their desktops," Krupka said. "And, they liked the visual look of it, they liked the ease of it, they liked the fact that you didn't need to read a big manual to figure it out."

Lastly, the internet revolution helped create consumers that are more tech-savvy. Herrod called this "The IT-ification of consumers." For the most part, an average user can update his or her own phone, they understand that viruses are bad, and they can install their own software.

What this all boils down to is the fact that the lines are blurring between who is considered an enterprise user and who is considered a consumer user.

"When people say, 'there's enterprise and there's consumer' -- well , it's the same person who's using the technology," Krupka said. "Partly, they're sitting at a desk, or in a business, or on the road as a company person. Then, part of the time, they're a consumer. And, with mobile technology, they can be either at any point in the day. So, it almost has to blend."

New tools

In addition to changes in the market and changes in user behavior, there has been an influx of new technologies, platforms, and models that have made it easier and less expensive to build a startup, especially in the enterprise space. Things usually don't move as quickly in the enterprise, so it is easier to identify pain points and trends, and build a company to address those issues.

"The ability to both move faster as a small startup and get to progress more quickly, as well as the amount of money needed to take something to scale -- both of them dramatically changed," Herrod said.

On of the chief advancements in technology has enabled these new companies is the cloud. Cheap cloud hosting has changed the game in terms of deployment models, specifically regarding SaaS, PaaS, IaaS, and any other "as-a-service" product you can think of.

Rollouts no longer require large capital outlays at the beginning of the term. SaaS products fit tighter budgets as they now offer enterprises, and SMBs for that matter, the option to pay as they go.

Hosting an enterprise startup product gives founders a cheaper and faster way to both deploy and service their products. Startups can move faster to get a client up and running, and enterprises experience less down time if they run into an issue.

Additionally, cheap hosting lowered the cost of building a startup and the cost of scaling it. It's now easier for a B2B startup to grow to meet the needs of large customers. According to Herrod, many of these products have been adding higher level services as well, such as built-in data analytics, and startups can leverage these platforms to build at a higher point on the stack.

The march toward open source is another aspect of the recent rise of enterprise startups, because it gives startups another step forward, something that the startups don't have to figure out themselves. Open source is, obviously, nothing new, but it is becoming more accepted in the enterprise.

According to Sandell, the combination of all these new factors is enabling companies to grow at rates that would have been unheard of ten years ago, and with much higher revenues. He said it has also led to a new generation of enterprise IT products.

"This architecture, which is mobile plus the cloud, essentially breaks all the existing technologies," Sandell said. "Nothing that anybody had purchased before this is really useful in this new era. So, that opens up innovation on every frontier at every level of the stack."

In looking to the future, Herrod doesn't think the current focus on enterprise startups is going to be a short cycle. In fact, he thinks the enterprise has much to accomplish to catch up to where the consumers are moving.

"I think we're in the early stages of what will be a very long and nice run," Herrod said.

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