The trajectories of great software companies

The trajectories of great software companies

Summary: Ever wonder how much growth a software firm should really target? If you thought the sky's the limit, you might want to think again.

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Part one: The different kinds of growing software vendors

Software buyers are second only to teenage clothing buyers when it comes to being fickle. The best vendors are those that capture as much market and mindshare as possible while the products are still perceived to be “hot." By inference, does this mean that the fastest growing vendors are necessarily the best?

The fickleness of software buyers has been known for decades and some may assume that the most successful software vendors are those that scale extremely quickly. But, is a great software company one that grows slowly, moderately or rapidly?

vendor types 01
Different trajectories for software firms. (Image: TechVentive, Inc.)

There are, it turns out, several growth trajectories for software companies. A significant number of vendors follow a very predictable pattern. These firms start off with a straightforward solution that solves a number of common business problems. Their solution usually appeals to a group of smaller businesses that may not need the capabilities (e.g., multi-currency) that larger firms require. As time goes on, these vendors expand their core functionality to solve more up-market needs and more vertical requirements.

A shorthand way of seeing the differences between these vendors is to classify a vendor into one of three categories:

  • Followers or Ernst & Julio Gallo vendors (with apologies to the winery) — These vendors move at a slow and steady pace. Like the winery’s old marketing adage: they won’t release a product before its time. Making sure the vendor only releases functionality that the market has absolutely demanded means the vendor usually offers products and enhancements after their competitors have done so. Slow and steady may be admirable in winning some races but not for firms vying for market share in rapidly changing, quick-to-obsolescence, fickle buyer markets.

  • Pacers — These software companies do a solid job of keeping up with the Joneses. They are not leaders but they aren’t followers either. Their innovations are often predictable and unsurprising yet they are still market relevant. Their unsurprising nature rarely garners much press or analyst focus.

  • Rocketeers — These vendors are screaming hot. They outpace competitors with their innovations and the speed with which they make their products attractive to ever larger customers. They can, though, spectacularly flame out if they get too far ahead of the market or bet the farm on an innovation that the market neither wants nor fully gets. Rocketeers can also flame out if they introduce bad products often enough that customers quit forgiving them. One software executive once said to his sales team something to the effect of “If you can name it, sell it. If you can compile it, ship it. We’ll fix the bugs after we achieve 85% market share.” That’s the kind of attitude that sinks a software company in a short time.
vendor types 02
(Image: TechVentive, Inc.)

Analysts, market watchers and other influencers often focus on only one category of vendors: the ones experiencing rapid, meteoric growth — the Rocketeers. Why? These vendors are doing lots of noteworthy or cool things. They’re taking chances, big risks and disrupting the status quo. They might also fail and fail spectacularly.

It’s that morbid curiosity of seeing a train wreck happen in real time that fascinates market watchers. They all want a front row seat to this spectacle just in case something wild, unexpected or explosive occurs. This is why high-growth firms are at hype-central. Other firms often can’t buy any publicity for themselves as the shadow cast over them by the fast growing firm(s) is huge.

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(Image: TechVentive, Inc.)

There’s another group of firms out there: Idlers. They make a number of innovations in the market space they currently occupy. These innovations just keep them in the same place competitively. Rarely are the innovations big or competitively differentiating. The changes they make keep them relevant but little more.

vendor types 04
(Image: TechVentive, Inc.)

Even rarer still are the scant firms that can start off selling and serving small firms and rapidly grow into an enterprise-class provider to the biggest software buyers globally. This kind of firm often has a serial entrepreneur at the helm. Think about someone like Dave Duffield at Workday. He’s launched four software companies in his career and understands what it takes to incubate, nurture and grow a software firm.

Solid growth in the application software space is actually a common occurrence. What’s less common is hockey-stick growth and rarer still is the firm that can sustain hockey stick growth for long periods of time. Xero, a cloud financial accounting software vendor, has produced the following chart of their revenues and losses over the last few years. This chart is an example of what many Rocketeers would want to achieve.

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Image from Xero website

The best of these big and explosive firms do one thing very well: They create their initial solution to be one that can and will scale. By doing this one thing well, they can easily increase their product line’s functionality and market appeal.

But whether the vendor can maintain its posture in that rarefied space where their solutions appeal to the biggest customers and their growth is still meteoric is far from guaranteed. 

vendor types 06
(Image: TechVentive, Inc.)

Small, entrepreneurial software companies often displace large monoliths simply because they possess the nimbleness that larger vendors have designed away. Large software firms, with their billion dollar R&D budgets, often relax their hiring standards just to meet their growth targets. When they were smaller, they often held out for the best and most amazing people possible. Now, they’re hiring average people who often deliver below average products at longer than average delivery rates. Mediocrity settles in for these firms. You can spot this happening when big firms prefer to “acquire” their innovation instead of “develop” it internally.

But larger firms often reach practical limits to their growth. Straight-line or curvilinear growth gets harder and harder to achieve once a software company approaches a given size. A new product that generates $100 million in new sales looks monstrous to a startup, while it barely makes a blip in a large vendor’s revenue numbers.

Many software companies hit the implosion point every year. When their growth stalls or goes negative, their best and brightest employees leave to work with firms that are growing. Growing firms offer career and equity opportunities for software employees. Contracting firms only offer the potential for a paycheck and maybe not for long. You can spot the failing firms by the exodus of great talent and the circling of potential acquirers looking to snap up the cash cow maintenance revenue business that is keeping the firm afloat.

Topic: Enterprise Software

About

Brian is currently CEO of TechVentive, a strategy consultancy serving technology providers and other firms. He is also a research analyst with Vital Analysis.

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  • Teenage clothing buyers

    The fickleness you mention applies almost entirely to teenage girls, as it did to their mothers, grandmothers, and great-grandmothers before them. While teenage boys don't want to look unfashionable, keeping up with the latest fashions is for them usually only a high priority to the extent that it is perceived to impress the girls (it's usually not to please themselves or each other); this is also a pattern that has endured across the generations.

    I've long joked that any deities presiding over fashion would have to be female ("fashion goddesses", not "gods").
    John L. Ries
  • What all the projections forget is that growth curves

    are never exponential - even if they get plotted that way.

    They are always an arc tangent curve.

    And companies never realize when they have passed the inflection point...
    jessepollard