Anyone with an internet connection knows the breadth of goods that can be purchased online, from kittens to handbags to coffins to legal contracts.  But POS software?  Enterprise collaboration solutions?  Today’s internet has become a thriving online economy for software vendors, who are forging new business models to reach consumers and business users in more efficient and authentic ways.      

We are experiencing a renaissance of software.  As internet pioneer-turned-VC Marc Andreesen recently pointed out, in fact, “software is eating the world.”[1]  Cloud computing, low-cost internet services, open source stacks, and inexpensive or free software development tools have made it simpler than ever to launch global software-powered startups, without needing to invest in physical infrastructure.  Further, with more than 2 billion people now using the broadband internet, a software delivery mechanism exists that Bill Gates could not have imagined 30 years ago.  Software is behind everything we do—it powers your digital music library, brings to life the Pixar characters we love, captures the photos we store on our smartphones, and even enhances our experience behind the wheel of a car.  As Jay Simons, President of Atlassian Software, has noted, “there are more lines of code in a Ford car than in Twitter and Facebook combined.”[2] 

But the most tectonic shift within this evolving software landscape is occurring in the realm of enterprise software.   Once regarded as a stagnant sector characterized by BMW-driving sales reps pushing archaic products onto dictatorial CIO’s, today’s enterprise software market has been inverted.  It is driven by the end user, whose needs are met by nimble new startups providing lightweight and feature-effective software that more closely resembles the products we use at home (or on the bus, at the gym, or in the crowd at a concert).  Today’s “consumer-worker” or “prosumer” defines the technology adoption process: he is self-empowered, value-driven, and social.[3]  Put simply, he wants to use software at the office that looks like the software he uses at home.  And rather than purchasing expensive disks of software in shrink-wrapped packages, he finds and buys his software in the same place he buys everything else: online.    

The result is a new breed of software companies relying on the internet as a distribution channel.  Their business model is distinct: low-ticket, high-volume, frictionless online sales.  They shun the RFP process and encourage credit card transactions.  Pricing is transparent, training needs are minimal, and pricey long-term maintenance contracts are unnecessary.  Products are sleek and simple to understand, and because they are delivered on-demand, updates and enhancements are frequent.  And, crucially, products sell themselves via word of mouth, social referrals, built-in network effects, and vibrant online user communities.  Freed from the necessity of expensive sales organizations, this new breed of startups commits more resources to engineering and enjoys higher margin profiles.  The proliferation of such business models is reflected in a 2011 study by Pacific Crest securities, which demonstrated that startup (private) SaaS companies in 2011 expected average gross margins of 79%, compared to gross margins of 65% for their public SaaS peers.  Further, the startups spent 24% of revenue on sales and marketing, compared to 48% for the public comps, reflecting their more efficient sales and distribution channel.[4]  To be sure, VC investors have taken note of these appealing new business models, and of their promise within a revolutionized software ecosystem: Accel wrote its largest check ever when it partnered with enterprise collaboration software vendor Atlassian[5], and Andreesen-Horowitz followed suit when it gave GitHub $100 million to build out its enterprise business.[6]  On the public markets, these next-gen business models receive a premium as well: web-distributed software companies like SolarWinds and ServiceNow trade at revenue multiples of 15x and 16x, compared to traditional vendors like Microsoft and Oracle at 2.6x and 3.6x, respectively.[7]            

The phenomenon can best be described as the consumerization of enterprise software.  But what is driving it, and what factors inform the prosumer?  I briefly outline 4 contributing factors below:

Seepage.  With the proliferation of social media, lightweight productivity apps and collaboration tools, consumers are unknowingly training themselves to prefer a lean, web-based variety of software.  In their personal lives, for instance, consumers enjoy Twitter as a collaboration platform, Evernote as a simple tool for note taking, and Dropbox for seamlessly managing files across devices.  But no one wants to use these popular tools on their way to work, then log into a legacy business application when they get there.  These tools, therefore, seep into the enterprise.  They are used in the workplace as they would be used at home, and in many cases they begin to proliferate within small work groups until they are adopted company-wide.  Once the CIO becomes aware of the organic and widespread adoption of such tools, the providers make it easy for him to turn to professional versions like Yammer Enterprise Edition, Sponsored Evernote Accounts, and Dropbox for Teams.[8]  As the lines between home and office continue to blur, so too will the distinction between consumer and enterprise software.

  1. Seepage.  With the proliferation of social media, lightweight productivity apps and collaboration tools, consumers are unknowingly training themselves to prefer a lean, web-based variety of software.  In their personal lives, for instance, consumers enjoy Twitter as a collaboration platform, Evernote as a simple tool for note taking, and Dropbox for seamlessly managing files across devices.  But no one wants to use these popular tools on their way to work, then log into a legacy business application when they get there.  These tools, therefore, seep into the enterprise.  They are used in the workplace as they would be used at home, and in many cases they begin to proliferate within small work groups until they are adopted company-wide.  Once the CIO becomes aware of the organic and widespread adoption of such tools, the providers make it easy for him to turn to professional versions like Yammer Enterprise Edition, Sponsored Evernote Accounts, and Dropbox for Teams.[8]  As the lines between home and office continue to blur, so too will the distinction between consumer and enterprise software.
  2. The Apple Effect.  The ubiquity of Apple hardware and software has reset the standard for a user’s interaction with technology.  Apple’s design principles mask deep technology sophistication behind an elegant user experience.  Put simply, anyone who has touched an iPhone, iPad or Mac understands and expects that technology should not simply be functional; it should be enjoyable.  For such users, a return to clunky and slow-to-load enterprise software is unpalatable.  And in today’s workplace, where 1 in 5 employees uses an Apple product in the enterprise, and IT departments are growing accustomed to managing Apple hardware, the voices of Apple advocates are becoming harder to ignore.  To be clear, the trend is not propelled purely by Apple users; it is advanced by designers who employ the Apple ethos and by consumers who expect the usability, intuitive workflows, and sleekness it embodies[9].
  3. Mobile Device Proliferation.  In addition to the design aesthetics previously described, the proliferation of mobile devices has further implications for how prosumers demand enterprise software.  Mobile devices have become “companion devices” that accompany the user throughout the day, both at home and at the office.  Progressive CIO’s are meeting their users halfway, by deploying software that can be consumed across devices.  This, of course, requires software vendors to write programs that are easily digestible across mediums.  An email client on a Dell laptop is no longer sufficient to keep the user engaged; today’s prosumer demands a more nimble solution that can be ported easily from home to office, and from phone to tablet to
  4. Democratization of Software Discovery.[10]  Software discovery was previously defined by costly industry trade shows, expensive analyst reports, and convoluted evaluations published in IT magazines.  Today, prosumers scan the web for recommendations and, eventually, the free online evaluations offered by many vendors.  Though software download portals like Softonic and Download.com have existed for more than a decade, online discovery of enterprise software has been accelerated and transformed in recent years on the heels of the social web.  Going forward, as in many other sectors, product relevancy will increasingly rely on the recommendations of colleagues and friends from both inside and outside the workplace.  Business software providers who hone their understanding of social platforms will penetrate enterprises through a “land and expand” approach, finding an initial champion within a work group and swelling across the enterprise through virality and strong network effects.  Products like Yammer with built-in network effects (mirroring those of Facebook and Twitter) will further exacerbate the trend.

Today’s internet has become the storefront for the enterprise software world.  Businesses stand to benefit from increased efficiency, smaller capital outlays, and happier employees.  Workers stand to benefit from more enjoyable and consumable software, and a less disjointed transition from the home to the office.  And software startups face an opportunity to become the next evolution of Oracle, SAP or Microsoft, delivering mission-critical applications but in a format familiar to the end user.  As the internet continues to emerge as a vibrant online economy for enterprise software, we can be certain that software will continue to eat the world.  


[1] http://online.wsj.com/article/SB10001424053111903480904576512250915629460.html

[2] http://pandodaily.com/2012/02/22/is-atlassian-the-next-big-enterprise-software-ipo/

[3] Accel Partners White Paper, Renaissance of Business Software: A “Sales-less Era”

[4] 2011 Pacific Crest Private SaaS Company Survey

[5] http://blogs.atlassian.com/2010/07/atlassian_closes_60_million_investment_from_accel_partners/

[6] http://techcrunch.com/2012/07/09/github-pours-energies-into-enterprise-raises-100-million-from-power-vc-andreesen-horowitz/

[7] CapitalIQ

[8] http://techcrunch.com/2012/03/10/3-predictions-future-of-enterprise-software/

[9] Accel Partners White Paper, Apple-ization of the Enterprise

[10] Accel Partners White Paper, Renaissance of Business Software: A “Sales-less Era”


read more

I like getting stuff for free. I think most people also like free stuff. To paraphrase Professor Edelman, if you want people to use your product, make it look free. The internet has made it even easier to get stuff for free, as consumers. Some companies make money by giving away free products and services to customers and then charging some customers for add-on features, advanced functionality, virtual goods and/or premium services. This business model has been dubbed “freemium” – a term combining “free” and “premium” – by Fred Wilson, a notable venture capitalist and blogger in 2006. Many of us now associate this business model with companies like LinkedIn, which charges customers for premium accounts or additional features such as messaging un-connected contacts. Another notable example is dropbox, which gives users a limited amount of free storage and then charges for additional storage. While this business model has become very popular in the most recent generation of internet companies, it has been in use in the software industry since the 80’s, when “lite” software (limited feature) was given away on floppy disk (or preinstalled on computers) for free to promote advanced paid versions. This is not to be confused with free-to-try business model where full versions are given away for a limited period of time and then require payment to continue to use.

Freemium has been a successful business model for software for a number of key reasons. First, the marginal cost of serving an additional customer is equal to or near zero. Because infrastructure costs (storage, computing, bandwidth, etc.) have decreased significantly, once a product has been developed or new features released, there is very little marginal cost. Secondly, customers are fundamentally attracted to the idea of free and will try nearly anything because they have “nothing to lose”, which does not account for the value of time. Assuming the product is actually useful and creates value for the customer, adopting a freemium model can greatly accelerate user growth. Specifically in software applications, integrating data and being compatible / integrated with other applications increases switching costs for the customer, making the app even more sticky. For these reasons, many companies have successfully adopted the freemium model as a strategy for quick growth and user adoption. Dropbox grew from 0 to 50 million users in less than 3 years.

To the extent that the economics work out profitably varies dramatically across companies, products and customers. One thing is certain, to be sustainable, the free to paid conversion rate and lifetime value of the customer must be greater than the cost to serve all customers. On its surface, the relatively straightforward economic formula should be very clear for any entrepreneur, executive or investor to understand the sustainability of a freemium business. How one thinks about a few key questions will define whether freemium really works:

  1. Who is the buyer? It’s not uncommon for the person making the decision to pay or not to be a different person than the end user. For example, enterprise software where the buyers are IT professionals, but the users are other workers in the company.  Understanding both the user and the buyer is critical.
  2. What is features will be free and what will be paid for? Seems simple, but there’s a delicate balance between creating value for the user, the costs associated with developing and delivering each product / feature and providing significant value for the buyer.
  3. How much do you charge? Not to be confused with how much you can charge. Maximizing the value you create and capture depends greatly on how much value customers derive from the product and how sensitive they are to paying for it.

read more