Is Enterprise Software Really Back?

I need to confess up front—I’m a sucker for enterprise software startups (launching and running them, that is). Why else would I be in the middle of the bootstrap phase for yet another enterprise software startup—veloGraf Systems—in a most unlikely location, Santa Fe, New Mexico?

You can imagine my surprise when Trevor Loy (@trevorloy) retweeted Kevin Spain’s (@kevinspain) link (http://tcrn.ch/axDwZf) to TechCrunch’s interview with Marc Andreessen’s where he stated his new firm is “very, very interested and active right now in enterprise software”. Can it be true? I share Marc’s view that most professional investors consider enterprise software investment opportunities non-starters (“dead” is the term he used). Is Marc really on to something or does he too suffer from an addiction to startups where serious innovation and solid engineering are table stakes before you even take on the even more daunting challenge of taking an enterprise-class software product to market? I’m thinking of LoudCloud/OpsWare.

Enterprise software startups are not for entrepreneurs who expect to cobble together a web 2.0 service during a short boot camp or investors interested only in consumer-driven home runs. However, for entrepreneurs and investors who don’t mind a bit of heavy lifting as the price for success, a few upside considerations …

  • As Marc points out, startups like these are often founded by “seasoned” (yes, that sometimes means “older”) executives who are way up the learning curve and less likely to make simple execution mistakes. They almost always understand the markets they are entering which can frequently be the most painful and expensive lesson to learn.
  • As with all startups, you want to swing for the fences every time but enterprise software leaves you opportunities for base hits because there is often a core product that meets “portfolio completion” needs of larger vendors who simply can’t afford to internally invest in nascent market opportunities.
  • In today’s software development environment, there are stunning amounts of really exceptional open source technology letting the startup focus on the vital, differentiating innovation and difficult engineering efforts required to build reliable, scalable products. This provides excellent leverage for a development team and can reduce the amount of investment required to get an initial product to market.
  • Contrary to what many believe, IT organizations do continue to adopt evolutionary technology. If an innovative product can meet a business need and the startup understands the rules of engagement for delivering a product to this market, I remain convinced there remains “white space” in the IT ecosystem. This does NOT mean wholesale displacement of the entrenched vendors like Oracle, IBM or Microsoft no matter how “breakthrough” your product may be. An unfortunate blind spot of many new entrepreneurs to this space is the unwavering belief that their technology is so innovative that CIOs will willingly discarded millions of dollars of development investment and untold measures of staff knowledge to adopt a new technology. Ain’t gonna happen. Think niche. Think evolution. Think playing nicely with others.

I’m certain there are many more “rationalizations” for investing in an enterprise software venture that I can add to this list since I need to hone the story much more before I hit the fund-raising circuit this summer. But on to the challenges…

  • The single biggest obstacle to succeeding in the enterprise software market is simply the difficulty of getting a product through the tortuous path to closing deals. While I do believe that we have tools today that can accelerate the sales cycle while reducing it’s cost, I’m still bedeviled by finding the ideal model to reduce the cost of distribution. Building a sales and marketing organization can be extraordinarily expensive and begins to rival product development costs at a certain point. When that happens, it’s easy to see why another company in our general market space (data warehousing and business intelligence) has taken at least $45 million from VCs since 2005. What is harder to see is how there can be a reasonable outcome for all stakeholders with that level of investment. The “base hit” option is clearly off the table.
  • The distribution cost challenge is closely followed by the risk of outsized product development costs which can easily spiral out of control if the product vision is too grand. Or maybe not carefully managed since I believe a “grand vision” is important to early-stage companies. Enterprise software suffers from those damned “customer prospects” each of whom has a set of must-have features. It’s very hard to manage feature creep in the face of a sales team prospecting for leads and investors pounding you for a pipeline.
  • Which really brings us to the overarching challenge–is it possible to build an successful enterprise software company for a relatively manageable investment that can offer VCs a good return even if it’s a solid base hit (let’s say a double) and exceptional returns if it’s a home run? The amount I have in mind is definitely a three-beer discussion but I think the number could be in single-digit millions of dollars). Yes, I know these numbers don’t work for firms that can’t write modest checks and have such unmanageable portfolio companies that partner leverage is limited to a handful of companies for each partner.

So what is the optimum model for an enterprise software startup that makes this possible? Probably not too different than it was 15 years ago but it is enhanced by leveraging the major leaps forward in software development technology and a communications environment for marketing and selling.

  • Think tactical (but don’t give up the grand vision). Agile development techniques should also be used for “agile selling” in the early days of the product. There is an incessant pressure to have the “complete product” in terms of all competitive features and support from day one. I may be overstating the flexibility of contemporary IT shops but I believe targeted products meeting specific customer needs can be introduced. Any IT team using open source software knows the product is never done.
  • The investment corollary is to take the right amount of investment to get to each stage. Yes, more is good but it often means building unnecessary features or spending money too soon on sales and marketing. And, yes, many VCs prefer to make fewer decisions and write larger checks. They may be the wrong investors.

Marc never mentioned whether his interest in enterprise software extends to improving the leverage. He may very well prefer the large-investment model depending on his investment strategy and fund size. I don’t. Been there, done that. If you have it, you spend it and not always wisely.

I think I have just outlined the manifesto for how we will run veloGraf Systems manifesto. Not my intention when I started this post and it needs further elaboration but it does articulate what I believe are the the basic principles for operating an enterprise software startup in 2010. Marc was right—enterprise software is back!

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