This article originally appeared on Forbes.com.
There’s little doubt that the cloud has reenergized the software sector with exciting new companies, high-profile IPOs and compelling services. Less certain is whether the cloud is good for the software industry’s giants. Software has been a high-growth, profitable sector for years, and disruptive changes are rarely kind to incumbents. How should software leaders interpret the changes in their business landscape, and what should they do to make sure they’re not left behind by the software as a service (SaaS) wave?
We believe the rules of the game that create leaders in the sector today will endure. Platform power will continue to be paramount. When other developers build applications that work on top of yours, longevity is an inevitable consequence. Just ask Salesforce.com and the thousands of developers that build apps on top of its Force.com platform.
Scale economics will still matter, too. Newcomers often show promising growth, but selling enterprise software is a scale business with heavy selling costs. That won’t change. And product stickiness will also remain important. New SaaS applications may be easy to access online, but the real friction—porting data and retraining employees—is just as real in a cloud environment.
In addition, we see a new “rule” that comes into play with cloud-based models. Software makers can learn a lot more about their customers in an SaaS world: When they host applications on their services, they can see in great detail and often in real time how customers use their products. Analyzing this data delivers insights that help them make better software, which in turn grows revenues.
With this opportunity in sight, software vendors face a choice: defend the status quo and risk being bypassed, or transform their business and embrace the SaaS model. Most are making the smart choice to experiment and evolve. In our experience, we see four steps that vendors need to get right to ensure they hold their leading positions:
- Commit to a strategic path. Software companies transitioning from a licensed to a subscription model need to decide on their migration path and commit resources to it. Almost always, that requires patience and discipline. On one end of the spectrum is a simple shift from license to subscription pricing models, with the software code base and delivery largely unchanged. Adobe started on this path for its Creative Suite, and it has now announced a full-scale transition to a subscription-only model. At the other end, Ariba’s radical transition from a traditional software model to an SaaS provider in 2005 put the company under intense pressure as license revenue dropped dramatically and it endured three consecutive years of losses during the transition. But the effort has paid off: By 2010, subscriptions accounted for more than half of revenues and the company’s total revenues have been growing by more than 20% annually since 2009, prompting SAP to acquire Ariba in 2012 for $4.3 billion.
- Embrace customer insight and intimacy. SaaS’s rapid development cycles require more customer contact than with the traditional model. In the old game, software companies focused mostly on the sale, and then on maintenance renewal. Now, customer contact happens every day, and vendors are learning that long-term loyalty is no longer optional but essential for success. With SaaS, the renewal process is continuous, and customer loyalty is important every day.
- Organize for innovation. The differences between selling licensed software and running a software service are greater than most executives anticipate. One major challenge lies in managing two distinct businesses within one organization. Aligning sales incentives can be particularly challenging since commissions are typically based on a large, up-front fee. Cloud customers pay for small, recurring payments, often with no up-front cost or commitment. Sales organizations need to reevaluate their commission structures—for example, compensating sales forces based on the expected lifetime value of customers.
- Speed it up. Development cycles need to speed up, sometimes by an order of magnitude or more. The old model of taking years to develop and debug new releases before unleashing them has given way to “release early, release often.” The same acceleration is required across all business functions, from marketing and selling to customer service and support. Microsoft, as an example, has announced weekly updates for its Office 365, a dramatic change from the historical two- to three-year cycles.
The software business of 2020 will look markedly different than it does today, and we expect the leadership in just about every category to be reshuffled. The surest path to success lies in expanding the new SaaS business while maintaining focus and consistency in the legacy business.
By Ravi Vijayaraghavan, a partner at Bain & Company in Boston; Mitchell Leiman, a Boston-based partner; and Simon Heap, a partner in Silicon Valley. All three work with the firm’s Global Technology practice.