So you’ve broken through that difficult startup phase, become profitable and maybe even have reached a dominant share of you market segment. Times are good and that usually lasts for a while. You’ve become what’s known as a mid-sized or even a large software company. In much of this article we’ll refer to this stage as “mature”.
But there comes a time when you hit new bumps in the road. Growth is slowing–or stopped — maybe even going negative. You’ve reached saturation in your market, or some hungry, disruptive new players have entered the picture and are chipping away at your existing business. The problem is you’ve never really “made it” in the software business; things just change too quickly to rest on your laurels for very long. Even once they’ve triumphantly gone from the upstart to an established brand name, it’s important for software company management teams to stay vigilant. As Andy Grove of Intel used to say “only the paranoid survive”.
Past those startup issues that can kill a software business so quickly, there are unfortunately almost always an upcoming new set of challenges. What are those issues most likely to be and how should you handle them? Here are a few possibilities it makes sense to prepare for:
Continuing growth
Whether it’s because you’ve saturated your segment or new competitors are nipping at your heals, this is probably the biggest concern that keeps software CEOs and management teams up at night. Maybe you’re even still growing nicely in absolute unit or dollar terms, but there is a perception of slowing growth because the denominator has grown so large that % revenue growth numbers have become puny. So what’s a software CEO to do? I like to say that there are 4 ways to grow: M&A, horizontally, vertically and geographically. I’ll discuss M&A as a special case a bit later in this article. I’d rate these four approaches in order listed above in terms of riskiness, as well as potential to add to growth. Higher risk usually yield higher reward–if successful.
Expanding geographically with existing products that are already very successful in your home market (especially if that market is the US – the most competitive in the world) is generally the easiest way to obtain additional revenue growth of the 3 categories. Unfortunately, by the time a software company is considered “mature” much as that geographic growth potential has likely already been realized. The next category: expanding vertically or selling additional new products to your existing customer base can also be very fruitful. But in many cases you’re already selling them the product categories that fill their greatest need and are the least competitive, or the ones you’re best suited to provide. Lastly, growing horizontally, or selling to a new market often looks very attractive, because it represents a true green field for new growth. But this is also the easiest place to fail. In many ways it’s like being a new startup again, with many of the associated risks and challenges. Success with a new horizontal growth strategy is most likely if you are able to leverage existing product technology or other differentiating IP in the new market segment.
Controlling software company costs to maximize profitability
While not as dramatic an issue as the growth problem listed above, I have found that controlling costs in a successful, mature software-based business can be quite challenging, but it’s also terribly important. It’s that cash flow maximized by cost control that often enables the growth initiative so important to the company’s continued success. On the surface, this might appear curious as it shouldn’t be that hard to control costs once you’ve grown into a substantial company. But in my experience, success leads to excess. The original management team that had to scrimp on every little expense finally feels like they’ve got room to breath–and take a little too much advantage of it. Or a new management team is brought in from an even larger company to “manage the next phase” and they are accustomed to much larger budgets. Those company offsite meetings move from the Holiday Inn to five star resorts. New staff is hired permanently to solve what is really a short term, or correctable process issue. Or people are hired just because you can afford to–something that was unheard of in the tight startup phase. In general, “nice-to-haves” suddenly become essentials.
The keys to controlling these excesses due to new-found prosperity is twofold:
1) Proper incentives to managers to “do the right thing for the business” rather than their own career. For example, if the pay structure of managers is based at least partially upon how many direct reports they have, what are you incentivizing them to do? Build their empire, of course. I find it really helpful to move P&L responsibility down to the lowest practical levels and make sure pay packages are aligned with the types of metrics important to efficient P&L management.
2) Have a strong CFO/Controller who has real influence. I want to emphasize here that there is a delicate balance that must be served in this area in a tech company. I have seen many companies destroyed by a strong financial manager that counts nickels so closely that it adversely affects the organization’s long term goals. This can be especially devastating in a software company, where marketing and product innovation are usually crucial to long term success. So the CEO needs to be astute enough to empower the finance guys to just the right degree to maintain efficiency of operations, while not choking off the lifeblood activities of the company. I consider this one of a CEO’s most important–and most difficult tasks.
Software M&A the right way
Acquisitions are of course just another way to continue growth (as mentioned above), but one which presents its own special set of challenges–as well as greatly elevated risk compared to other growth initiatives. I find this is often a favorite activity of the CEO of an increasingly mature software business. And it can make a lot of sense when done properly. As organizations grow it becomes increasingly difficult to drive innovation and the corresponding organic growth that comes with it. The reasons for this are better left for another discussion. Because of this phenomenon, mature software companies often look to M&A as a way to replace that internally-generated organic growth as it slows. But acquisitions are also a great way to get fired; statistically most of them end up as failures. I find the biggest problem to be that the drivers of M&A deals are too often a) ego, akin to bagging that big game on safari or b) driven by purely financial metrics.
Software industry acquisitions should be driven by FIT–both technologically as well as the “softer” (but no less important) considerations. How does the acquisition target’s product fit in the market with your existing products? How compatible are the two code and technology bases, ESPECIALLY if it’s going to be important to combine products into a single product offering over time. This is the biggest problem when buying a direct software competitor; if you’re not able to combine the two products into a single offering that serves both existing installed bases in a reasonable time–you’ve usually accomplished very little. And spent a lot of money doing it. Companies that buy direct competitors more often than not end up losing most of the installed customer base of the product that ultimately gets the short end of development resources picked off by their competitors lying in wait.
Even if you get the product/market/technology fit right and the deal’s numbers add up, there is still one area that destroys the value of many acquisitions. That’s those “soft factors” I alluded to above. When it comes to software/SaaS industry M&A, it’s the people, stupid! The most key assets of any software business walk in and out of the building every day. Mergers strike fear into many employee’s hearts and send them heading for the exits. Others stay but are alienated by the foreign culture and new management instantly foisted upon them. These soft factors that are so crucial to M&A success are often largely ignored, or left for post-close consideration–when it’s often too late. Doing M&A right is the topic for another article. My general advice is to stay away from those very large deals which can jeopardize a company as well as deals with direct competitors, unless they’ve been thoroughly vetted from EVERY angle and are really slam dunks. Better to focus on small acquisitions that bring cutting edge technology (M&A as a proxy for R&D innovation) or an entry point into a new market segment.
Motivating and keeping software industry innovators
One of the things that change slowly and subtly as you grow is the type of employees that find you attractive. No longer are you the young exciting startup offering lot’s of options at pennies per share. But the company’s enhanced stability now becomes more attractive to folks that have a more conservative nature. There is nothing inherently wrong with this; as companies grow the nature of many jobs change and a different temperament is sometimes appropriate. But it’s important to keep in the mix some of the innovative, risk-taking, hard-chargers that were attractive when you were a startup, along with those with a more conservative approach to business. To do this, you will need to maintain some vestiges of the startup days, at least for certain roles within the company where innovation is a crucial element. This can lead to a real balancing act as a more process-oriented culture often takes hold. But it’s important to be aware of this issue and structure appropriate pay packages, incentives and the authority to make decisions– cutting through red tape when necessary–in the areas identified as requiring innovation. Otherwise those key people that drive much of your growth with be doing it for your upstart competitors.
Navigating major software technology and market shifts
While technology has become important to literally every business today, it’s the lifeblood of a software-based business. Missing the next inflection point in key technologies can ultimately mean the death of a software company, no matter the size of the business. By inflection point I’m referring to the emergence of new platforms, SaaS business models, change in programming languages/tools, etc. A common occurrence in the software business is that an existing market leader with a large installed base is often outflanked by emerging competitors using the latest technological advantage. Mature companies are often slow to act and afraid of prematurely introducing new products that are seen as possibly jeopardizing an existing revenue stream. These new competitors can move aggressively because unlike the established player, they have no existing revenue stream to protect, or installed base to nurture. This is of course what has happened broadly to the large traditionally licensed on-premise players, as they’ve been ambushed by new SaaS and cloud-based entrants into their market segments. If the new entrants are successful at significantly chipping away at the incumbent’s market share, the more mature player is then forced to respond in kind, albeit belatedly.
Often by the time they do respond the more mature companies are faced with an almost impossible issue, what I call the “shrinking snowball problem”. This occurs when the existing market leader’s installed base revenue is shrinking faster than the revenue being generated by the new product/platform. When this happens it can lead to disastrous consequences from a financial & stock market perspective, even if the new platform revenues are growing briskly and faster than the competitors. For this reason I believe once you see an emerging technology trend that you believe will become mainstream, it’s advisable to jump in as early as possible–even if it means “obsoleting” your own products. Because it you don’t, someone else inevitably will. If you do it early enough you have a much better chance of reach critical mass on the new technology/product before that snowball of existing revenue melts completely. I find this is one of the more common critical mistakes made by mature software companies, especially public software companies necessarily driven by the quarter-to-quarter thinking of public stock markets.
Software market/technology creep
Above I discussed the need to be open to adopting new technologies at an early stage. While this is very important, conversely there is another problem develops if you don’t do this properly. It’s akin to buying the newest fashions every year, but never cleaning out your closet. Pretty soon the closet becomes an unmanageable mess. Similarly, if you’re always adding new products and technologies–especially across a wide swath of diverse markets, the company will eventually become a “software conglomerate”. The conglomerate business model lost favor many years ago because of its inherent manageability. The problem occurs because it’s often difficult to axe a product line or technology that is still bringing in revenue, for obvious reasons. But at some point this becomes penny-wise and pound foolish as product lines pile up, as there are many hidden costs that accumulate with such complexity. Among these issues are the real financial inefficiencies that come from running a weak or declining business. But no less important are the opportunity costs associated with the senior management team having to expend precious bandwidth to manage all of these disparate businesses. For this reason I recommend an annual review not unlike the spring cleaning of your closet, taking a hard look and eliminating businesses that no longer make sense.
Staying relevant–and learning new tricks
Lastly, the senior executives of many businesses that are perceived to have “made it” tend to become more conservative over time. Once you’ve established and are leading a real, successful business, there is a natural tendency keep doing what got you there. Often there is also a shift in thinking and policy toward risk-aversion, because now there is actually something to lose! Unfortunately, our industry changes very fast; activities that were bleeding edge yesterday will be seen as dinosaurs tomorrow. The risk of becoming irrelevant in any market segment is great, without constant innovation. This is somewhat true in every business, but in software-based businesses you really can’t afford to be too conservative. And this starts at the top with the senior management team. This is the overarching message that I believe executives of mature software businesses really need to take to heart.
The above is obviously an incomplete and very subjective list. What does your list look like? Please expand on this discussion if you have a point of view. Post a comment to add to the list above, subtract from it, or propose your own.
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All good points, there! Stuff that we usually discuss in round tables, now concentrated in a information-packed article.
Thanks!