by Ajay Agarwal and Kevin Zhang

“Software is the best business opportunity on the planet,” Joe Liemandt circa 1988

This has become an obvious statement in retrospect, but when I first heard those words, I was still a sophomore at Stanford. It was the fall of 1988: 15 percent of U.S. households had a personal computer, and the Internet had fewer than 500,000 users. I was hanging out on the campus lawn with my classmate Joe Liemandt, who even at age 19 proved to be preternaturally mature and savvy: “Software is the greatest business in the world. Once you write the software for the first customer, each incremental customer is essentially 100% gross profit!”

Joe and I were plotting our first business together, building a product to help salespeople manage their rolodex — an early stab at the customer relationship management (CRM) market. We coded it up in Fourth Dimension and drove down El Camino Real in Palo Alto signing early customers. Six years later, I would join Joe in building Trilogy, an enterprise software pioneer that achieved $300 million of annual revenue, before coming to Bain Capital Ventures, where I have worked for two decades with category creators including SendGrid, Kiva Systems, Gainsight, Clari, and FourKites.

Over those combined decades, software has proven definitively to be the best business on the planet. Depending on the day, the world’s most valuable public company is often Microsoft ($1.5 trillion!), predominantly a business software company. Within those thirty years, though, there has been massive evolution in how the outsize winners get built, from the initial wave of client-server powerhouses in the 90s, to the cohort of cloud software that lifted Salesforce, ServiceNow, and Adobe to nearly $100B in market capitalization each over the past two decades.

Nowadays, cloud is no longer new — it’s the bare minimum expectation. To differentiate, new startups must aggressively (and at their outset) rethink fundamental assumptions of how to build a software company. My partners and I are convinced that we are in the early innings of the next big transition. This era is all about the user, and we want to focus on three strategic pillars that best-in-class software companies will exemplify: user-centric products and distribution, global distributed teams, and creative monetization.

Modern Product and Distribution — the Rise of the User

While the last two cycles of software focused on the “economic buyer”: the CIO, CRO, CMO, or CFO, who was the ultimate check-signer and decision-maker, the focus on any software startup in 2020 begins with users, who are gaining more power to purchase and use their own choice of technology. Consumer demand to use iPhones at work, for example, was an early flash-point that ended up loosening IT’s hold on bringing technology to work. This empowerment was also initially prominent with developers choosing open source projects and dev tools, but has increasingly spread to other teams as diverse as design, marketing, and even manufacturing operations.

As a result, multi-billion dollar outcomes can now be built in categories where there is no obvious executive level buyer. Who is the executive in charge of “collaboration”, “communication”, or “productivity”? There isn’t one! But companies such as Slack, Airtable, and Wrike have built $100M+ ARR companies through bottom-up adoption by individual workers and teams willing to swipe a credit card to improve their quality of life.

It’s a no-brainer to say that fantastic products lead to passionate users, who are eager to share and collaborate with their co-workers. Smart teams are harnessing and investing in this energy, reaching new fans with events and user-level personalized marketing, forming communities of loyal followers. To encourage more users to tell their friends, the most effective practitioners also combine removing the financial barrier (e.g. freemium, open source), with viral product features (e.g. sharing Dropbox files naturally signs up more accounts).

As it turns out, once it gets going, bottom-up organic distribution from user to user is far more efficient to scale than the traditional top-down approach that has been the norm for the past 50 years of technology sales. These communities evangelize the solution, offer product feedback, and form, in effect, an extended salesforce inside of major companies. This creates fertile ground for a lean enterprise sales team to approach a very targeted set of prospects, and maximizes the odds of upgrading organic and freemium usage into an enterprise account.

Focusing on loyal users can become the lifeblood of both the product development cycle, and the business growth cycle. When it works, it is absolutely magical. Public software companies utilizing these modern techniques (note: these companies all have salespeople, too!) are spending anywhere from 20 to 50 percent less on sales and marketing, and they can scale more quickly by not having the constraint of waiting 9 months for new sales hires to ramp into hitting quota.

Modern Monetization: Go Beyond “Per-Seat”and Licensing

When I first started selling software, the truth was vendors could win while their customers lost. Because perpetual license contracts were paid upfront, deployments could fail, the user experience could be awful — but the vendor had already walked away with the dollars. When cloud software companies (pioneered by Salesforce) started charging on an recurring license that could be cancelled anytime, that created stronger incentives to retain and grow customers, and spawned the entire function of “customer success” (thank you Gainsight!), which was a shockingly rare business objective in enterprise software prior to 2001!

Moverover, it turns out that if the marginal cost of reproduction is zero, then the price of software itself comes under downward pressure over time. In motivating developers to think beyond “per-seat” pricing, this can certainly be seen as a threat, but it is also an opportunity: as alternative revenue streams and lifetime value grows, the size of the customer audience necessary to build a great company gets smaller and smaller, freeing up developers to be hyper-targeted and focused on the needs of a specific set of customers.

The next wave of software monetization goes beyond typical “per-seat” licensing, to other forms of revenue which are tied to usage, scale, and consumption, and include non-software sources like payments and data. For example, BCV portfolio company Attentive Mobile provides consumer-facing businesses with SMS marketing. Rather than charging on the number of marketers using the software, the company primarily monetizes on a fee that scales with message volume. As marketers see results with their campaigns, they send more messages — this alignment of value has powered Attentive’s unprecedented growth.

When it comes to even more creative opportunities, such as marketplace fees, or financial services, a software provider with a pre-existing customer relationship is often well-placed to deliver additional services.

Companies that thereby figure out how to closely align their revenue with customer value can grow more naturally with the account, producing unprecedented net revenue retention (customer expansion) numbers with minimal sales effort or upselling. Great examples of this are payments revenues (Shopify), implementation services revenue (Guidewire), or a network-based marketplace take-rate (Coupa).

When it comes to even more creative opportunities, such as (marketplace, or financial services), a software provider with a pre-existing customer relationship is often well-placed to deliver additional services. In our portfolio, Homebase built a sizable SaaS business offering scheduling and time tracking for local businesses and their hourly employees. On top of this foundation, they’ve recently launched a “pay advance” service (for merchant employees), which integrates tightly with the existing SaaS solution and utilizes the proprietary data Homebase already has to deliver an amazing end-user experience, while growing customer lifetime value.

What’s particularly interesting is that thus far investors have decided to value these ancillary revenue streams at the same multiple as the core software, even though these other sources of revenue may be lower margin or carry some additional risk. One logical justification is that these revenue streams are within a captive existing client base, and can grow faster than the overall top-line software sales.

We expect that with the maturing of the software industry, the increased sophistication of software buyers, and the sheer number of new entrants, core per seat license fees will continue to experience downward pressure. Hence in the future, pursuit of these ancillary streams will become core to a larger percentage of software companies.

Modern Teams: Embrace Global Technology Talent

Just as software companies are now born in the cloud, their tech stacks and internal processes can also be “web-native”. With better cloud collaboration and communication tools, the cost of working with a team across geographies and time zones is declining.

Whether you are based on Silicon Valley or not, almost all business software companies today have 50%+ of their engineering staff outside of the Bay Area, and often outside of the United States, by the Series C. Within our growth stage portfolio, for example, an average of about 70% of engineering headcount is based outside the high cost markets of the Bay Area and New York City. Our companies such as Bloomreach, Gainsight, FourKites, Argyle, and Clari get enormous R&D leverage through their distributed and remote R&D teams.

Whether or not they are monopolies, the reality is that Google, Facebook, and other consumer internet companies can set the benchmarks for compensation due to incredibly lucrative and durable fundamental businesses. For most enterprise technology companies, this competitive dynamic, as well as a culture of fairly short (two- to three-year) tenures for technical talent, makes it borderline financially and organizationally irresponsible to rely solely on Silicon Valley talent.

Even before a global pandemic forced everyone to work from home, an increasing share of seed and Series A-stage companies we met were hiring full-time engineering teams in Europe, Canada, Asia, or fully distributed. While COVID-related social restrictions may fade, we expect this broader trend to persist, as stubborn limits on high-skill immigration programs persist in the United States, and technology and practices to support remote work continue to improve.

For most software companies, R&D is the lifeblood and ultimate source of their business success. While successfully implementing policies and technology for distributed teams is challenging, the innovation leverage to be gained can be dramatic. Companies successfully leveraging distributed engineering teams in less saturated U.S. or overseas markets can benefit not just from cost savings versus solely Bay Area-based teams, but more importantly, by unlocking new and broader pools of top talent with essential skills.

The Best Business on the Planet

Through the decades, software has navigated from client-server roots, through a journey to the cloud, and now into the user-centric future. Along the way, marketers have reached more (and more relevant) customers, salespeople have closed more accounts, and support staff have helped more subscribers reach a satisfactory resolution. It is no exaggeration to say that billions of people have found better tools to complete their work and meet their objectives more quickly, efficiently, and easily. For all that, software remains the best business opportunity on the planet.

We could not be more excited to support the next generation of founders in meeting this new standard for company-building. If you are building a modern software company — or perhaps technology to enable this transition — we would be honored to connect with you.

Special thanks to Matt Martin (Clockwise CEO), Nick Mehta (Gainsight CEO), John Waldmann (Homebase CEO) along with BCV colleagues Wilson Chockley, Aaref Hilaly, Jessica Retrum, and Annis Steiner for their feedback on this post.