Is software dead? I don’t think so

Lately, there has been plenty of chatter about software being dead. This narrative has been driven by several factors, including lowering growth rates, reduced valuations, and a general belief that software is becoming so easy to create that it will eventually create and execute itself, leading to its invisibility. Currently, the BVP Cloud Index is down more than 50% from its peak at the end of 2021. Additionally, funding is at an all-time low, which further adds to the credibility of this argument.

The issues with the software industry are only partly related to the industry itself. Most of it, in my opinion, is due to macroeconomic factors, particularly high interest rates.

Since the Global Financial Crisis (GFC), we are experiencing such high interest rates for the first time, with the rate currently at 5.5%. The 10-year US Treasury bond yields have been greater than 4.5% for most part of the year, allowing investors to get high risk-free returns. High interest rates generally lead to lower market multiples as the Weighted Average Cost of Capital (WACC) is higher, which means future cash flows are discounted at a higher rate. 

This is squeezing the supply of capital to higher-risk investments, both private and public. Software has one of the highest structural risks, which, in my opinion, is resulting in reduced allocations to this sector. The high beta (measure of risk/volatility) of software investments makes them more volatile and sensitive to market fluctuations. This is in stark contrast to large tech companies like FAANG/MAMAA, which have much lower betas than the rest of the technology sector and are benefiting from the current environment.

Further, the software sector is today under pressure to balance growth and profitability due to the capital squeeze. Loss-making companies are finding it hard to raise capital, so they squeeze growth investments, both in go-to-market (GTM) and product. This squeeze is directly impacting growth.  

We may be reading too much into short-term market variations. Since the inception of software, the process of software development has continually become easier, levels of abstraction have increased, and more software has been integrated into our lives. The annualized growth of the software industry has been going up over the last 30 years. The long-term trend indicates that this progress is not stopping anytime soon.

As an investor, I do see enterprise software startups face demand side challenges, but that does not necessarily equate to software being dead. In addition to capital scarcity, demand and supply-side challenges are driving the software industry's current state.

Entry barriers have been reduced, and the number of new software startups has skyrocketed. This situation is similar to what we witnessed in the late 90s with the web and the late 2000s with the cloud. The first cloud companies, like SuccessFactors and Salesforce, emerged in the late 90s when building a cloud delivery engine was challenging. It was only in 2006 when AWS was born and it democratized cloud services, leading to massive growth in cloud startups. Artificial Intelligence (AI) and Generative AI (GenAI), on the other hand, have been democratised from the start. A massive number of releases are being made each month, continuously changing the status quo and the "art of the possible." This rapid innovation has resulted in a high number of new startups, driving higher engineering costs due to the fight for talent and increasing Customer Acquisition Costs (CAC) as companies compete for customer attention.

While the above is a driver of “supply”, it is a challenge for “demand" as well. CIOs, CTOs and other business stakeholders acknowledge that we are in a game-changing innovation environment today, but at the same time, are also witnessing high levels of uncertainty. It is unclear how to make longer-term investments today as current solutions might become obsolete by the time they are implemented. Our view is that we will be in the midst of this environment until there is some stability on the technology front.

We are in an interesting environment today, where the market is highly competitive for software companies, demand remains weak, and capital supply is scarce. But I have no doubt that rather than software being dead or getting commoditised, the value of software in our lives and in the world will only grow in the years to come. I’m betting long on this industry!

Alok Goyal

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Alok Goyal is Partner at Stellaris Venture Partners