Who's Going to Consolidate all These Software Companies?

(Hint: its not big tech)

Lina Khan this, Lina Khan that. Every time i speak to an investor, the response to the lack of M&A has been government’s opposition to big tech consolidation. Yes that’s true to some extent, but I’d postulate that this is a very small part of the reason. I’m going to focus strictly on the enterprise side.

Traditionally, there are 3 types of M&A: (1) Innovation: Think new market expansion, getting into a new business that a company is not in before (2) Consolidation: Buying in an existing market to build market share to have higher market pricing power, eliminate cost and (3) IP/Talent where the goal is to buy something purely to accelerate organic R&D and the end product will look and feel like an organic product.

Obviously consolidation transactions (particularly in hot topic areas like advertising) is a serious consideration for big tech, and rightfully so. But I would argue that large innovation transaction are also not as interesting for big tech in the next several years.

Why?

STRATEGY and BANDWIDTH. Let me explain.

I think of the period between mid-2000 to mid-2010s as the golden age of software M&A for large companies. Cloud was just starting to mature as a business model, and the big guys are beginning to worry. Building or re-platforming internally was going to take far too long so naturally everyone turned to M&A. During this period SAP/Oracle consolidated a large volume of best of breed applications, Microsoft did all kinds of silly deals (remember Nokia and Fast Search and Transfer?).

What’s obvious in hindsight is that this was a period where each of these large cap software companies were trying to find their identity. Fast forward to today, every large cap in software has built their brand and ecosystem:

Microsoft’s focus is Azure and Office. Oracle’s focus is OCI and Fusion. SAP’s focus is Hana (whatever that means). Google’s focus is GCP, and so on. This isnt just branding, but an entire GTM motion that comes with it. Each of these ecosystem players have thousands and thousands of sales and marketing staff where the training and collateral is squarely focused on how to sell x and y within their brand umbrellas.

In this new ecosystem model, best-of-breed software becomes an odd duck. What’s also interesting is that during this same period, venture funding has helped traditional smaller ISVs get to new scale. As a result, the markets have created dozens and dozens are sizable independent software vendors that are best-in-breed of what they do.

Instead of calling them best-of-breed, I prefer the term neutral software. When you think about these businesses, their success rests on a few factors (1) They are good at the little niche that they do, (2) they integrate to everyone well and (3) Their go-to-market is to sell as much as they can do anyone in the market. This is in sharp contrast with the strategy of large software ecosystem players. To give a few examples:

Why was Anaplan destined for PE? Imagine you are SAP and you wanted to make a bid. What is the business case you’d have to present? For starters, you need to maintain the momentum of the existing Anaplan business which means there needs to be a salesforce that knows how to sell budgeting or planning solutions into customers that run Oracle or Sage ERP. Sure its possible to make this work internally but its NOT STRATEGIC?

Another example is a company like New Relic. Observability and monitoring is almost by definition a game of neutrality. Every cloud platform has their native observability features. Maybe its not as good as New Relic but it does the job as long customers run on my cloud. Is there money to be made by AWS through creating a new salesforce to sell into Azure or GCP customers? Sure, but once again, its not strategic.

When I go down the list between apps, infra and security, I quickly come to the conclusion that the vast majority of these ISVs are simply no longer strategic to the large caps strategy. Of course we’ll see exceptions and there will also be companies to be bought and sold but from a strategic standpoint, I do not believe that next phase of consolidation will be through the mega cap software vendors, even without Lina.