Maturing Software Companies

Technology companies, and software companies in particular, do a great job of growing. They don't do such a great job of maturing. That is to say, when it comes time to transition from a growth-oriented business model to a more mature replacement-oriented business model, a lot of companies fall flat on their faces. This is not merely hypothetical: Microsoft will almost certainly have to confront this issue over the next few years, as it runs out of new "must have" features to force its customers to upgrade.

The consumer software business generates revenue mainly by doing two things: bringing new users into a piece of software, and getting existing users to upgrade. Without upgrade revenue, the total size of the market is limited.

There comes a point when a given piece of software fills nearly everyone's needs, and there's no particular reason to upgrade anymore. This poses a significant business challenge for a software company.

When this happens, the only reason for someone to pay for an upgrade to their software is because they're buying a new computer, say, every 3-5 years on average.

Take Microsoft for example. They're coming out with a new version of Office this week. Unfortunately for Microsoft, even the Microsoft MVPs (who generally haven't met an upgrade they didn't like) are saying that there isn't a whole lot new here. So why bother upgrading? Many, perhaps most, users will likely stick with the version they've already got, and only upgrade when they get new computers, or when the older version becomes so out-of-date that it is difficult to find hardware and software to support it.

The problem is that software companies in general, and Microsoft in particular, are growth oriented. They don't have to be, but that's the way Wall Street likes them, and that's what most people in the industry want. The opposite of growth oriented is cash-flow oriented, that is, the business is managed to generate maximum profits on an ongoing basis, rather than revenue growth.

It can be difficult to make the transition, even if a company recognizes it needs to. Software companies rarely admit when their markets are saturated and the businesses can no longer sustain revenue growth. After all, who wants to work for, or invest in, a software company run like an auto factory?

Failing to recognize the need for a transition can be disastrous. In trying to maintain its growth rate, a company will enter new markets which make no sense (X-Box?), make acquisitions which have no strategic advantages, and generally waste the shareholder's money trying to find some new growth engine.

So, how can a software company (a) recognize that it is no longer in a growth business, (b) figure out how to best manage the company in a mature market, and (c) gracefully manage the transition from growth to cash flow? All subjects for future articles....