Today the market (incorrectly in my view) is associating weaker software bookings in Q1 with Software getting crowded out by Enterprises choosing more budget to AI. The book “7 Powers The Foundations of Business Strategy” by Hamilton Helmer was written in 2016, and despite that now being 8 years, there are a lot of the core principles are still very relevant today in the technology landscape. Interestingly one of the oldest and most legacy of the public Software companies out there, can help frame the Software vs AI debate.
One of the 7 Powers brought up in the book Switching Costs and that is illustrated in the book through SAP. The author talks about how SAP user groups consistently talk about the complexity and difficulty of using SAP software. In fact a survey done by ~600 SAP customers, indicated that 43% were unhappy with it, 50% felt it to be unpredictable, almost all believed it would cause financial risk of some sort, but ~90% would continue paying for annual maintenance fees.
Why is that? Because as the author astutely points out, “once an ERP is integrated into a clients business, employees have sunk the cost of learnings to use this system and investments have been made in compatible software to customize the system to the clients needs. Once done, changing that only comes at extraordinary high cost: the time and effort to research competitive offerings, the purchase cost of replacement ERP, new complementary software, transferring data, retraining employees, and risking interruptions of services and data from migrations from one service to another.”
“SAP has a paradoxical combination of high retention and low satisfaction reflects the economic reality of a software product of great value to a corporation but one that also comes with high switching cost. Once a customers has bought it they are hopelessly hooked, enabling SAP to reap the rewards of a future steam of revenue for annual maintenance, upgrades, addon software.”
What does this have to do with Software & AI? The book was written in 2016 so some things have changed including SAP’s own software and transition to a Subscription & SaaS model. One could argue it’s potentially easier to switch off vs 8 years ago. However it does highlight that Software usually have very high amount of Sunk Cost in them, especially those that are 1) systems of records & 2) highly integrated into other systems.
It’s not clear today if the advancements with AI are enough to overcome the cost already spent on these technologies (I believe the answer is NO today), nor is it clear that the advancements with AI will allow new entrants in the Software market or end customers the ability to custom design applications that will replace core systems today.
So far most of what has been talked about above has been around existing customers. It is fair to posture that AI could be slowing down deal cycles for new vendors not presently in the stack, leading to weaker net new business. But does this really come at the expense of a software vendor? Or is this a temporary delay? Is someone not going to buy Workday HCM or a Salesforce.com CRM because of what they are going to do with AI? Today I believe that answer is now.
I do believe a lot of the current debate on “will Software lose it’s prominence in an IT Stack/Budget” has more validity when applying to areas of the stack that are:
Point products & nice to have products
Less integrated throughout the IT processes/technology (easy to replace)
Low amount of data gravity (somewhat related to #2)
Have large parts of functionality coming from manual/repetitive tasks (more human labor at this point)
The conversation around AI replacing spend, is the same conversation that many enterprises have today on the Build vs Buy (use internal engineer manpower to custom develop apps vs pay for a 3rd party vendor), and the real question to be answered is: does AI tip that towards the Build part (which has been losing steam) vs Buy over the last decade? There is inherently a lot of sunk costs in a lot of existing software and both vendors/customers alike are unaware of what real ROI there is from adoption GenAI solutions. This is where going back to SAP is a great way to close the loop - Switching Costs still are a relevant power today aren’t they?
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