Venture Capital View: Battery Ventures' Exec On The Massive Software Opportunity For Solution Providers

No Slowdown For Software

As much growth as the software market has seen so far, there are plenty of reasons to believe that "we're in the early innings of software," said Neeraj Agrawal, general partner at venture capital firm Battery Ventures. Agrawal, a VC veteran whose investments have included Nutanix and AppDynamics, recently released a report dubbed "Software 2017" that lays out analysis and predictions for the growth of Software as a Service. He sat down with CRN at Battery Ventures' Boston office to discuss what sort of opportunities the continued explosive growth of software could create for solution providers. What follows is an excerpt of our interview with Agrawal.

What are your goals with highlighting the software market in this way?

I would say our aspiration is that, if you think of the [Kleiner Perkins Caufield & Byers partner] Mary Meeker report -- which is thinking about internet trends broadly speaking -- there really isn't an equivalent of that for B2B software. We think that if we keep working it, we can fill that void. So we said, let's take a look at where we are in software. One of the questions that often gets asked to folks like us is that the Nasdaq is at a high. You might reach a conclusion that it has peaked, so that probably means the next five to seven years are going to be potentially a down cycle. But if you look at where software is from a general penetration perspective, we still think it's pretty early in the cycle. In fact, if you looked at any of the software revenue growth curves, at any point it looked kind of high, but then fast forward 10 years, and you realize, it's 5X to 10X where we were before. And to me that's the big takeaway -- that there is a lot of growth opportunity here for software.

And in my mind it's actually inflecting in the sense that it's actually growing faster now in the next 10 years than in the prior 10. You would say, 'Hey that's kind of surprising -- it's a big market, and it's hard for markets to grow faster.' They tend to asymptote down to GDP levels, and kind of peter out like every other sector of the economy. And the big difference here right now is that software really is penetrating a lot of markets that it never penetrated before.

What are the implications of this for the channel?

So for example, vertical software has never really been an area that has enjoyed software because horizontal software was really the first wave. But now if you're an insurance company you can buy great vertical software built on the cloud by companies like Guidewire and enjoy the benefits that the horizontal problem set enjoyed. And the channel for doing that could be maybe the system integrators. But I think we'll see some new channel partners that are kind of vertically centric, cloud-centric channel partners emerge that pull some of these tools together. SMB is another whole area. If you think about the economy overall, half the economy -- meaning the SMBs -- basically missed out on the last 30 years of software advancement. And they're really benefiting now. So companies like Shopify, Zendesk, HubSpot -- these companies couldn't really exist before. Because the cost of distribution, finding customers, was too high. But now through the internet, you can find customers at a lower price point, and make the math work. And so you have these companies that never could work 10 years ago that are doing really well now. And so that whole segment of the economy is buying software that never bought software before. And those things are helping to drive the software growth rate.

How does automation through software come into play in the growth of the market?

The general trend of automation, where labor and services continue to get automated, is kind of a one-way trend. It has obviously massive societal impact and questions, but it's a growth opportunity for software. What functions get automated, what functions remain driven by humans, that line will always kind of keep moving. And so in my mind, if I look at the cost structure of a company right now, it might be 80 percent labor and maybe 5 percent software and 15 percent other things like rent. But I think that 5 percent software number can easily grow to become 20 [pecent] to 25 percent of the overall cost structure of a business. And when that happens, that's really when software grows dramatically. The basic thesis that we had in the report is that we're in the early innings of software. And even though we've accomplished a lot, with where we are with the cloud transformation, I think we're very bullish -- that even though Nasdaq is peaking, I think the best days are still ahead.

Are there other verticals that you think haven't necessarily taken off with software yet, but could? And maybe might be a channel play also?

I honestly think almost every vertical has had an OK start with software, but there's a lot more to come. Areas where there's an overlap between vertical and small-medium businesses, I think is a great area. So, one example would be within the area of health care IT, if you look at small-medium doctor practices, that whole space will eventually move to the cloud. There's an opportunity for channel partners to really help there. A lot of different cloud vendors are required to make a physician practice actually operate. So I think the channel partner has an ability to pull that suite together. I think the one thing for channel partners though is really the business model is likely to change. It's been interesting to see what folks at Google have done with Google Apps -- I'm sure you're familiar with how they go to market with channel partners, where channel partners get a percentage of the recurring revenue over time. And so, it's a very different business model than pushing a piece of hardware and getting a onetime revenue piece, and then maybe nothing after that. And so I do think there's going to be a business model shift that's happening as more of the market shifts to cloud and recurring models. But I think it's a great time to be a channel partner because you can build a nice recurring revenue business, which will help you have a lot more predictability.

At one point, cloud software/SaaS was seen as something that hurt the channel -- do you think that in this wave, it's different?

There are the SIs and then there's the traditional channel partners -- and I think the big SIs, the difference with them is the ratio of services to software is different. That has a little bit to do with SaaS, but I think it has as much to do with customers saying, 'Hey, we need to find a better outcome here.' So what used to be maybe $5 of services to $1 of software, I think for something super complicated -- like insurance policy management -- might be $3 of services to $1. But I think for the vast majority of markets, we'll see it be closer to 2-to-1. So there is some shrinkage of the services opportunity, but I think because software is still so early, you make it up on volume. The billable hours are being spread differently than they were before -- but the need for more billable hours is clearly there.

On the channel partner side -- we're investors in Nutanix and also in Cohesity. And I think there's a segment of companies that are looking at cloud architectures, finding a way to package them, sell them through the channel for the segment of the market that is going to be on-prem. Or hybrid cloud. And I think that's a great market for channel partners because they can bring all of the innovation and architectural benefits that folks like Google have figured out, package and bring it to their customers.

Do you see helping everyone to become software companies as an opportunity for channel partners?

I do -- I would say if you look at traditional channel partners, I'd break them up into two buckets. One is the more hardware-centric partners, almost your traditional Cisco channel. And maybe you'd put the security channel in that bucket as well. And then you have these next-gen software-centric channel partners -- and I think that's where there's a lot of opportunity. And that could mean helping people leverage technologies like Chef to do private cloud, data center automation. That skill doesn't really exist in the customer side, and that strategic advice can exist on the channel side. That's probably similar to how a Google Apps-type channel partner would work. I think there's an opportunity on Office 365 -- Microsoft is clearly making a huge push around [Office] 365. And, by the way, I think Microsoft with Azure, unlike AWS, will be very channel-friendly in their approach.

What other opportunities are you seeing for the channel in software?

You're seeing more specialization -- so I think there's an opportunity for channel partners to become more domain-centric. So, whether they are the Chef expert, or they're the Sprinklr social media expert, I think there's an opportunity for those players. What used to be more of a technology, Cisco expertise, I think there'll be less of that and more of the things I described.

Do you think channel partners need to become more software-centric in general? Do they need to think more about having software talent on staff?

I think it's happening. There was a point in the cycle, 10 to 15 years ago, that everybody knew they needed to develop their networking infrastructure, and they all wanted to buy Cisco or somebody like that. The channel did really well. By the way, it only made 1 [percent], 2 [percent] or 3 percent margin on selling Cisco boxes. And they couldn't have a lot of technical talent because they didn't have the margin structure to support it. And so it was a very different business from what it's going to now. It's more consultative, it probably looks a lot more like a mini-Accenture than it does a Cisco-like market. So I think the transformation is becoming more software-centric. I'll tell you where I think there's a really large opportunity. I used to be on the board of Marketo, and I was on the audit committee there. And we'd do an inventory of all the apps that [Marketo used]. The number of SaaS apps [in use] was 140. Every little nook and cranny has a SaaS app. So what that means to me is there's an opportunity for someone to think about data governance, data security across all these apps -- how you make sure data is not flowing across them. Is that a traditional channel -- Cisco box channel? No. But is there an opportunity to build a practice across each of the functions, to help an SMB company think through all of this? Probably.