In short, the investment requirements to develop groundbreaking product often don’t make sense for slow moving behemoths.
“Because they suck,” would be the easy answer. That was literally the first thing that came to mind when one of our SEs asked me this question last week. I was calm, sober, and under the influence of joy, so it’s not like I was feeling punchy or anything.
“A prospect just asked,” replied our SE.
“Oh. I guess I should give a more PC / factual response, then.”
So here is my PC, factual, and objective response to why big companies choose not to innovate, and instead focus on mergers & acquisitions.
Over the past decade I’ve competed with nearly all of the big vendors I’ve mentioned here. Not one of them has organically developed a new product that has made me think, “Wow, that’s really good.”
Building New Products Doesn’t Move the Needle
IBM, HP, CA, and BMC all have north of $2B in revenue. If a cool new startup (like Moogsoft) comes along and does, say, $10M in revenue in its first few years of selling, that traction, at best, represents a measly 0.1% – 0.5% of top line growth (assuming execution) for these gorillas. Then factor in the cost, risk, and unknowns of building a new product, and the argument in favor of new product starts to look weak pretty quickly.
It therefore makes more sense to acquire a startup with new technology that has a proven product / market fit and a decent revenue run-rate.
The Real Cost, Risks & Unknowns
Sure, most large software vendors spend billions of dollars in R&D every year, but most of that money is spent on existing products versus new products. For the benefit of this blog, let’s assume we’re going to build a new product like Moogsoft from scratch, so then what do we need?
- 1 dedicated senior product manager, cost: $200,000 each/year (preferably domain experts)
- 2 dedicated software architects, cost: $250,000 each/year (preferably domain experts)
- 15 dedicated engineers, cost: $200,000 each/year
Right — above is $3.65M in fully-loaded employee costs per year, over three years that’s $10.95M with no guarantees of execution, revenue, or success. These cash costs are typically what a large vendor would have to pay, given most startups have a larger equity incentive.
Notice the use of the word ‘dedicated’ in those people needs. When you build a new product, there can be zero distractions or lack of focus. Shared resources don’t work, you need absolute commitment to the cause. This is tough for big vendors because, more often than not, their ‘best players’ are working to keep existing customers happy with change requests, fire drills, and troubleshooting.
The above cost example is about as simple as it gets. If you think $10M isn’t a lot of money, that number can easily snowball into tens of millions, if not hundreds — just look at how much the average startup raises these days.
The key point here is that investing $10M in developing a new product has no guarantees, revenue or results. It’s also very difficult to fund this type of innovation at scale. CA, IBM, HP and BMC have multiple product lines, and to remain competitive in the market (and lead), they would need to invest a few hundred million every year on new products to organically grow their revenue and top line. Again, another reason why M&A is so much more attractive and less risky.
Attracting Domain Experts & Talent is Hard
Domain expertise and talent are critical ingredients for any startup success or new product. To disrupt, you need to figure out new and unique ways of solving complex problems, new or old. Why do you think New Relic and AppDynamics were so successful? Do you think it’s pure coincidence that both founders were APM domain experts and leaders in a previous life/job at CA? In 2006, CA acquired Wily Technology for $375m, which, at the time, was a leader in APM. That’s a pretty good example of why the likes of CA invest in M&A versus organically developing new products.
Further still, the war on talent is tough for any large company to fight. Employer branding is the name of the game right now. Don’t believe me? Check out Glassdoor and take a peek inside your company. Candidates, especially in tech, are very savvy and influenced by the information they can find on the web.
Here’s a quick glimpse of how some of the big software companies are perceived by current and former employees on Glassdoor:
- CA – 3.3 company rating, 43% positive outlook
- IBM – 3.4 company rating, 42% positive outlook
- HPE – 3.3 company rating, 31% positive outlook
- BMC – 3.7 company rating, 56% positive outlook
Let’s take a look at a few tech startups who compete with these companies:
- AppDynamics – 4.1 company rating, 78% positive outlook
- Moogsoft – 4.9 company rating, 98% positive outlook
- Wavefront – 4.7 company rating, 94% positive outlook
- Datadog – 4.6 company rating, 100% positive outlook
Notice a trend? Finding domain experts and talent isn’t easy at the best of times, but it’s vital if you want to build the “next big thing.”
Yes, big vendors can potentially offer a great work/life balance (9-to-5), and perhaps can offer more cash compensation — but for any domain expert or professional at the top of their game, is this what really drives them? Disruptors want to disrupt, innovators want to innovate, and domain experts want to push the envelope of what’s possible and actually have an impact.
Lastly, over the past decade I’ve competed with nearly all of the big vendors I’ve mentioned here. Not one of them has organically developed a new product that has made me think, “Wow, that’s really good.” Yes, several have made solid acquisitions, but none has developed innovation which has been game changing. If you think I’m wrong feel free to share your findings with a comment below, or let us know on Twitter.
Why do you think big software vendors can’t innovate and really disrupt?