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March 10, 2005

The Young Turks of Business Software

Justin Hibbard

Last week, I dropped by VC firm Foundation Capital to meet three CEOs of startups that are selling business software via the Internet. (I don't mean software you download and install. I mean the kind you use inside a web browser.) You may ask, as I did: why would anyone start a business software company at a time when the industry appears to be consolidating? As Larry Ellison might say, it's all part of the great circle of life.

Interestingly, the CEOs I met with had previously worked at companies like Manugistics, Netscape, and Interwoven--all of which represent the old guard that these young-blood CEOs are trying to topple. The old guard make client-server software, which consists of one piece that you install on a PC and another piece that you install on a server computer. The customer pays a one-time licensing fee to use the software on a limited number of machines, and the software company recognizes all or most of that fee as revenue during the quarter in which the software is delivered.

By contrast, so-called on-demand software companies run their software on computers in a central data center. Customers access the software by logging in over the Internet--there's nothing to install. The software company charges a subscription fee that typically covers two or three years of use. The company recognizes the subscription revenue in regularly scheduled chunks over the life of a contract, which makes for a predictable revenue stream.

Even before went public last year, proponents of on-demand software were declaring that software delivered as a service over the Internet would grind client-server software into little bits of crushed CD-ROM. Clearly, that's an overstatement. Even the CEOs I met last week said not all software should be on-demand. But for applications that don't require lots of customization, on-demand makes sense. has proven that the approach works for sales-force automation software. Now startups like Ketera are applying the on-demand model to spending-management software. Rearden Commerce is using the model for employee self-service applications like travel. And BoardVantage is developing an on-demand application that helps board members eliminate paper.

Many of those applications have been the domain of client-server companies like Siebel, Ariba, and Commerce One, all of which rose to prominence during the naughty nineties and have since seen their stocks fall. Some of them, like Siebel, are slowly shifting their business to an on-demand model. But that's a tough trick for a public company to pull off since it changes the pattern of revenue recognition that Wall Street has come to expect. That's why many on-demand startups think they've got the client-server companies over a barrel--just as the client-server companies once thought about mainframe software companies. It's that great circle of life.

UPDATE: A PR representative wrote in to say that Ariba makes "Java-based enterprise applications" and not client-server software. That means the client piece of Ariba's software runs inside a browser rather than requiring installation on a PC. We're happy to clarify that detail. Nevertheless, Ariba still sells most of its software as a packaged application for a one-time licensing fee, and most of Ariba's customers still install and run the software on their own server computers.

09:36 PM

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