"The enterprise software business model is dead…VC appetite for standard enterprise software appears to be dwindling to nothing,” proclaimed Jeff Bussgang, a serial entrepreneur turned VC at the annual Microsoft VC summit.

A partner at IDG Ventures in Boston, Bussgang believes that price pressure is incredibly intense. “It used to be that you could build a profitable enterprise software company at the $15-20 million threshold. But with today’s pricing pressures and high cost of sale, it seems to have jumped to $40 million, and it’s harder to reach that threshold quickly,” he notes. And this is the reason why many VCs are mumbling to each other lately.

Palo Alto, CA based VC Jeff Nolan agrees with Bussgang. However, he says enterprise software is not really going to die. VCs will continue to fund enterprise software companies. “While the overall model and outlook admittedly looks grim, there are still a few remaining pockets where innovative start-ups will fill in gaps with new technologies facilitating localized change,” he says.

Ajit Nazre, Partner at Kleiner Perkins Caufield & Byers acknowledges that investment in the enterprise software space has slowed down compared to previous years. “The slow down is primarily in the applications area.

However, there are occasional investments in the infrastructure space, which includes middleware, operating systems, search, and security. The focus has shifted from applications to the infrastructure side,” he notes.

Interesting Themes
VCs across the board are constantly watching for these “pockets of innovation”. Mitchell Kertzman, Partner at Hummer Winblad Venture Partners is closely observing companies that build software leveraging open source stacks and components.

Nazre points out that earlier customers opted for packaged application software instead of custom-developed application simply because maintenance, service and the cost were predictable, though it did not fit the business processes in its entirety. “However, that economic argument will not hold true when you start using open source. You can get custom application on open source for less than packaged application,” says Nazre.

Kertzman is also betting on “actionable analytics software”. Unlike pure business intelligence tools, analytics-oriented company puts analytics into real time business processes. This enables organizations to react to the current business demands, threats and opportunities based on our observations, understanding and predictions.

More and more companies are using search as a platform to derive valuable information from terabytes of unstructured data sitting within the enterprise. On top of the search platform, companies are building innovative applications through which business value can be derived. VCs are excited about such companies.

Pricing Strategy
“In the last two years, there have been many changes within the enterprise. One needs to take into account these changes while investing or evaluating companies,” says Kertzman. Changing market forces, noise of consolidation and technological advances are fast changing the traditional means of buying software— already a buyer’s market, the way forward looks very challenging from the price perspective. Enterprise software companies have begun to adopt buzzword monikers like Software-as-a-Service.

In the old model in which software was licensed, it took long time to build a business with sustainable revenue streams. In the new model, where software is sold as a subscription, the capital required to build the business is large. This is because one needs to invest in IT resources to be able to deliver software as a service. Hence, the break even time is also longer. As a result, you need to create a business model to grow your top line and become profitable in a competitive way. A lot of people [entrepreneurs and VCs] are afraid of that model. “We believe it is lot more easier for startup companies to succeed in this model than an established company,” notes Kertzman.

For the new model to succeed it requires more patience on everybody’s part—entrepreneurs, sales force and investors. Though, it could result in less dramatic growth curve on the top line, there is greater visibility into future revenue streams.

Go-to-Market
The biggest challenge that any software company faces is in maintaining a direct sales force. A typical software company has to spend 30 to 40 percent of its revenues on marketing and sales. “For a startup earning a revenue of say $10 million, close to $3.5 million will be spent on sales and marketing. With that allocation, at best you get seven or eight people to work on sales. The number of feet on the street is limited, which constraints the amount of sales you can do. If you don’t have a go-to-market channel partner then it becomes really difficult to scale your revenue in economic fashion,” says Nazare.

He further points out that Oracle and SAP have emerged as leaders because they have sales force of 5000 plus people. However, companies like Siebel, Ariba and i2 have their own challenges with limited sales force. “Technology does play a role in success. But how the software is delivered is also equally important. We keenly look at the go-to-market strategy of startups while investing,” says Nazre.

As Ravi Mhatre, general partner at Lightspeed Venture Partner puts it, “Excitement has not gone away. What we need is a fresh perspective.”