Initially this benefits both startups and mature software companies, especially early adopters, who enjoy a significant but temporary margin windfall. As coding tools evolve, moving beyond mere autocomplete to advanced functions like debugging and refactoring, the overall cost of developing software approaches zero.
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Starting 2024 with a THERMONUCLEAR hot take
Step 1: Generative tools radically improve the productivity of software development teams [we are here]
Initially this benefits both startups and mature software companies, especially early adopters, who enjoy a significant but temporary margin windfall. As coding tools evolve, moving beyond mere autocomplete to advanced functions like debugging and refactoring, the overall cost of developing software approaches zero. With cost barriers for building software removed, new players flood the market, intensifying competition. This puts negative pressure on software pricing leading to industry consolidation and a perception that software products are increasingly fungible and commoditized.
Step 2: Vertical SaaS becomes an obsolete concept
As software development costs asymptotically approach zero the classic “build vs. buy” debate (that has historically anchored market prices for SaaS) becomes more straightforward — If the cost of building software tools is nominal then why wouldn’t every company, from large enterprise to mom-and-pop shop, build custom tools that suit their context and needs?
As bespoke software becomes the norm, vertical SaaS companies struggle to justify their recurring revenue models and are forced to backstop by providing greater support and service level offerings. Providing “white glove service” further erodes margins and undermines the outlier revenue multiples that tech companies have been able to command in the public/private markets.
Step 3: The venture capital returns model breaks
As greater emphasis on service and support becomes necessary, the dogma that technology businesses can scale with low marginal costs no longer holds true. No other product category in history has been able to command the multiples of SaaS companies and this marginal cost vs. scaling paradigm is the main reason for it.
As SaaS multiples drop, venture investors will be under pressure to become more accurate with their bets. The so-called Power Law — which suggests that a small number of ‘grand slam’ investments can overcome a larger portfolio of failed investments — will break down when even the ‘grand slams’ can only IPO at 4x revenue multiples. The industry will contract around a smaller number of VC firms that are successful in influencing the success of their portfolio companies via robust portfolio support and venture fund performance will converge towards PE performance ie. consistent base hits become the watermark for success.
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