The Fundamental Vulnerability of Software Businesses (Ankle-Biters and Open-Source)

Right before the holidays, I attended an amazing presentation by Fred Wilson on software and the enterprise.

The thesis of the presentation was network effects, and it underscored to me that in developing a product a key test has to be whether there is a sustainable network effect in addition to delivering value.

This has inspired me to write an ongoing series of posts on network effects.

The first question that we will take on is why network effects are important in software businesses.

Fred demonstrated his answer in the form of something he called a software morality play in three acts:

  • Act 1: A high end enterprise software company launches costing hundreds of thousands dollars in recurring fees.
  • Act 2: This value is undermine by a couple of entrepreneurs funded by Paul Graham working on the software in their garage selling it on self-serve basis rather than through a large sales force.  This venture serves as an ankle-biter to the big enterprise company causing pressure on prices.
  • Act 3: An open-source technology is launched further destroying the value of big enterprise company.

Network effects serve to protect the venture from the fundamental point of Fred’s morality play: software is easily duplicated.  Network effects are most importantly about defensibility.

More on what those networks effects are in future posts.  Fred’s talk is here.