The spend was particularly acute across larger companies where the efficiency gains were the highest. Today for example, companies with more than 10,000 employees have on average 650 software applications. Although it’s hard to observe in aggregate stock prices, software spend has been in decline for the last couple of years. Why?
While companies provide numerous reasons, from economic concerns to budget constraints, in general, they are in a software digestion phase from years of spending. The more acute and potentially chronic factor, however, is wallet share take by artificial intelligence.
Technology is deflationary over time because it removes frictions from society. Replacing an old technology with a new technology allows not only for cost savings but greater and more efficient output, driving its value to society. When most people think of AI, they think of the benefits and positive impact to productivity. That’s true. But what about the revenue streams tethered to the technology AI is replacing? Many of those companies are driving the exhibit above and are facing collapsing returns.
Look in the right places
Investors are following cues from economists and policy makers, whose rear-view oriented models seek to assess future economic activity and interest rate levels. I think they may be looking in the wrong places. Much like generals tend to fight the last war, the next bust won’t come from where the last bust was. It will come from where the boom was.
The boom wasn’t in GDP, the labor market, household spending, etc. The boom was in software. And while that boom was justified by attractive return on capital and efficiencies for enterprises, AI can potentially do more at a fraction of the costs. We expect to see IT budgets shift from software to AI and for the number of software applications to fall. The question isn’t the direction of travel, but only the speed.
While software is saturated with too much competition, AI may not be able to duplicate mission-critical applications. Software and AI will work together, but the excess of sub-scale providers in undifferentiated categories needs to “recess.” Avoiding terminally value challenged companies while owning mission-critical software providers may prove a powerful recipe for outsized performance. That’s why I believe active management will be important after years of dormancy.
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