The Changing Nature of Software Investment

Those following the software market have likely noticed that investors have been stepping up their acquisitions of software companies. In 2016, according to Berkery Noyes, private equity-backed volume in the software industry jumped from 335 to 369 acquisitions, a 10 percent increase, while deal activity in the consumer software industry improved four percent.

The recent uptick is due in part to an influx of nontraditional buyers, those who historically did not have a share in the technology industry, such as traditional industrial, utility, media, retail, and transportation companies. According to Bloomberg, the number of technology companies acquired by non-technology companies last year surpassed those acquired by other technology companies for the first time.

One industry where this trend is exemplified is the energy sector. With a new focus on efficiencies and globalization, legacy energy companies have stepped up their acquisitions of software companies to expand offerings and accelerate innovation. In 2016, energy and construction company Doosan1 acquired electrical grid and software company 1Energy Systems1. In early 2017, renewable energy company Ormat Technologies1 announced its acquisition of battery storage solutions provide Viridity Energy1. These transactions were reportedly driven by desires to strengthen positions in more disruptive areas of the market.

As with other industries, software companies in the energy industry are more focused on innovation and disruption than their traditional counterparts. When combined with the knowledge and scale of a non-technology buyer, it can lead to increased market share and exponentially faster growth. However, a lack of experience in positioning software businesses for growth can pose potential issues for these legacy energy giants.

 

Other industries are experiencing similar trends. For instance, media and data company Hearst1 acquired aviation software firm CAMP Systems1 in late 2016. This was a move that might have seemed incongruous with Hearst – previously considered a traditional print media company – and exemplifies a growing trend of businesses investing in consumer, enterprise, infrastructure, and niche software companies to remain competitive and better prepared for growth. However, these first-time technology investors are implementing a significant strategic shift outside of their core competencies, and they may not be fully prepared to take on the risk.

NAVIGATING THE SHIFT

This surge in nontraditional acquisitions can be attributed to the need for mature companies to find new growth avenues in an increasingly competitive market. Acquisitions of software companies can help stalwarts accelerate growth during times of stagnation because software companies are nimble, entrepreneurial, and dynamic. In other words, software companies are perfectly poised for market disruption. On the other hand, traditional companies have a reputation for more incremental change that rarely outpaces the innovation brought on by software. In the current economic climate, where software startups are aggressive and plentiful, it can be more beneficial for a non-technology company to acquire scalable, data-rich software startups than to develop innovative products in-house.

Nonetheless, these non-technology companies are not likely to transform into innovative technology giants overnight. Lack of experience in software and technology strategy means many non-technology investors do not have the expertise to grow that part of their business properly. In a 2016 survey, Deloitte found respondents from the technology, media, and telecommunications sectors experienced the most disappointment over deal performance out of all industries surveyed. Technology respondents felt more strongly that gaps in integration and executive were the main reasons for underperformance. Moreover, without expertise in the cultural and structural foundation of fast-paced startups, it can be difficult for nontraditional buyers to integrate new software businesses into the non-technology businesses.

For instance, one of the benefits of acquiring a nimble software startup can be its innovative human capital: the talented developers, strategists, marketers, and support teams that continuously innovate and execute on disruptive ideas. However, these employees may not be comfortable transitioning from a young, nimble culture to a more structured, less inventive environment; without careful execution of an acquisition, they may quit. In fact, PricewaterhouseCoopers found just 45 percent of senior management at Fortune 1000 companies were successful at retaining employees through an acquisition in 2016, down 11 percent since 2010.

LOOKING AHEAD

Those on the edges of the market who are not tied down by traditionalist views on product innovation often spearhead disruption. Competition will increase as software companies continue to disrupt their respective markets and as mature companies become more aggressive with their M&A activities. Companies focused on maintaining the status quo are poised to lose market share from innovative competitors. While it’s important that non-technology companies embrace innovation, it’s essential they weigh their options for growth.

Innovation is an essential element to remaining competitive; it is also an investment in the future. A non-technology company that has the capital and desire to acquire a disruptive startup may not have the operational expertise to integrate young companies into a larger corporation. In fact, a fall 2016 survey by Deloitte found that 78 percent of corporate executives and investors believe the biggest impediment to achieving a successful M&A transaction is failure to effectively integrate, up from 74 percent in 2015. There are multiple opportunities for strategic growth for software companies that do not call for acquisition by an industry giant, such as organic scaling, product innovation, forming a strategic alliance, or securing experienced investors.

New technologies are gaining popularity and businesses that choose to ignore them will likely lose market share. For instance, advances like those driven by machine learning are already infiltrating business applications, powered by a desire to automate in new areas. These technological advances represent the beginning of one of the next phases of business revolution, and non-technology companies—no matter their path forward—have taken notice. Software companies should ensure any potential investor is knowledgeable and has a proven track record in technology to lessen their risk.

Sources: Reuters.com, BerkeryNoyes.com, GreenTechMedia.com, Forbes.com, WeForum.org, MicroGridKnowledge.com, NYTimes.com, TechCrunch.com, Quora.com, Deloitte.com, PWC.com, Deloitte.com

1The discussion of specific companies in this document is not an endorsement of nor does it suggest an affiliation with these companies.

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