Compressing Switching Costs In Software

The spectre of software fluidity

Feb 19, 2024

Hey friends! I’m Akash, an early stage European software & fintech investor.

I write about startup strategy to help founders & operators navigate their company-building journeys from inception onwards.

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“What do you want to be best known for? Is it upgrading an existing ERP system or bringing in technology that delivers immediate value, net new innovations and a user experience that is unmatched?”
Bill McDermott, ServiceNow CEO on ERP modernisation

Myopia imperils CIO decision-making when it comes to costly but necessary migrations.

I’ve written before about how JP Morgan Chase is unique relative to other banks in how it has allocated IT spend, migrated to the cloud, and leveraged AI/ML to attain product velocity and efficiency. Atlassian embarked on a multi-year cloud transition in 2016 that was necessary in order to effectively cross-sell its product portfolio. Heck, even SAP is jeopardising its customer base by taking the necessary step to becoming a cloud-first company with its planned cessation of SAP ECC servicing after 2027.

Speaking of banks’ reluctance to modernise their IT estates from the increasingly obsolete COBOL programming language,

Packy McCormick

wrote:

Decades may as well be millennia from the perspective of the people running the banks today: they would need to foot the bill under their watch for a payoff that might come long after they’ve sailed into retirement. So they take the hidden but pernicious risk that comes with inaction.

Inertia to switch/modernise comes down to (and is compounded by the tenure of executives and compensation tied to quarterly earnings):

Uncertainty around the ROI of longer-term IT projects
Business disruption in the pre and post-implementation period

By the time the laggards accumulate evidence on longer-term ROI, they will have become market share donors to those that realised the inevitable early on.

The disruption precipitated by migrations is trivial compared to the increase of fat-tail risks like Credit Suisse’s risk management systems costing them $5.5bn.

The merits of migrations from legacy solutions, whether they be on-premise software to the cloud or between different cloud vendors, are widely acknowledged but remain too peripheral to become the CIOs top priority.

Y-Combinator put out a request for more companies to innovate around ERP software last week; even Mike Speiser is rumoured to be building a modern ERP competitor.

The challenge is that the majority of CIOs are simply not contemplating migrations to new vendors.

Where there is appetite, the refresh cycles are disparagingly long.

Of the many potential unlocks for this market, minimising disruption seems like surface area that’s worth allocating more attention to.

Has AI killed switching costs? Sure enough, LLMs will help address some of the migration pain points:

Luckily, generative AI showed up and broke the equation on both sides. Hand it an export file, ask it to reformat it for a new app, and moments later you’ll have turned migration costs into a rounding error.
AI to SVG, JSON to CSV, all convertible and cleaned up in a few seconds of compute time. Can’t export the data? Your computer’s AI-powered OCR can extract the text, or a GPT 4 crawler could read the page and extract data.

Modern ERP vendors would do well to work together with IT service providers responsible for transformation/migration mandates like Accenture/Deloitte/IBM/Infosys to productise more of the migration journey, reduce disruption and ultimately lock-in.

You might say that the new vendors will induce the same vectors of lock-in themselves once they’re in, and the cycle repeats.

That may be the intention, but to the extent that AI is an enabler for lower switching costs, it won’t discriminate against legacy or modern vendors. If we cast forward 5 or 10 years, inertia from switching costs won’t protect Workday/Salesforce/NetSuite any more than it’ll protect newer vendors. The vendors that endure will induce retention through multi-product platforms, novel UI/UX, opinionated workflows, and the fastest learning rates about their customers.

Charts of the week

ARPUs and profit margins by Nubank products

Productivity gains from GenAI mentioned in company earnings calls

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Quote of the week

‘Instead, we felt that it should be considered a privilege to invest in someone else's dream. To us, it wasn't about the money at all, but rather about what we could do to help. In our minds, we could make more of a difference if we actually worked for them. We would be the stagehands, and they would be the stars. It sounds pretty simple, and it was. There's no doubt in my mind that the reputation that we've built and the success we've enjoyed at Benchmark are mostly due to that attitude - along with a little luck too.’
Bob Kagle

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