I’m a big believer in the thesis that software is eating the world. One main driver is the fact that software is so much cheaper to produce and now there are billions, not millions of devices. Those factors don’t describe the core product change that is happening though. When people hear software is eating the world, they think that it means software is being created for every industry. That’s actually nothing new. You could look back to the 80s and find niche software for many industries. What’s really happening is that we’re shifting from software being created for 3rd parties, but software being created for 1st party use by a startup that wants to replace incumbents on the Fortune 500. It sounds crazy, but the hotel and taxi industries were upended in approximately five years.
What is a 3rd party software startup?
3rd party software is when you create a piece of software and sell it to enable an existing player in an industry. You are the 1st party creating the software and you are selling it to a 3rd party, the actual company that uses it. Think of it like this, if Uber were a software company, they would be selling software to the taxi industry and helping enable them. In return, they’d receive money for the software on a monthly basis as SaaS. Believe it or not, Bill Gates’ first company was a 3rd party software provider for school buses. It didn’t work out. Many 3rd party software companies exist for many different verticals – Escapia for vacation rental management is one that I’ve spent time looking at recently.
This statement doesn’t mean that I believe 3rd party software and therefore SaaS is a bad business. On the contrary, I think it’s a great business if you’re selling for horizontal functions that exist in any company. Hubspot for marketing, Salesforce for Sales, Slack for communication, Hootsuite for social media marketing, etc. The list goes on of 3rd party software companies that help with horizontal functions in a company and I think they’re all great companies that entrepreneurs should start.
Where I don’t think 3rd party software has as lucrative of a future is in vertical applications. Vertical 3rd party software is often a bug, not a feature of a company. It tries to make a non technology or software company in a vertical industry “have technology” for their industry, but that never works out well. You can’t just add technology to an old company’s DNA. It has to be at your core from the beginning. 1st party software companies change this.
What is a 1st party software startup?
A 1st party software company uses technology and software at their core to reinvent an industry from the ground up. The software it develops isn’t sold to incumbents, but is made for internal use to help efficiently scale and disrupt the current industry. Uber has done this with the taxi industry. Another great example is Buzzfeed, which originally tried to deliver software to media companies (3rd parties) to make their content go viral. They realized that software would be better used internally to actually disrupt and therefore eat the media world. This is the fundamental fire that is changing the economy of the world. Mobile and the cost of software development are the gasoline to this fire.
1st party software startups are akin to full stack startups. Since they’re not just making the 3rd party better, but replacing it as a whole, they have to bite off a lot more than a normal software company. From afar, it looks like they’re biting off more than they can chew, but they’re actually shifting resources that are now available. A decade ago many of a startups’ engineers had to focus on things like building bare metal, but that’s all a commodity now with AWS. Horizontal software companies for developer functions and infrastructure have now allowed resources to shift onto other parts of the stack.
1st party software startups also require an intense understanding of branding and marketing. 3rd party software startups were primarily B2B and only needed to know how to sell to businesses. 1st party software startups end up becoming the brand and connect directly with consumers. Uber and AirBnB have built tremendous brands. The same will have to happen for any other 1st party software startups.
We haven’t seen anything yet. Uber, Airbnb, Buzzfeed are just the first wave. The right thing to do would be to spot large existing industries that may have large dedicated 3rd party software companies servicing them. In advertising, there’s ad-tech, in the healthcare industry there are software companies selling to doctors, and hundreds more. Over the next 25 years we are going to see every single industry reinvented from the ground up by 1st party software. Companies started by product/engineering founders that utilize software at its core to reinvent an industry instead of just servicing it. Now is the best time ever to be an entrepreneur or venture capitalist. Normally, entrepreneurs (of high risk ventures) and VCs would only really be investing in 3rd party software companies. Now they are investing in 1st party software companies that are going to replace every major Fortune 500 company that has come before them. This sounds crazy, but in under 4 years we’ve seen AirBnB and Uber both completely upend the hospitality and transportation industry. There is absolutely no reason why any other industry is safe.