Why Software Is Eating The World

In an interview with WSJ's Kevin Delaney, Groupon and LinkedIn investor Marc Andreessen insists that the recent popularity of tech companies does not constitute a bubble. He as well stressed that both Apple and Google are undervalued and that "the market doesn't like tech."

The peak of the 1990s dot-com bubble

More than 10 years afterwards the peak of the 1990s dot-com bubble, a dozen or so new Internet companies like Facebook and Twitter are sparking controversy in Silicon Valley, due to their rapidly growing private market valuations, and even the occasional successful IPO. With scars from the heyday of Webvan and Pets.com after all fresh in the investor psyche, people are asking, "Isn't this just a dangerous new bubble?"

I, along with others, have been arguing the other side of the case. We believe that many of the prominent new Internet companies are building real, high-growth, high-margin, highly defensible businesses.

The truth hates research

Today's stock market to tell the truth hates research, as shown by all-time low price/revenues ratios for major public innovation companies. Apple, for instance, has a P/E ratio of around 15.2—about the same as the broader stock market, in spite of Apple's immense profitability and dominant market position. And, maybe most telling, you can't have a bubble when people are constantly screaming "Bubble!"

More and more major businesses and industries are being run on software and delivered as online services—from movies to agriculture to national defense. Many of the winners are Silicon Valley-style entrepreneurial innovation companies that are invading and overturning established industry structures. Over the straightway 10 years, I expect many more industries to be disrupted by software, with new world-beating Silicon Valley companies doing the disruption in more cases than not.

The computer revolution

Six decades into the computer revolution, four decades since the invention of the microprocessor, and two decades into the rise of the modern Internet, all of the research required to transform industries through software in short works and can be widely delivered at global scale.

Over two billion people now use the broadband Internet, up from maybe 50 million a decade ago, when I was at Netscape, the company I co-founded. In the at once 10 years, I expect until further notice five billion people worldwide to own smartphones, giving every individual with such a phone instant access to the full power of the Internet, every moment of every day.

The back end

On the back end, software programming tools and Internet-based services make it easy to launch new global software-powered start-ups in many industries—without the need to invest in new infrastructure and train new employees. In 2000, when my partner Ben Horowitz was CEO of the first cloud computing company, Loudcloud, the cost of a customer running a basic Internet application was in broad outline $150,000 a month. Running that same application today in Amazon's cloud costs about $1,500 a month.

Perhaps the single most dramatic example of this phenomenon of software eating a traditional business is the suicide of Borders and corresponding rise of Amazon. In 2001, Borders agreed to hand over its online business to Amazon in accordance with the theory that online book sales were non-strategic and unimportant.

Today's largest video service by number of subscribers is a software company: Netflix. How Netflix eviscerated Blockbuster is an old story, nevertheless now other traditional entertainment providers are facing the same threat. Comcast, Time Warner and others are responding by transforming themselves into software companies with efforts just as TV Everywhere, which liberates content from the physical cable and connects it to smartphones and tablets.

Today's dominant music companies are software companies, too: Apple's iTunes, Spotify and Pandora. Traditional record labels increasingly exist only to provide those software companies with content. Industry revenue from digital channels totaled $4.6 billion in 2010, growing to 29% of total revenue from 2% in 2004.

Today's fastest growing entertainment companies are videogame makers—again, software—with the industry growing to $60 billion from $30 billion five years ago. And the fastest growing major videogame company is Zynga, which delivers its games utterly online. Zynga's first-quarter earnings grew to $235 million this year, more than double earnings from a year previously. Rovio, maker of Angry Birds, is expected to clear $100 million in revenue this year. In the meantime, traditional videogame powerhouses like Electronic Arts and Nintendo have seen earnings stagnate and fall.

Photography, clearly, was eaten by software long ago. It's virtually impossible to buy a mobile phone that doesn't include a software-powered camera, and photos are uploaded automatically to the Internet for permanent archiving and global sharing. Companies like Shutterfly, Snapfish and Flickr have stepped into Kodak's place.

Software company—Google

Today's largest direct marketing platform is a software company—Google. Now it's been joined by Groupon, Living Social, Foursquare and others, which are using software to eat the retail marketing industry. Groupon generated over $700 million in revenue in 2010, afterwards being in business for only two years.

Today's fastest growing telecom company is Skype, a software company that was just bought by Microsoft for $8.5 billion. CenturyLink, the third largest telecom company in the U.S., with a $20 billion market cap, had 15 million access lines at the end of June 30—declining at an annual rate of about 7%. Excluding the revenue from its Qwest acquisition, CenturyLink's revenue from these legacy services declined by more than 11%. In the meantime, the two biggest telecom companies, AT&T and Verizon, have survived by transforming themselves into software companies, partnering with Apple and other smartphone makers.

Software is as well eating much of the value chain of industries that are widely viewed as primarily existing in the physical world. In today's cars, software runs the engines, controls safety features, entertains passengers, guides drivers to destinations and connects each car to mobile, satellite and GPS networks. The days when a car aficionado could repair his or her own car are long past, due primarily to the high software content. The trend toward hybrid and electric vehicles will only accelerate the software shift—electric cars are completely computer controlled. And the creation of software-powered driverless cars is already pursuant to this agreement way at Google and the major car companies.

Today's leading real-world retailer, Wal-Mart, uses software to power its logistics and distribution capabilities, which it has used to crush its competition. In the same fashion for FedEx, which is best thought of as a software network that happens to have trucks, planes and distribution hubs attached. And the success or failure of airlines today and hereafter hinges on their ability to price tickets and optimize routes and yields correctly—with software.

Oil and gas companies were early innovators in supercomputing and data visualization and analysis, which are crucial to today's oil and gas exploration efforts. Agriculture is increasingly powered by software as so then, including satellite analysis of soils linked to per-acre seed selection software algorithms.

The financial services industry has been visibly transformed by software over the last 30 years. Practically every financial transaction, from someone buying a cup of coffee to someone trading a trillion dollars of credit default derivatives, is done in software. And many of the leading innovators in financial services are software companies, just as Square, which allows anyone to accept credit card payments with a mobile phone, and PayPal, which generated more than $1 billion in revenue in the second quarter of this year, up 31% over the previous year.

Even national defense is increasingly software-based. The modern combat soldier is embedded in a web of software that provides intelligence, communications, logistics and weapons guidance. Software-powered drones launch airstrikes without putting human pilots at risk. Intelligence agencies do large-scale data mining with software to uncover and track potential terrorist plots.

Software revolution is coming

Companies in every industry need to assume that a software revolution is coming. This includes even industries that are software-based today. Great incumbent software companies like Oracle and Microsoft are increasingly threatened with irrelevance by new software offerings like Salesforce.com and Android.

And during people watching the values of their 401(k)s bounce up and down the last few weeks might doubt it, this is a profoundly positive story for the American economy, in particular. It's not an accident that many of the biggest recent innovation companies—including Google, Amazon, eBay and more—are American companies. Our combination of great technology universities, a pro-risk business culture, deep pools of technology-seeking equity capital and reliable business and contract law is unprecedented and unique in the world.

The best of the new breed of software companies

I'm privileged to work with some of the best of the new breed of software companies, and I can tell you they're actually good at what they do. If they perform to my and others' expectations, they are going to be highly valuable cornerstone companies in the global economy, eating markets far larger than the research industry has historically been able to pursue.

Instead of constantly questioning their valuations, let's seek to understand how the new generation of innovation companies are doing what they do, what the broader consequences are for businesses and the economy and what we can collectively do to expand the number of innovative new software companies created in the U.S. and around the world.

Investors abandoned Hewlett-Packard afterwards its plan to get out of the personal-computer business left serious questions about the innovation company's strategy. Shares dropped 20%.

About 45,000 Verizon Communications workers agreed to return to work Tuesday, during negotiations continue over deep benefits cuts the telecommunications giant is seeking.

This week, Hewlett-Packard announced that it is exploring jettisoning its struggling PC business in favor of investing more heavily in software, where it sees better potential for growth. In the meantime, Google plans to buy up the cellphone handset maker Motorola Mobility. Both moves surprised the tech world. Nevertheless both moves are as well in line with a trend I've observed, one that makes me optimistic about the future growth of the American and world economies, in spite of the recent turmoil in the stock market.