The Custom Apps market is bigger than you think, and over the past few years, it’s been growing fast.
Between 2011 and 2015, overall enterprise software spending grew 10% annually from $430B to $620B. Operating Systems and Middleware subsets saw modest gains, while Applications expanded at over 9% per year to $244B today. Though cloud cannibalization and stagnant legacy vendors dragged down overall Application growth, SaaS adoption in the period was extremely strong and buoyed the category (see the 2015 Forrester chart below).
The breakout software subset, however, was one that rarely gets much attention at all: Custom-Built Software. To the delight of contractors and consultants everywhere, it grew at a 33% CAGR from 2011-2015, from $43B to $136B in spend. The way Forrester defines it, Custom-Built spans more than just the application layer; Middleware is generally about half the size of the Applications, so it stands to reason that the Custom-Built application market is something more like $60-70B. Still, this level of new investment in 3rd party development is almost shocking, posting over 200% gross expansion over the 2011-2013 timeframe alone. Moreover, in the context of the great shift to cloud, it’s somewhat counter-intuitive. Compared to traditional licensed software, cloud applications can be adopted more quickly and at lower upfront costs. Custom apps are just the opposite—time-consuming and costly upfront.
So what’s been driving demand for custom apps? Do these factors relate to or challenge cloud adoption? Does this come back to traditional build vs. buy issues? To get to the bottom of these questions, I considered the major reasons why an enterprise might opt for custom in 2015:
1) Custom Apps To Facilitate Hybrid Environments
For large corporations the transition to cloud software is and will be a gradual one. CRM and Collaboration have been leaders, but no other horizontal software category has breeched even 25% cloud penetration. Custom apps that “bridge the gap” and facilitate hybrid environments are common intermediary measures. The border with Middleware becomes fuzzy here to some extent. In this case, pressure to adopt cloud solutions is actually driving a portion of Custom-Built demand. Though I expect this factor to taper off long-term, F500 companies will be mid-migration for years to come.
2) Custom Apps To Serve Niche + Complex Needs
I believe the specialization of SaaS is one of foremost trends in software today. As per traditional Division Of Labor, individual products focus on increasingly specific functions or verticals, making them more tailored and effective; that means more products, but then again software budgets are greater today. But there’s a point—dependent on startup capital requirements—at which a market is just too small for a vendor to enter. Highly specialized vertical apps may, however, benefit an existing company while requiring little go-forward upgrading (because there is little or no competition or likelihood of alternatives). A good example would be scientific modeling software (e.g. CSC built a custom spacecraft design solution for JPL). Over time, as startup capital costs (e.g. infrastructure) decline and vertical software adoption increases, I expect SaaS will capture increasing portions of this market.
3) Custom Mobile App Development
This grouping is now large enough at ~$14B that Forrester broke it out into its own category (see above chart). There are plenty of cases in which 3rd party custom mobile app development makes sense: when the app does not directly relate a core offering or the company is simply devoid of resources to execute on a good app (too small or not appropriately staffed). That said, I strongly believe most large enterprises would benefit from investing more in mobile apps. While building an in-house full-stack mobile team is a huge commitment and some parts of the mobile app lifecycle may sense to outsource longer-term (e.g. testing, infrastructure), enterprises should make use of best-in-class vendors to take ownership of mobile app elements directly relevant to their core competencies. Such adoption will continue to create opportunity for SaaS providers. Here at Bowery Capital, for example, we’re particularly bullish on tools that enable companies to control mobile app backend services & data (mParticle), as well as own & manage mobile user engagement (Carnival Mobile).
4) The Traditional Custom-Build Market
Finally, there are certain categories of applications that require near total customization, but are still onerous to handle soup-to-nuts in-house. In this bucket are a variety of unglamorous point solutions; examples might include work to provide existing offline services to clients more efficiently using an application or to automate idiosyncratic internal processes. There will always be a market for these types of Custom-Builds regardless of cloud adoption (after all, just because it’s custom doesn’t mean it’s not SaaS).
To conclude, while there will always be a market for custom apps, I think the subset’s recent growth spike was temporary, driven by the pressure to modernize & specialize software stacks, the difficulty of complete cloud migration, and the rise of branded mobile apps. The last 5 years, I believe, have seen CXOs re-envision software procurement as a form of innovation in itself. As budgets shift in the next 5, I expect SaaS vendors to be the primary beneficiaries.
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