The software spending environment slowed in the first half of 2022, as post-COVID demand cooled for technologies that enabled more collaborative remote work and interest rates ratcheted up against discretionary software budgets. Two years later, the demand environment is largely unchanged, as the impact from higher interest rates has hampered growth in discretionary software projects. Also, the mandate to spend on AI has created some pause as CIOs and CFOs evaluate the return on investment of these new technologies. The BofA U.S. Software Research team and I have highlighted expectations for a better software spending environment later this year, led by an improving spending backdrop (from lower rates) and traction with new AI offerings.
We have been highlighting stocks benefiting from three key trends shaping the industry in 2024: AI, consolidation and cloud. With the breakthrough in generative AI by large language model ChatGPT in November 2022, software firms have been in a race to build AI enabled features for the enterprise. Vendors with workflow and infrastructure already embedded in the enterprise and sizable sales distribution channels have an inherent advantage in this new software frontier. Indeed, many software firms have launched compelling new AI features to increase productivity for general purpose tasks like notetaking and scheduling, as well as job specific functions such as marketing content creation or sales communication. The productivity gains are real, with some firms citing hours of time saved by the knowledge workers on a weekly basis.
Regarding consolidation, the enterprise software environment remains highly fragmented. Decision-making for applications and infrastructure is often made at the departmental level, which has led to a proliferation of applications across the enterprise. The average sales department is running no fewer than 58 applications. Enterprises have been consolidating spend on applications to reduce this complexity and save money. This trend is heightened in an environment where IT budgets are more limited and platform vendors are often viewed as the safest option.
Lastly, the shift to the cloud is an enduring cycle. We aren’t arguing that we are in the first innings of public cloud, rather that the move is ongoing and vendors that have had a first mover advantage in cloud have an enduring advantage. The network effect behind cloud users, distribution and R&D budget is compelling and provides a formidable competitive moat. With the cloud expected to drive outsized growth (17% to 19% growth versus 10% to 12%), we remain bullish on cloud leaders in large categories like Customer Relationship Management (CRM) and infrastructure.
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