Reflexivity and the Software Selloff

Market narratives create their own future — Regardless of AI’s impact, software companies have been harmed — Identifying value in software requires understanding the narrative.

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REFLEXIVITY AND THE SOFTWARE SELLOFF

The market, via reflexivity, can create the future it predicts. Simply the existence of a narrative, true or not, can instigate change in the real-world.

The AI-displacement hypothesis driving the software selloff has already impacted not just the trading multiples of software businesses, but the businesses themselves. 

Regardless of AI's ability to displace existing software leaders, the software sector will be under pressure in the near term due to the changes this story creates.

“Sell Me This Software”

Today, every CTO is focused on AI. In addition, the role of the CTO has expanded from technology leader to key thought partner across the business.

CEOs and Boards need answers on how AI will impact their long-term plans. Sales, marketing, and R&D need AI roadmaps to enhance their performance. HR, legal, and finance need AI tools to improve their productivity. CTOs are now required to assist every other executive in achieving their goals.

As a consequence, CTOs will have less time to evaluate software solutions. We do not envy the enterprise software sales rep tasked with breaking through the AI noise.

This problem will be worse for the largest, most expensive software implementations: what company is interested in starting a multi-year, multi-million-dollar software implementation while AI promises increasingly disruptive potential?

The AI narrative is already impacting software sales. Slower software sales means slower revenue growth and, correspondingly, lower valuation multiples for software businesses.

Evolving Pricing Models...Again

While software buyers are distracted by AI narratives, the underlying revenue model of software once again must evolve. In an agentic AI world, selling software via a seat license is obsolete.

Going forward, software must be sold on a compute basis for businesses to capture the value their software creates. An AI-enabled sales counterpart (or replacement) may improve productivity manifold by accessing a CRM database at an exponentially higher rate than a human could. In this scenario, the value of the CRM software may be exponentially higher; software sellers must adapt to capture this value.

Notably, software businesses have already shown an ability to evolve their pricing models. Originally, software was sold via perpetual licenses. The growth of cloud computing enabled today’s seat-based, software-as-a-service (“SaaS”) pricing models.

The transition from license to SaaS roiled the accounting for software businesses and, optically, made these businesses look as if they were growing slower. Similar to the SaaS transition, recognized revenue may be pressured if compute-based pricing is adopted.

Once again, slower revenue growth will be an outcome of today’s AI story, whether or not the AI promises come to fruition.

AI-Replacement Theory

Software businesses are also under pressure, as are other industries, due to the dramatic AI-replacement narrative. Given the exponential leaps in AI performance, it seems only a matter of time before white-collar workers are no longer needed.

Supporting this narrative is continually weak employment data and growing layoffs in the tech sector. In the short-term it is impossible to tell if weak employment is driven by early AI-adoption or simply our stagnant, “K-shaped” economy.

AI narratives frequently veer into the realm of science fiction, with outlier scenarios ranging from doomsday global unemployment to earth-wide utopia. Given the wide range of potential outcomes, short-term economic data can appear to support almost any narrative.

The market prices in all potential future outcomes, though, and an outcome where software is unneeded by our AI overlords requires a discount to valuation multiples, even if the probability is low. 

Creating the Future

Even unproven today, the AI-disruption narrative is having a real-world impact on software businesses: revenue growth will slow as CTOs pivot to evaluating AI tools, pricing models will need to be updated to work in an agentic world, and terminal values are changing to incorporate a wider range of potential futures.

The AI narrative is feeding itself, driving its stated outcome. The narrative that AI will negatively impact software businesses has already negatively impacted software businesses.

Investors must acknowledge the impact of this narrative. Software valuations will not simply revert to their historical levels — they do not deserve to.