When ERPs Take a Back Seat
Thoughts on the Evolution of B2B Software
Overview
Enterprise Resource Planning Software (ERPs) has been at a state of maturity for decades, leading many to contemplate what technology will disintermediate it (Gartner Research touched on this in 2000 with ERP Is Dead — Long Live ERP II). In my opinion, the need for ERPs won’t be eliminated any time soon given legacy technology often plays a critical role in enabling the next generation. Because the consumer landscape evolves faster, we saw this enablement first occur as big banks propped up consumer fintech and now, we are witnessing the creation of the consumer Super App. Though it’s early, I believe we are moving toward a similar dynamic in B2B software and will see ERPs prop up and herald in the next great SaaS application.
First, Some Context
Each generation believes they are witnessing a paradigm shift that renders prior technology obsolete. This belief leads to bold claims that either take a long time to come to fruition or never do. We see this today in crypto. Claims that Decentralized Finance (DeFi) will disrupt fintech and render upstarts like NuBank unnecessary. Or that Web3 will upend today’s compute paradigm and how users interact online, ultimately destroying Google, Facebook (I refuse to say ‘Meta’), Microsoft and Amazon’s stranglehold on our lives. I’ve even heard some bulls claim that Decentralized Autonomous Organizations (DAOs) will render formal organizations and corporate entities as we know them relics of the past. These assertions are radical and highly forward looking. We’ll see how it plays out. But for many reasons (including the fact that they are integral to crypto’s existence), I have a sneaking suspicion that Big Tech and C-Corps aren’t going anywhere soon.
If we dial back time and look at the 20th century, there have been other, more tangible examples of this phenomenon. Before it was DeFi vs. fintech, it was fintech vs. the big banks. For transportation and logistics it was air travel vs. trains. For computing it was mobile vs. desktop. There is always this promise of newness rendering the prior paradigm void. And yet, here I am writing stream of consciousness nonsense on a MacBook purchased by a digitally native credit card (yet financed by a bank founded in the 1800s) and assembled with components likely sent via railroads and shipping technologies developed well over 100 years ago. Despite the continuous belief that the ‘new thing’ will change the world forever, old technologies persist. Usually, the previous generation’s technology just plays a different role. It takes a back seat.
Case Study: Neo-Banking vs. the Traditional Banking System
Let’s hone in on the state of traditional banking and lending for a moment. It’s been nearly 15 years since the great recession, and banks are still performing, playing an integral role in the U.S. economy. JP Morgan’s stock price is nearly 7x the trough in 2008, and the Company finished out 2021 with $2.5 trillion in average deposits, up 17% year over year. Zoom out to the 4 largest U.S. banks (JP Morgan, Bank of America, Wells Fargo and Citi) and you find that they own 35% of U.S. deposits, a market share figure that has been stable since 2013. Though blog posts and media coverage often claim incumbent banks are on their last legs, the data suggests otherwise. So then, what is driving the claims of victory for fintech? The obvious answer is growth.
The key metric to consider here is the relative equity value creation. Over the past 5 years an index of bank stocks have returned ~31%, while an index of fintech has returned ~93%. In other words, value is accruing to fintech at 3x+ the rate of the traditional banking system, and this gap will only widen as time progresses (e.g., banks continue to consolidate and cut costs, while high flying fintech companies like Ramp attract customers and eventually go public).
Below graphics compare stock price performance for Bank ETFs vs. Fintech ETFs
Working in fintech, I have a lot of friends that have long shifted away from the likes of JP Morgan into the welcoming hands of neo banks like Chime. They see the value in entrusting their finances to businesses that are able to prioritize creating a fantastic user experience (e.g., better UI, less annoying overdraft / banking fees, etc.) because they aren’t burdened by legacy infrastructure (e.g., mainframe tech, thousands of ATMs / physical locations, etc.) which empowers them to invest more (via lower fixed and marginal operating costs). I’m long fintech. My friends are long fintech. The VC community is long fintech. But ultimately the biggest supporter of fintech is the traditional banking system.
All of the fintech darlings that consumers and businesses love are enabled by the traditional banking system. One of the early fintech successes was Lending Club, founded a couple years before the Great Recession. They IPO’d in 2014, and in many ways, paved the path for the fintech explosion that has erupted since. The founders and employees made a killing off of the successful IPO. But one of the biggest winners of the IPO was none other than Wells Fargo, both as an investor and a banking partner. Fast forward to today and this trend continues.
- Better.com offers a digitally native mortgage origination platform to customers, empowering customers to raise capital for homeownership, without having to directly interface with a bank. But in the background, they’re backed by Goldman Sachs and Citi and harvest the capital they lend to their customers via the big banks’ balance sheets.
- Square (now Block) unlocked a new growth engine in bringing Square Banking to market last year. Businesses that leverage Square have a front-end relationship with them and as far as they’re concerned, Square is providing them the loans they need to fuel their growth. But on the back-end, Square is partnering with Sutton Bank, an old-fashioned, Ohioan institution founded in 1878.
- Affirm and other companies have created new payment modalities for my generation via Buy Now Pay Later. On the front end, it feels to me that I’m landing on whatever random direct-to-consumer website Zuckerberg’s algorithm has sent me to that week, and using interest-free money from Affirm to buy that thing that I don’t really need. But under the hood, Affirm is partnering with Cross River Bank and Celtic Bank to make it possible.
We must of course acknowledge the role regulation and lobbying has played in incentivizing cooperation between fintech and big banks, but the outcome is the same nevertheless.
To put this dynamic more succinctly, consumers and businesses are not abandoning the traditional banking system; they are just changing their relationship with it.
Banks once had front-end relationships with their customers. We would go to the local bank and meet with the same bank teller. Businesses would check in several times a year with the banker who originated their loan. But today, (fin)tech (increasingly) owns the customer relationship, and has relegated the traditional banking system to the back-office. Banks have become repositories of capital that more intelligent, tech-savvy companies draw from in order to provide value to their customers.
There will be parallels in the B2B software world as well, namely the emergence of Systems of Intelligence.
The Dawn of Systems of Intelligence
Rising B2B software vendors will increasingly extract and combine data from different systems to provide improved workflows and more value to customers, ultimately leading to the creation of a new B2B platform. Investors at Greylock addressed this concept in a 2017 paper titled The New Moats. If you haven’t read it. Do yourself a favor and check it out. There are a lot of concepts they walk through in the post. I will (poorly) attempt to summarize the most relevant ones.
It kicks off with a quote from the Sage of Omaha, Warren Buffet. “In business, I look for economic castles protected by unbreachable ‘moats’”. The article then talks through some of the traditional moats. Economies of Scale and Network Effects, followed by Deep Tech / IP / Trade Secrets and Brand and Customer Loyalty. All of these are critical to understand and you need some combination of them to build a world class business. But in my past life as an enterprise software / fintech investor, the most pervasive moat was High Switching Costs. The post comments on the power high switching costs can have in keeping legacy tech afloat. “Strong moats help companies survive through major platform shifts… high switching costs can partly account for why mainframes and “big iron” systems are still around after all these years. Legacy businesses with deep moats may not be the high growth vehicles of their prime, but they are still generating profits”. Ultimately, this moat fuels the resilience of enterprise tools most commonly referred to as ‘Systems of Record’.
Systems of Record are the original B2B, platform software businesses. A System of Record emerges when “the data and app power a critical business function.” For sales that is your CRM Platform (e.g., Salesforce). For HR that is your HRM Platform (e.g., Workday). Often there is an entire ecosystem of applications that get built around these Systems. CRMs have sales enablement software like Salesloft supplementing them, while HRMs will integrate with alternative application tracking systems like Greenhouse. In my view, these periphery applications often get squeezed in the long-run as the value continues to accrue to the Systems of Record. This occurs because ultimately it is the System of Record that maintains an invaluable resource for its customers, their data. This position allows them to both directly and indirectly apply pricing pressure to both the consumers and the applications around it and is ultimately the reason we haven’t seen too many successful HR or sales-tech IPOs over the last decade. Under pressure, these apps eventually either cut and run toward private equity or sell to a System of Record.
Systems of Engagement are another class of enterprise solutions that emerged over the past several decades. They act as “the interfaces between users and the systems of record and can be powerful businesses because they control the end user interactions.” One of the most famous examples in the U.S. for this would be Slack. Though a smashing success by most accounts, Slack became increasingly outmaneuvered by an entrenched System of Record by the name of Microsoft, who was able to leverage its position and offer competing solutions (Microsoft Teams), give them away for free and ultimately blunt the forward outlook for Slack’s business. To alleviate this dynamic, Slack ultimately sold to Salesforce, another System of Record. I wouldn’t be shocked if in the next couple of years, Zoom (whose stock is down ~80% from its peak) ultimately suffers a similar fate.
If the point solutions around Systems of Record sit in a precarious position, and beloved Systems of Engagement can also get squeezed, it begs some concern. The article asks: “In this current wave of disruption, is it still possible to build sustainable moats?” The answer is an emerging, future platform dubbed the System of Intelligence.
“Systems of intelligence are the new moats… What makes a system of intelligence valuable is that it typically crosses multiple data sets, multiple systems of record… For a startup to thrive around incumbents like Oracle and SAP, you need to combine their data with other data sources (public or private) to create value for your customer…In all of these markets, the battle is moving from the old moats, the sources of the data, to the new moats, what you do with the data.”
I would argue that this is exactly what Salesforce is trying to create through its acquisition of Slack. A combination that can extract data not just from Salesforce but from other systems of record as well, and deliver actionable insights to its customers (via Slack’s messaging application interface). We’re clearly seeing the early pivots of this on the sales-tech side (i.e., the original SaaS application). However, what have been the innovations for the ERP tools (SAP and Oracle) that the post briefly touched on back in 2017?
Unbundling the ERP
There is a recurring pattern where new vendors unbundle legacy platform tech solutions into different components to improve workflows, and then eventually re-consolidate to streamline tech management.
ERPs have long been a critical System of Record for the Office of the CFO, but sadly, they’ve been notoriously difficult to work with. SAP for example has struggled with customer satisfaction for years. They’ve made moves toward becoming a more intelligent platform with the release of S/4HANA, but 7 years later customers are still having issues with this cloud version and have attempted to delay transitioning. Nevertheless, as was the case with the traditional banking system, it would be ridiculous to claim ERPs are going anywhere anytime soon. As the core System of Record, ERPs function as repositories of granular, time-series financial data, requiring that finance professionals and others interact with them directly and indirectly every day. Similar to what Salesforce has done for sales-tech, ERPs are also responsible for enabling an ecosystem of hundreds of applications — which has not only benefited these upstart applications, but also the incumbents. Since I started following software and fintech, I’ve long heard chatter and longing for the ‘Next-Gen ERP’ that might disrupt the incumbents. And yet, as of today SAP and Oracle alone are worth a combined $350 billion in market cap and continue to generate positive IRR for investors — a true testament to the power of High Switching Costs. So where is the chink in their armor? Again, we look at relative equity value capture.
While SAP has grown its stock price by ~12% over the past 5 years. There is an ecosystem of applications around it that have thrived by unbundling core workflows that ERPs (theoretically) offer, but doing it better.
Below graphics compare SAP’s stock price performance vs. stock price performance for various fintech companies within their ecosystem
Despite being a relatively old company with a dated UI/UX, Bill.com (founded in 2003) share price has seen over 400% appreciation in the ~3 years since it IPO’d. It’s done so by offering a superior accounts payable experience to its users vs. legacy ERPs.
Anaplan, which recently announced a take-private by Thoma Bravo, grew its stock price by over 150% in the last 3 years by empowering users to budget / forecast more effectively than the ERPs allowed.
There are dozens more examples I could continue to highlight between disruptive companies raising at $3 billion dollar valuations for improved accounts receivables workflows, to newly minted unicorns offering a better cloud-based treasury management experience and of course successful public debuts for tax software. The clear trend is that different next-gen vendors are building point solutions that pull information out of the ERP to provide a more dynamic workflow experience than what the ERPs were once responsible for, and pushing the information back into the ERP once complete. While these vendors have dramatically improved efficiency, they are unbundling an ever increasing amount of niche workflows, which can become a pain for businesses (I realize the shameless marketing incentives behind the author of that article, but I digress).
The dynamic I’m presenting is part of a natural, recurring cycle. First new tech unbundles solutions provided by the incumbent, offering more insights and efficiency. Then, these superior point solutions gain adoption. Next, the best solutions extend into logical adjacencies, and then into further adjacencies (either organically or via M&A), until eventually, the market gets tired of managing hundreds of niche offerings and consolidates under new, leading platforms. Since consumers are more flexible in adopting new tech than businesses, this has occurred more quickly in consumer-facing industries like neo-banking.
Revisiting Neo-Banking: The Consumer Super App
Over the last 10–15 years fintech companies unbundled consumer banking into various improved, digitally-native solutions — today, we’re starting to see a reversal of this trend via consolidation.
I mentioned Square earlier. On the consumer side, they started with the launch of Cash App in 2013 (peer-to-peer payments offering a more convenient solution relative to wires / ACH). Then, after allowing users to hold cash within the application, they launched a new debit card experience in 2016. A couple years later, bitcoin & then investing became the killer pivot. Most recently, Square pivoted toward Buy Now Pay Later with the acquisition of Afterpay (competitor to Affirm) last year. This might appear like a series of interesting, somewhat disconnected product moments to some. But I believe the Cash App team is clinical, releasing a couple key offerings per year with intentionality.
Square understands that while at first, consumers were happy to unbundle their bank into various consumer apps serving specific fintech use-cases (i.e., Robinhood for investing, Venmo for P2P payments, Coinbase for crypto, Affirm for BNPL, Sofi for lending, etc.), once the new product offerings in the market reached parity, consumers want to consolidate under one streamlined vendor (High Switching Costs of course slows this process). I can personally attest to consolidating my apps already. I believe point solutions will have challenged futures given the ever increasing customer acquisition costs and decreasing forward outlook for new customer lifetime value, and my hunch is that the majority of these consumer fintech solutions (e.g., LendingClub, Sofi, Robinhood, Affirm, etc.) will struggle to reach the peaks they did during their public debuts. Excited investors were wildly off in forecasting the present value of future cash flows due to either (i) underestimating the ability for existing platforms to compress their own take-rates and reduce the forward outlook for industry profits, or (ii) overestimating the ability for these point solutions to ultimately expand into platforms themselves (Robinhood, SoFi and others are trying with varied success to expand their platform).
Below graphics convey consumer fintech’s challenged stock price performance post IPO
Square however, has a clear vision in the wake of these market dynamics. Ultimately, they seek to build the consumer financial ‘Super App’.
The original Super App was WeChat who successfully executed on this consumer fintech consolidation play in China (and at the risk of sounding like a broken record, WeChat is also enabled by the traditional banking system). They did this through succeeding in offering an effective wedge, messaging. Square intends to follow that blueprint after building on its wedge, P2P payments. It’s worth pointing out that Square isn’t the only one with these ambitions. Many increasingly point to Apple, Paypal and others as potential competitors. The nut that all of these consumer (fin)tech companies have cracked is that through delivering an superior consumer experience on a critical use-case, they first built ownership over the customer, and from there extended into providing more dynamic, higher-stakes workflows. These workflows were only possible through seamlessly pushing and pulling information into the dumb, financial repositories of old (i.e., the traditional banking system). As an aside, I can’t overstate the importance new infrastructure tools like Plaid have played in enabling this seamless transfer of information across fintech and the traditional banking system.
Business innovation often trails consumer paradigm shifts. But eventually businesses and consumers can converge. I believe a similar dynamic will occur on the B2B side.
When ERPs Take a Back Seat
The next great B2B software application won’t be built through overthrowing the ERP. It will be built simply through changing a customer’s relationship with it — relegating ERP’s to the back office.
Like the railroads and (eventually) the traditional banks, ERPs will still be there, playing an important role. They’ll just be an invisible back-end, focused on consolidating and retaining the data that a more intelligent system seamlessly calls on (in conjunction with data from other sources) in order to provide insights to the end user. These end users, frankly might not even realize the ERP is there. Newly hired finance professionals over the next decade will continue to leverage ERPs to execute the same workflows that are required today. From tax compliance, to AP / AR automation, to treasury management and FP&A planning. It’s just that they’ll do it a hell of a lot more quickly and more accurately via a B2B ‘Super App’ equivalent that sits on top and has the customer’s true brand loyalty. This app won’t just sit there, ready to engage when you are, but will be proactive and engage you when you need it.
Note: the relative simplicity of consumer applications allows Super Apps to be built largely via organic innovation — conversely, the B2B Super App will require more partnerships and/or M&A. Some Companies like Workday are already attempting to position themselves as this platform.
ERPs will certainly fight this inevitability in the short-term, opting to acquire emerging software companies that offer superior offerings to their own. But it will be futile. Similar to how the traditional banking system’s legacy infrastructure and shareholders (who optimize for ROE and P/E multiples) make it impossible to appropriately compete for future equity value creation. The ERPs legacy infrastructure (e.g., sprawling employee base, disorganized product strategy) and shareholders (who optimize for margin and EBITDA multiples) will make it impossible for ERPs to invest and drive true innovation for their core customer. Growth will accrue disproportionately, first to a plethora of more nimble point solutions, and inevitably a superior, intelligent platform. We will pair-purchase this intelligent platform and ERPs , but who knows, in a couple decades might purchase only this intelligent platform (similar to how Gen Z / Gen Alpha could eventually bank exclusively with the Consumer Super App).
For well over a decade investors, companies and business users alike have complained about ERPs, wondering when a magical company will disrupt and render them a relic of the past. I believe ERPs aren’t going anywhere soon, and will play an important role for many years. But over the next 10–20 years, finance professionals will slowly forget that they’re even there. As we all slowly, but surely, start to engage with and build alongside the Intelligent Financial System of the Future.
Definitions
DeFi = Decentralized Finance
DAO = Decentralized Autonomous Organization
ERP = Enterprise Resource Planning Software
CRM = Customer Relationship Management Software
HRM = Human Resources Management Software
CAC = Customer Acquisition Costs
LTV = Customer Lifetime Value
