Reversal of fortune: How European software can play to its strengths

In 2011, renowned US tech entrepreneur and venture capitalist Marc Andreessen published an essay entitled “Why Software is Eating the World,” arguing that value would shift away from traditional industries to providers of software and software-enabled services and products.

It was a prescient thesis. In the past decade, the software sector has grown at twice the rate of the aggregate of all industries

—a disparity only reinforced by the rapid acceleration in digital behaviors the COVID-19 pandemic has fueled. While the global economy shrank by 3.3 percent in 2020 compared with 2019, revenue in the software industry grew by 2.7 percent and is expected to grow at more than twice the rate of world GDP over the next five years.

What Andreessen did not assess, however, was how software might also eat away at the strength of certain parts of the global economy, such as Europe, for instance. By September 2021, seven of the ten most valuable companies in the world were software or software-enabled companies, reflecting the sector’s growing economic importance. And the year before, well over a third of the 100 most valuable companies in the United States came from the sector, as did about a quarter of those in Asia. In Europe, however, that figure stood at just 7 percent (exhibit). Today, not a single European company features on the list of the world’s ten most valuable software and software-enabled companies, and there are just three among the top 20.

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Those kinds of large companies can have a potentially disproportionate impact on a region’s economic competitiveness. The winner-takes-all dynamic prevalent in the software sector dictates that larger players enjoy significant advantages, creating powerful ecosystems that attract more partners and customers. And because software is largely a fixed-cost business, the margins they enjoy as they expand can be used to fund further innovation and expansion—including the purchase of smaller players globally. Hence, unless start-ups grow rapidly and become leaders themselves, they are likely to be acquired or outcompeted by industry giants.

Building more market-leading software and software-enabled companies is thus critical to Europe’s future in the sector and for its overall economic competitiveness and vibrancy. But how can this be accomplished? To identify solutions, we spoke with more than 20 key participants in the software industry, including CEOs who were leading or had led software companies in Europe and in the
United States, investors, software experts, leaders of industry associations, and public-sector representatives.

European software solutions

Some solutions proffered by the interviewees were familiar, namely, calls for government assistance to help overcome barriers caused by Europe’s market fragmentation, labor policies, and certain regulations. They address the same barriers often cited as impediments to the development of AI, digitalization, and start-ups in Europe, and range from more actively promoting technical fields of study in universities to providing fiscal and capital incentives for investors and streamlining and harmonizing regulations.

The interviewees further asserted, however, that the private sector—software companies, companies that use software, and investors—has a big role to play.

One common message was the need for a cultural shift. There was a perception that European investors and entrepreneurs had lower growth ambitions and, not surprisingly, a lower appetite for risk. Some interviewees felt Europeans’ discomfort with the risks associated with growth was partly responsible for what they see as a focus on short-term profit rather than value creation in the medium and long term. “European entrepreneurs tend to be conservative. They are often more willing to cash out than their American counterparts,” was the perception of one interviewee. “In consolidation scenarios, European companies often prefer to be the seller rather than buyer,” another commented.

On a broader scale, the interviewees proposed an overarching strategic shift to help European companies succeed in the software industry. They encouraged the sector to focus on areas where Europe could leapfrog ahead by playing to its strengths, rather than trying to play catch-up in areas already dominated by others. “A strategy that entails copying the greatest US hits may, in some cases, have provided solid returns, but it is certainly not a formula for building software giants,” said one interviewee. At the same time, on a more practical level, the interviewees noted the importance of embracing state-of-the-art operating practices to help new companies scale rapidly and overcome the inherent disadvantages of a fragmented market (See sidebar, “European software executive perspectives,” for more views).

Our interviews and research point to three areas where Europe could take a lead and build large players by playing to the continent’s strengths: vertical B2B software, software platforms for digitizing small and medium-size enterprises (SMEs), and horizontal platforms built on European R&D excellence.

Vertical B2B software

The annual global market for vertical software, which powers industry-specific processes, currently stands at around $100 billion and is expected to grow at an annual rate of some 19 percent over the next five years. That level of growth not only exceeds that of more general functional or horizontal software but would be strong enough to support existing software companies as well as a number of new, global champions.

Many of the largest B2B software companies have already made moves to establish themselves in the space. Salesforce has acquired Vlocity, a start-up with industry-specific solutions; Oracle has made multiple acquisitions of software companies that serve industries such as construction, communications, retail, and hospitality and travel; and SAP, Europe’s largest software company, has launched an industry cloud to provide solutions for many verticals. Notwithstanding, the field still remains relatively open, and Europe has grounds on which to build leadership.

It is important to note that Europe already has a strong position in a number of industry verticals such as automotive, construction, pharmaceuticals, and travel, giving would-be European software giants valuable access to target customers in order to understand their businesses and emerging needs and develop close working relationships.

Software companies could then choose to build and scale their own solutions or consolidate assets with other software companies to build scale. They could even join forces with companies in the target industries to create new solutions. And large industrial companies could leverage their own software assets by treating them as truly separate businesses. On these last two points, Europe has a strong track record with two of the three most valuable software companies in the continent (Dassault Systèmes and Amadeus) emerging from the initiative of the vertical industries involved.

Amadeus, a global airline reservations system, was formed in 1987 in a collaboration between Air France, Iberia, Lufthansa, and SAS. It has since grown to become a world leader in this segment, expanding to provide software for airlines, hotels, and airports and establishing itself as one of Europe’s largest and most valuable software companies.

Dassault Systèmes has carried off a similar feat in aerospace and heavy engineering. It was created in 1981 when Dassault Aviation spun off its software division in a strategic partnership with IBM, aiming to commercialize its computer-aided aircraft design software. Today, the company is the second most valuable software company in Europe and is recognized as a global leader in software for 3-D product design, simulation, manufacturing, and more. Recently, it expanded into pharmaceuticals, providing software for drug development and the development of COVID-19 vaccines.

Cross-border platforms for SMEs

SMEs—small to medium-size enterprises with fewer than 250 employees—dominate the European Union’s economy, accounting for more than 50 percent of GDP and 65 percent of employment. In the United States, the figures are around ten to 15 percentage points lower.

Despite that prominence, European SMEs have been slow to digitize, and large B2B software companies tend to not serve the sector, regarding it as a niche market in which local companies can compete more effectively. Nevertheless, European SMEs have been significant spenders in technology, with companies with
fewer than 1,000 employees spending more than $30 billion a year on software alone (nearly
half of which is spent on vertical- or industry-specific software).

That demand is likely to grow as the COVID-19 crisis has prompted SMEs, like larger organizations, to recognize the importance of digitization if they are to buy, sell, and collaborate remotely. Aspiring software champions have the opportunity to meet that demand and grow it further by building large SME platforms that span Europe and beyond and offer newer, more advanced solutions such as predictive AI or Internet of Things (IoT).

The largest software companies currently exploring this seemingly fertile ground are not European—Intuit being an example. And even Stripe, a software-enabled payments company now dual headquartered in the United States and Ireland, was started by its Irish founders in California. Notwithstanding, a crop of new European companies are emerging in areas from financial management to process automation. Amsterdam-based fintech unicorn Mollie, a payments services provider, is one such player.

Horizontal platforms built on European R&D excellence

European private investment in R&D lags well behind that in other regions—1.4 percent of GDP compared with 2.2 percent in the United States and 1.7 percent in China.

Some interviewees noted that this was consistent with what they see as the short-term focus and moderate growth ambitions of European companies and investors. Others felt that European companies lacked confidence in their ability to innovate.

In contrast, Europe performs well when it comes to R&D in the public and educational sectors, spending 0.7 percent of GDP compared with 0.5 percent spending in China and 0.8 percent in the United States.

This is reflected in its academic record: Europe is home to 16 of the top 50 global life-science universities and is recognized as a world leader in some spheres, such as cell and gene therapy (CGT) research. Between 2017 and 2019, it published some 120,000 CGT research papers whose lead authors were affiliated with a European institution. Equivalent figures for US and Chinese papers were 72,000 and 100,000, respectively.

The interviewees felt that investors and companies could work more closely with European research universities and institutions to translate this kind of basic research into economic value and market leadership. In doing so, they could emulate the model used in technology hubs in Silicon Valley, Boston, Austin, or North Carolina’s Research Triangle, where local companies cofund many projects with top educational institutions, and investors are quick to identify new ideas and talent from those institutions to help create new companies and innovative products and services.

Similar hubs are being built in Amsterdam, Barcelona, Berlin, and Paris, and there is a “golden triangle” in England with strong ties to top-tier UK universities based in Cambridge, London, and Oxford. This hub kick-started the lion’s share of the United Kingdom’s approximately 100 unicorns and attracted venture capital worth $15 billion in 2020.

Notwithstanding, our interviewees believe that Europe’s academic strength is not being used to its full advantage. They felt that government promotion of hubs could help, but companies and investors are ultimately those that must forge the links.

European companies can also help shape the agendas of academic and research institutions, as these are not always aligned with future economic priorities. For example, as of October 2021, Europe’s share of patents granted in three high-potential technology areas—edge computing, computer vision, and blockchain—stood between 9 and 11 percent. The US share was 72 to 88 percent and Asia’s 8 to 19 percent.

Operational and management best practices

European companies seeking to become big players would need to think about how to adopt the software industry’s operational and management best practices in order to overcome the challenge of a fragmented European market. They will also likely need to build scale—fast. Two practices stand out.

Scalable sales models. Chinese and US software companies can build scale quickly given their huge home markets. In Europe, analysis shows that it takes companies time to expand across multiple smaller markets—time software companies do not have if they want to compete for global leadership. One interviewee went as far as to suggest that some companies—those with novel, deeply technical applications that do not depend on local knowledge, for example—might even eschew the European market and expand in the United States first. “Country-by-country expansion within Europe is too time-consuming, giving US and Chinese competitors the chance to catch up and occupy those markets,” one CEO told us. A United States–first approach is one that many Israeli and Indian technology companies have used successfully.

Companies that focus on Europe initially could consider remote-sales-hub models to speed expansion, rather than rely exclusively on country subsidiaries. Often adopted by US companies entering Europe, the model entails creating pan-European, “inside sales centers” in locations where many prospective employees are multilingual—Barcelona, Dublin, and Tel Aviv, for example—and can drive sales remotely. Our analysis suggests that such a sales model can be 25 percent more productive than a field-sales-only model if used with the right set of accounts and with effective operational practices and tools. In fact, operational excellence is such a critical differentiator that the sales ROI of the top quartile of inside-sales organizations are more than double that of the bottom quartile.

World-class product and development management. Interviewees pointed out that European companies are often slow to adopt the latest development tools and architectures. “The larger ones in particular are often less likely to move fast on new-technology adoption,” said one interviewee. This, in turn, impacts growth. On average, top-quartile software organizations grow roughly four to five times as fast as bottom-quartile performers with respect to developer velocity, our research shows, and these fast growers are largely based in the United States. Growth (or lack of it) then feeds into valuations: only three of the ten most valuable companies in Europe enjoy an enterprise-value-to-revenue multiple comparable to or higher than the median US software-as-a-service (SaaS) company.

Several interviewees emphasized there was a perceived shortage of product managers. “Europe has great talent, but loses more than it attracts,” said one, partly due to greater financial rewards elsewhere. “The critical combination of technical skills coupled with strong business judgment and an entrepreneurial mindset is hard to find in Europe,” said another. Interviewees wanted to see governments help build and attract the talent needed by, for example, promoting programs to help international software talent live and work in Europe or global or regional university rotation programs to expose promising European talent to more ambitious environments. But to win at a global scale, software companies would likely have to establish a high-quality, end-to-end operating model for product management, central to which will be talent management.

Israel perhaps serves as the strongest proof that smaller countries can thrive in the global tech economy. Its well-studied start-up ecosystem has produced outsize successes, with companies such as Amdocs, Check Point, and NICE now global software players, and the likes of and SentinelOne having had successful IPOs in the United States.

While the public sector can help European companies make a similar leap, entrepreneurs, investors, and private-sector companies have an important and urgent role to play too. They cannot wait for conditions to change before taking action. To prevent software gnawing away at the competitiveness of many of its industries and its economy, Europe must aspire to generate global software and software-enabled companies within the next decade by taking a new, bold approach that builds on its strengths rather than trying to make up for its weaknesses.