Investing in Software Infrastructure in a Downmarket
While the market is down on software infrastructure, it’s still a great time to build! Below are some trends we think will be behind new investments.
By: Robby
Software infrastructure companies have been hit hard by the market downturn of 2022. While the NASDAQ composite is down (20%) YTD, high-flying software infrastructure companies including Cloudflare, Confluent, Hashicorp, Okta, and Snowflake are down by even more — the average public software infra company is down a whopping (40%) in 2022.
Software infrastructure, which we broadly define as developer, data, and security tools, is expected to be resilient through a downturn. Business models are typically recurring SaaS, and this category of software is hard to cut. If you get rid of the tools your team needs to build, ship, secure, and manage software, day-to-day operations will come to a halt.
However, software infrastructure companies haven’t been immune to today’s downturn. And while companies at scale are dealing with layoffs, hiring freezes, and managing large teams, new opportunities to build are being left open.
Historically, public market and economic downturns have been a great time to build new tech companies that ultimately become category leaders. We’re excited to find the bold seed-stage founders taking this time to look at the software infrastructure landscape and identify opportunities. Some ideas from us are below.
1. Cloud cost management becomes a top priority
2. Developer productivity tools turn into must-haves
3. Open source demand rises
1. Cloud cost management becomes a top priority
Since the start of cloud computing in 2006 when AWS launched¹, outsourcing the set-up and management of software infrastructure has become the norm. While moving a fixed cost to a variable cost is arguably the most significant benefit of moving to the cloud, controlling cloud costs is challenging.
In a down market, cloud cost management moves up in importance. Gross and operating margins are bigger factors in company valuations, and cloud costs are one of the most impactful line items.
When assessing tools to manage cloud costs, key factors to buyers will be the quantitative benefit, time to cost savings, and the continued ROI of using the tool over time. We also believe the next generation of cloud cost management tools will be adopted bottoms-up, like many other developer tools are today.
Cloud cost management has historically been a mandate that comes from directors and VPs. However, in order to truly optimize cloud costs, individual engineers must be involved in the process. They are on the frontlines making resourcing decisions.
Reworking software after the fact to make it less cost-intensive is time-consuming and suboptimal. We think that companies in this category that can insert themselves into the development process, and delight individual engineers, will ultimately come out on top.
One company that does this today is Infracost. Their platform allows individual engineers to see cloud costs before launching resources, involving them in the cloud cost management process in the development stage.
Below, we’ve mapped out the cloud cost management space to show how tools in this category are positioned². We think demand in this category will go up — with innovation from new startups to follow.
2. Developer productivity tools turn into must-haves
Everyone needs to do more with less in a downturn, including software developers. Countless tech companies have announced layoffs or hiring freezes including Robinhood, Meta, Coinbase, Oracle, and many others. This impacts engineering capacity, while customer demand for new features and improved product experiences remains unchanged. Developers will need tools that help them do more with fewer people.
Luckily, there are tools that can help. This category we call “developer productivity” — and we think it will be massive. It includes tools that automate creating code, understanding code, shipping code, and managing developer output.
One of the strongest examples of a developer productivity tool that has, and will continue to, capture developer mindshare is GitHub CoPilot. Put simply, this product collaboration between GitHub and OpenAI is an AI assistant that helps developers write code. It first launched as a free preview to 1.2M developers in 2021 and was just released to GitHub’s entire user base of 83M+.³
Other companies focused on developer productivity include next gen terminals and terminal add-ons that help developers create code faster such as warp.dev, Fig, and Zed; code understanding and documentation tools Sourcegraph, CodeSee, and Documatic; and developer workflow automation tools Trunk and Aviator
Tools that help developers and their managers analyze output are also more important as teams try to ship more code with fewer people. Tools in this category include Code Climate, DX, Jellyfish, Linearb, Haystack, Intuned, and Uplevel.
It’s important that new tools in this category are loved by individual developers and not just managers or leadership. Otherwise, developers may feel like they’re being micro-managed, with every code commit analyzed, ultimately hurting culture and retention.
3. Open source demand rises
What started as a niche model for a few software engineering categories has become the standard across developer tools — and we see open source going much further than that. We believe today’s market will push more tooling categories towards open source — including data science, analytics, and security.
If given the option, the average tech buyer would be more likely to buy a product that they were first able to try for free. That is especially true when budgets are tight. Open source offers that — along with so much more.
For starters, in a true open source model, you can fully integrate the “free” open source product without committing to buying anything.⁴ Developers can get a sense of product quality and stay in “free mode” for as long as they want. This is a compelling alternative to a trial with an end date and/or product that’s only lightly integrated and can’t be fully tested before it requires payment.
Additionally, there are entire communities supporting open source projects, in addition to the customer support offered by commercial products on top.
Community members can also be product contributors. One example is Airbyte, an open source data integration company whose community builds new connectors that are folded into the product.
A benefit of open source that isn’t often discussed, but matters a lot today, is resiliency. Over the past few years, we’ve seen companies with unsustainable business models get created, and it’s hard to tell from the outside how healthy they actually are. Many will NOT withstand a market correction long-term.
From a customer’s perspective, this increases the risk of adopting and renewing software that could cease to exist in a year or two. If that happens after a tool has been integrated into day-to-day operations, it can be highly disruptive. With open source, the core software will continue to exist even if the company doesn’t, lowering the risk for users.⁴
There is a catch-22 with security that comes with dependence on open source, which in itself is a big opportunity, but that’s for another post to unpack.
At Cowboy, we’ve been believers in open source for a long time. It’s why we started the Open Source Startup Podcast with Tim Chen of Essence VC. Together, we’ve interviewed 40+ founders of the top open source companies to learn how the model helped them be successful.
Over the past few years, we’ve seen a stark increase in demand for open source outside of developer tools. This includes tools for data scientists and analytics engineers such as DBT, Airbyte, Elementary, and Prefect. We think this trend will continue — with the next generation of successful software infrastructure companies being majority open source.
In summary
At Cowboy, we’re always re-assessing the pain points in the categories we invest in given shifts in the broader market. We hope this post sheds light on our investment thinking for software infrastructure. If you’re a founder that is building with the above areas in mind, we’d love to talk! Feel free to email robby@cowboy.vc 👩💻
PS if you’re interested in where we’re looking to invest in FinTech given today’s climate, check out my colleague Jill Williams’ post here!
1/ Followed by Google with their cloud platform’s general availability launch in 2011 & Azure’s launch in 2010.
2/ Representative cloud cost management tools.
3/ For more on GitHub CoPilot and other large language model applications, check out my friend Leigh-Marie’s excellent post here.
4/ This assumes an open core model where the company provides products and services on top of an open source core.
