SaaS and the Subscription Economy: How Cloud Software Is Reshaping Business Competition and Market Concentration
The economic narrative in enterprise software is less about innovation than it is about lock-in. As a result, the paradigm will shift from one-time purchases to recurring subscription models for the majority of software opportunities, allowing for an increased concentration of market power and increased costs associated with customer switching to another vendor for the majority of software types.
The primary driver of this paradigm shift is the concept of increasing returns to scale; however, the SaaS (not all software) model can magnify the effects of increasing returns compared to traditional manufactured goods.
Historically, traditional manufacturing has been characterised as having diminishing returns to scale after a certain point; adding inputs to the manufacturing process eventually results in additional costs associated with producing additional units. On the other hand, once the code is written for software, regardless of whether it is a single-use or unlimited-use license, there are essentially no costs associated with distributing it to the 10 millionth customer excluding the costs of running the server and providing customer support. Combine this with the exponential effect of network usage — i.e., SaaS companies increase their platforms' value as users continue to join the SaaS ecosystem — and SaaS companies achieve self-reinforcing market power that would have been virtually impossible to create in the vast majority of traditional physical limits.
W. Brian Arthur, an economist, was the first to formally describe the principles of increasing returns in his work. However, Arthur's principles have become more fully expressed in modern cloud computing, where the economic benefits of increasing returns have become a reality.
Furthermore, SaaS companies have been able to achieve massive market penetration — in fact, SaaS companies were the fastest growing segments of the technology sector in overall growth and future projections.
Statista indicates that global SaaS revenues is projected to reach $512.27 billion by 2026. The five largest enterprise software companies — Microsoft, Salesforce, Oracle, SAP, and ServiceNow — currently control a large portion of the SaaS global market, and this concentration of market power is growing rather than diminishing. Microsoft's cloud division alone generated revenues of $135.7 billion in fiscal year 2024 or a year-on-year growth rate of 21%. These five companies do not operate on a level playing field; rather, they have established their dominance in the SaaS market by leveraging their former dominant positions in the development of enterprise software.
This concentration of market power is driven by three reinforcing mechanisms.
First, the high cost associated with switching from one vendor to another: enterprise software becomes embedded in the workflow, the structure, and the organisational culture and way of working with data over a long period of time. Companies that migrate away from Salesforce CRM, for example, or Microsoft 365 will incur costs associated with re-educating and re-training employees, migrating their data, recreating their integrations with the existing vendor, and incurring productivity losses measured in the millions of dollars. Additional costs associated with using a second vendor's software are not merely related to switching to that product; there are also costs associated with adapting to a different vendor's product.
The second reinforcing mechanism is data network effects. Data network effects result when users of SaaS products build a vast repository of operational and user behavioral data that can be used to make their enterprise valuable; therefore, as time goes on, these products are becoming more and more useful to their users, making it less likely that they will switch to another vendor's SaaS product.
The third reinforcing mechanism is bundling. Microsoft's decision to bundle Teams with Microsoft 365 was investigated formally by the European Union in 2023. By bundling products together in a package deal, Microsoft leveraged its entire subscriber base in order to eliminate the opportunity for competitors to achieve market share.
Salesforce provides unmistakable evidence of how aggressively companies that operate within the SaaS framework are capitalising on market potential. Organizations navigating this landscape can benefit from specialist guidance; Cloudfresh helps businesses evaluate, migrate, and optimise their enterprise software ecosystems. Salesforce began as a single product (CRM) company; however, it has successfully expanded into an integrated platform known as "Customer 360" by acquiring multiple companies, such as MuleSoft, Tableau, and Slack. Each acquisition raised switching costs for existing Salesforce CRM customers and increased the number of potential new customers. Salesforce has created an ecosystem around the Salesforce brand; therefore, any organization that finds itself within the Salesforce ecosystem will face significant obstacles in finding alternatives to Salesforce products. Salesforce's direct revenue increased to over $34 billion by the end of fiscal year 2024, and their customer retention rate remains above 90%.
As a result, it raises the question of whether an effective response is possible through the use of traditional competition tools that have evolved to address the dynamics of industrial markets via the introduction of increased utility costs and switching costs over time. There are many such examples, including but not limited to thresholds imposed by regulators (e.g., EU Digital Markets Act) to ensure there is enough competition at various levels of the market and reduce barriers to entry to reduce switching costs. At this point, it is unclear if these types of interventions will be able to effectively reduce switching costs or if the structural inertia that currently exists in the enterprise software market can be successfully addressed through the use of regulatory intervention.
