"Despite this explosion of new software, the software industry itself is shrinking. In 2005, the aggregate market capitalization of the software sector shank by almost 10% despite the broader NASDAQ market being up 1.4%. Even if one adjusts that number to account for privatizations, M&A and IPOs, the software market still shrank by 9%. This shrinkage is also apparent when looks at the raw number of public software companies. There were 236 public software companies at the start of 2005, but only 213 at the end of the year, a decline of 10%. Put another way, for every new software company that went public in 2005, almost 7 were acquired or went out of business. Not exactly an encouraging picture."

"Open Source and SaaS. The modern software market was built on the backs of large one-time perpetual license sales. Unfortunately two major trends are conspiring to make it increasingly difficult to grow revenues quickly: Open Source and SaaS. Open Source basically flips the revenue model: it gives away the source code up-front and tries to make money on the back-end by charging for support. SaaS (Software as a Service) allows companies to purchase software "on demand" over the web. As a result, SaaS requires little or no up front investment from a customer and is often purchased on a short term subscription plan. The lack of large up-front payments makes it very difficult to grow SaaS revenues quickly and reduces margins because the company actually provides a real service as opposed to just shipping a disk. Thus, as Open Source and SaaS gain prominence it's becoming increasingly clear to investors that the good old days of 200% revenue growth/year at 95%+ gross margins are gone for good and stock multiples are responding by heading south."