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This week, Hewlett-Packard (where I am on the board) announced that it is exploringjettisoning its struggling PC business in favor of investing more heavily in software,where it sees better potential for growth. Meanwhile, Google plans to buy up thecellphone handset maker Motorola Mobility. Both moves surprised the tech world. Butboth moves are also in line with a trend I've observed, one that makes me optimisticabout the future growth of the American and world economies, despite the recentturmoil in the stock market.

In short, software is eating the world.

More than 10 years after the peak of the 1990s dot-com bubble, a dozen or so newInternet companies like Facebook and Twitter are sparking controversy in SiliconValley, due to their rapidly growing private market valuations, and even the occasionalsuccessful IPO. With scars from the heyday of Webvan and Pets.com still fresh in theinvestor psyche, people are asking, "Isn't this just a dangerous new bubble?"

I, along with others, have been arguing the other side of the case. (I am co-founder andgeneral partner of venture capital firm Andreessen-Horowitz, which has invested inFacebook, Groupon, Skype, Twitter, Zynga, and Foursquare, among others. I am alsopersonally an investor in LinkedIn.) We believe that many of the prominent newInternet companies are building real, high-growth, high-margin, highly defensiblebusinesses.

Today's stock market actually hates technology, as shown by all-time low price/earningsratios for major public technology companies. Apple, for example, has a P/E ratio ofaround 15.2—about the same as the broader stock market, despite Apple's immenseprofitability and dominant market position (Apple in the last couple weeks became thebiggest company in America, judged by market capitalization, surpassing Exxon Mobil).

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ESSAY

Why Software Is Eating The World

August 20, 2011By MARC ANDREESSEN

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And, perhaps most telling, you can't have a bubble when people areconstantly screaming "Bubble!"

But too much of the debate is still around financial valuation, asopposed to the underlying intrinsic value of the best of Silicon Valley'snew companies. My own theory is that we are in the middle of adramatic and broad technological and economic shift in which softwarecompanies are poised to take over large swathes of the economy.

More and more major businesses and industries are being run on software and deliveredas online services—from movies to agriculture to national defense. Many of the winnersare Silicon Valley-style entrepreneurial technology companies that are invading andoverturning established industry structures. Over the next 10 years, I expect many moreindustries to be disrupted by software, with new world-beating Silicon Valley companiesdoing the disruption in more cases than not.

Why is this happening now?

Six decades into the computer revolution, four decades since theinvention of the microprocessor, and two decades into the rise of themodern Internet, all of the technology required to transform industriesthrough software finally works and can be widely delivered at globalscale.

Over two billion people now use the broadband Internet, up from perhaps 50 million adecade ago, when I was at Netscape, the company I co-founded. In the next 10 years, Iexpect at least five billion people worldwide to own smartphones, giving everyindividual with such a phone instant access to the full power of the Internet, everymoment of every day.

On the back end, software programming tools and Internet-based services make it easyto launch new global software-powered start-ups in many industries—without the needto invest in new infrastructure and train new employees. In 2000, when my partner BenHorowitz was CEO of the first cloud computing company, Loudcloud, the cost of acustomer running a basic Internet application was approximately $150,000 a month.Running that same application today in Amazon's cloud costs about $1,500 a month.

With lower start-up costs and a vastly expanded market for online services, the result isa global economy that for the first time will be fully digitally wired—the dream of everycyber-visionary of the early 1990s, finally delivered, a full generation later.

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Perhaps the single most dramatic example of this phenomenon ofsoftware eating a traditional business is the suicide of Borders andcorresponding rise of Amazon. In 2001, Borders agreed to hand over itsonline business to Amazon under the theory that online book saleswere non-strategic and unimportant.

Oops.

Today, the world's largest bookseller, Amazon, is a software company—its core capability is its amazing software engine for selling virtually everything online,no retail stores necessary. On top of that, while Borders was thrashing in the throes ofimpending bankruptcy, Amazon rearranged its web site to promote its Kindle digitalbooks over physical books for the first time. Now even the books themselves aresoftware.

Today's largest video service by number of subscribers is a software company: Netflix.How Netflix eviscerated Blockbuster is an old story, but now other traditionalentertainment providers are facing the same threat. Comcast, Time Warner and othersare responding by transforming themselves into software companies with efforts suchas TV Everywhere, which liberates content from the physical cable and connects it tosmartphones and tablets.

Today's dominant music companies are software companies, too: Apple's iTunes, Spotifyand Pandora. Traditional record labels increasingly exist only to provide those softwarecompanies with content. Industry revenue from digital channels totaled $4.6 billion in2010, growing to 29% of total revenue from 2% in 2004.

Today's fastest growing entertainment companies are videogame makers—again,software—with the industry growing to $60 billion from $30 billion five years ago. Andthe fastest growing major videogame company is Zynga (maker of games includingFarmVille), which delivers its games entirely online. Zynga's first-quarter revenuesgrew to $235 million this year, more than double revenues from a year earlier. Rovio,maker of Angry Birds, is expected to clear $100 million in revenue this year (thecompany was nearly bankrupt when it debuted the popular game on the iPhone in late2009). Meanwhile, traditional videogame powerhouses like Electronic Arts andNintendo have seen revenues stagnate and fall.

The best new movie production company in many decades, Pixar, was a softwarecompany. Disney—Disney!—had to buy Pixar, a software company, to remain relevant inanimated movies.

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Photography, of course, was eaten by software long ago. It's virtually impossible to buy amobile phone that doesn't include a software-powered camera, and photos are uploadedautomatically to the Internet for permanent archiving and global sharing. Companieslike Shutterfly, Snapfish and Flickr have stepped into Kodak's place.

Today's largest direct marketing platform is a software company— Google. Now it's beenjoined by Groupon, Living Social, Foursquare and others, which are using software to eatthe retail marketing industry. Groupon generated over $700 million in revenue in 2010,after being in business for only two years.

Today's fastest growing telecom company is Skype, a software company that was justbought by Microsoft for $8.5 billion. CenturyLink, the third largest telecom company inthe U.S., with a $20 billion market cap, had 15 million access lines at the end of June 30—declining at an annual rate of about 7%. Excluding the revenue from its Qwestacquisition, CenturyLink's revenue from these legacy services declined by more than11%. Meanwhile, the two biggest telecom companies, AT&T and Verizon, have survivedby transforming themselves into software companies, partnering with Apple and othersmartphone makers.

LinkedIn is today's fastest growing recruiting company. For the firsttime ever, on LinkedIn, employees can maintain their own resumes forrecruiters to search in real time—giving LinkedIn the opportunity toeat the lucrative $400 billion recruiting industry.

Software is also eating much of the value chain of industries that arewidely viewed as primarily existing in the physical world. In today'scars, software runs the engines, controls safety features, entertainspassengers, guides drivers to destinations and connects each car to

mobile, satellite and GPS networks. The days when a car aficionado could repair his orher own car are long past, due primarily to the high software content. The trend towardhybrid and electric vehicles will only accelerate the software shift—electric cars arecompletely computer controlled. And the creation of software-powered driverless carsis already under way at Google and the major car companies.

Today's leading real-world retailer, Wal-Mart, uses software to power its logistics anddistribution capabilities, which it has used to crush its competition. Likewise for FedEx,which is best thought of as a software network that happens to have trucks, planes anddistribution hubs attached. And the success or failure of airlines today and in the futurehinges on their ability to price tickets and optimize routes and yields correctly—withsoftware.

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Oil and gas companies were early innovators in supercomputing and data visualizationand analysis, which are crucial to today's oil and gas exploration efforts. Agriculture isincreasingly powered by software as well, including satellite analysis of soils linked toper-acre seed selection software algorithms.

The financial services industry has been visibly transformed by software over the last 30years. Practically every financial transaction, from someone buying a cup of coffee tosomeone trading a trillion dollars of credit default derivatives, is done in software. Andmany of the leading innovators in financial services are software companies, such asSquare, which allows anyone to accept credit card payments with a mobile phone, andPayPal, which generated more than $1 billion in revenue in the second quarter of thisyear, up 31% over the previous year.

Health care and education, in my view, are next up for fundamental software-basedtransformation. My venture capital firm is backing aggressive start-ups in both of thesegigantic and critical industries. We believe both of these industries, which historicallyhave been highly resistant to entrepreneurial change, are primed for tipping by greatnew software-centric entrepreneurs.

Even national defense is increasingly software-based. The modern combat soldier isembedded in a web of software that provides intelligence, communications, logisticsand weapons guidance. Software-powered drones launch airstrikes without puttinghuman pilots at risk. Intelligence agencies do large-scale data mining with software touncover and track potential terrorist plots.

Companies in every industry need to assume that a software revolution is coming. Thisincludes even industries that are software-based today. Great incumbent softwarecompanies like Oracle and Microsoft are increasingly threatened with irrelevance bynew software offerings like Salesforce.com and Android (especially in a world whereGoogle owns a major handset maker).

In some industries, particularly those with a heavy real-world component such as oiland gas, the software revolution is primarily an opportunity for incumbents. But inmany industries, new software ideas will result in the rise of new Silicon Valley-stylestart-ups that invade existing industries with impunity. Over the next 10 years, thebattles between incumbents and software-powered insurgents will be epic. JosephSchumpeter, the economist who coined the term "creative destruction," would be proud.

And while people watching the values of their 401(k)s bounce up and down the last fewweeks might doubt it, this is a profoundly positive story for the American economy, inparticular. It's not an accident that many of the biggest recent technology companies—including Google, Amazon, eBay and more—are American companies. Our combination

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of great research universities, a pro-risk business culture, deep pools ofinnovation-seeking equity capital and reliable business and contractlaw is unprecedented and unparalleled in the world.

Still, we face several challenges.

First of all, every new company today is being built in the face ofmassive economic headwinds, making the challenge far greater than it was in therelatively benign '90s. The good news about building a company during times like this isthat the companies that do succeed are going to be extremely strong and resilient. Andwhen the economy finally stabilizes, look out—the best of the new companies will groweven faster.

Secondly, many people in the U.S. and around the world lack the education and skillsrequired to participate in the great new companies coming out of the softwarerevolution. This is a tragedy since every company I work with is absolutely starved fortalent. Qualified software engineers, managers, marketers and salespeople in SiliconValley can rack up dozens of high-paying, high-upside job offers any time they want,while national unemployment and underemployment is sky high. This problem is evenworse than it looks because many workers in existing industries will be stranded on thewrong side of software-based disruption and may never be able to work in their fieldsagain. There's no way through this problem other than education, and we have a longway to go.

Finally, the new companies need to prove their worth. They need to build strongcultures, delight their customers, establish their own competitive advantages and, yes,justify their rising valuations. No one should expect building a new high-growth,software-powered company in an established industry to be easy. It's brutally difficult.

I'm privileged to work with some of the best of the new breed of software companies,and I can tell you they're really good at what they do. If they perform to my and others'expectations, they are going to be highly valuable cornerstone companies in the globaleconomy, eating markets far larger than the technology industry has historically beenable to pursue.

Instead of constantly questioning their valuations, let's seek to understand how the newgeneration of technology companies are doing what they do, what the broaderconsequences are for businesses and the economy and what we can collectively do toexpand the number of innovative new software companies created in the U.S. andaround the world.

That's the big opportunity. I know where I'm putting my money.

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—Mr. Andreessen is co-founder and general partner of the venture capital firmAndreessen-Horowitz. He also co-founded Netscape, one of the first browser companies.

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