11 Oct Custom Application Development Trends & Outlook
Read more about our insights on Custom Application Development trends in our recent blog post: https://www.revenuerocket.com/custom-application-development-trends-outlook-end-of-2021/
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Mike Harvath 00:04
Hello this is Mike Harvath with this week’s Shoot the Moon podcast, broadcasting live and direct from Revenue Rocket world headquarters in Bloomington Minnesota. Revenue Rocket is the premier M&A, and growth strategy champion for IT services companies worldwide. Today joining me on the podcast are my partners Ryan Barnett and Matt Lockhart. Guys, welcome. We are going to be talking about custom application development trends and outlook. We certainly have a big, big percentage of our work in our customer base that do custom Dev and you know, Matt, I know from your background, certainly you spent the lion’s share of your career with a firm that did custom application development. And today, we want to just share a few, a few salient facts about that part of the IT services landscape. And as such, I’m going to turn it over to Ryan to get rolling.
Ryan Barnett 01:16
Thanks, Mike. Really happy to have Matt here on the call here today spent a good few decades in this space. And I’d love to pick your brain a little bit on this. So when we think about our categories of companies that we deal with, we think about application integrators think Microsoft type partner with the cybersecurity vendors, we have MSPs. But one of the ones that we come back to quite a bit is custom application developers. And Matt, I’d love for you Just help me out define what a custom application development permits.
Matt Lockhart 01:50
Sure, yeah. Thanks, Ryan. And, wow, a few decades. Yeah, I started in business at about seven years old. So that few decades puts me you know, right about where I want to be. So you know, thanks for that. No kidding. Yeah, custom app dev. I mean, it’s been called that for well, literally decades. And, and in the context of, you know, all these sort of hot properties in the IT services space, you know, we we talked last about cyber security, and, you know, and, managed service providers are really hot, well, you know, custom application development spans all of this, right. And so when we think about the overall breadth of custom app Dev, I think maybe let’s kind of change the term to custom solutions, right. And it is wherever, you know, software is being written to differentiate an organization’s, you know, offering to the marketplace and or to make them more efficient and improving the bottom line. And so, you know, there’s sort of the traditional line of business cup custom applications. There are front end and or commerce, b2b or b2c applications. There’s, you know, in the custom solution space, there’s heavy data analytical applications that are creating greater insights into, you know, the trends for the business, their customers buying patterns, you know, so on and so forth. The operational efficiencies within the business, the emerging space around machine learning and or artificial intelligence is, is very much in the custom solution space IoT is, is certainly in there. I think that one of the things that we’ve seen a tremendous increase in this space is overall application modernization, which certainly fits within the overall customer solution space. And that’s largely driven by the push to the cloud, which is a more secure environment, it’s a more operationally effective, effective environment and cost effective environment and yet all of the legacy applications need to be modernized to take advantage of that new cloud infrastructure. And so you know, it’s really a pretty broad and probably the, you know, continues to be the largest sub sector within the overall IT services marketplace, and, and that’s not going to go down anytime soon, you know, 10 to 1015 years ago. You know, the term software is eating the world. emerged and, and that really continues and, you know, and clients via enterprise customers middle market and even small and medium businesses are differentiating themselves because of their effective use of custom software solutions. So hopefully that helps. I know it, it is still a broad space. But you know, we have to incorporate all of that when we think about, you know, custom software solutions.
Ryan Barnett 05:35
It’s fascinating, and maybe even 10 years ago, if you thought custom application development, it was that line of business, maybe writing a chunk of code for an enterprise type system. And that is greatly evolved to, to UX UI through custom through through DevOps, and including all the coding in the middle. And that can be on a mobile device, it could be on a desktop, it could be through all sorts of apps. So in this category that we find someone represented in this space, it’s it is it’s a deaf, it’s really hard definition challenge, because it can be something as big as ml and AI, or it could be as specific as application modernization. And it’s, it’s difficult to say, Hey, this is what I do, because the scope is so large. It very interesting. I wonder if I’d love for you to help me also understand, Matt, is there? Have you seen a change in digital delivery methodologies? In the last few years, and I’m going to kind of frame this up of staff augmentation versus product, you know, product teams versus project teams or pay per sprint models? What changes? Have you seen in the last few years, that that may be impacting how companies work?
Matt Lockhart 07:03
Sure, I think that’s a great question, Ryan. And, you know, let’s kind of unpack it first by talking about the needs of customers, right? And so, again, if custom solutions are a differentiator for an organization, then you know, that a, an Enterprise’s customers, right are expecting, you know, the very best in their interaction, you know, through technology via through a mobile app, or through through a website or through a variety of interactions should, you know, they show up on Apple watches, and being able to refresh that experience for a customer, you know, for end customers for end users is absolutely critical. So, you know, the the revs of new applications and or updates to applications is really critical for an enterprise customer or any customer to differentiate themselves. Okay? So if you if you understand that, right, then you think about, how do I build the capability of being better at delivering software on a more agile, and more frequent basis, and, you know, many customers, many, you know, enterprise customers have recognized that working in traditional models, you know, be at a high staff augmentation, or trying to do all the work themselves, you know, just doesn’t work. Because, you know, say you’re a retailer or you’re a manufacturer, you know, you’re a distributor, you know, building great software isn’t necessarily your core competency. And so they need to work with software delivery organizations in different ways. And much more, you are finding a project based method, you know, where they’re working with a key partner on a product management product development mentality. It’s oftentimes in an agile based method, you know, they’re tracking their sprint very well. They’re aligning on priorities and changing priorities on an ongoing basis. And so, yeah, that delivery methods have changed. I think that you know, for for our customers in the custom app dev space, what we see is is the, the strongest the winners have built in in a very strong agile methodology. They’ve got very strong UI UX leadership skills. They’ve you know, to the extent that they’ve got very strong product management and product owners skills, they are They’re very strong with DevOps, they’ve got, you know, really good cloud native engineering skills, right? And they’re able to bundle all of those skills in an effective and repeatable project based method. So they’re in a very strong leadership position, you know, with their customers. And that makes them very sticky, right? The No, typically, custom application development isn’t delivered in a, you know, monthly recurring, you know, revenue model, right? It’s just doesn’t work that way, in a project based method. And in the past, you know, firms when they’re assessing custom app dev or a custom solution chaps, you know, would sort of look at that as a negative, right? Because it’s not in a in an MRR monthly recurring revenue model. The fact of the matter is, is if the strongest custom solution firms, when they are in a leadership position with their customers, well, you know, those customers don’t go away. Right. And so, in effect, they are, you know, they’re, you know, resigning year over year with those strong custom solutions firms.
Ryan Barnett 11:17
Yeah, it’s, it’s absolutely so interesting. It’s, it’s not necessarily MRR. But and we have seen companies that do do some of those. So we’ve seen a pay per sprint method, but it’s your point they have the variability can go up or down based on the spread. But if you do a great job, you execute Well, your your, your experience, portfolio grows, those customers continually come back. So it may not, yes, you may not be charging them a fixed amount per desktop, that you are getting them to build an application, and hopefully some kind of maintenance and services on top of that allows them to build a full lifecycle of offerings. I’d love to also know, what impact Have you seen from COVID? And it seems we’ve seen a lot of remote work being adopted. I love to get your perspective on our firms adopting new methodologies, for example, is our our nearshore trends or or rural sourcing or other type of methodologies? What kind of trends Do you see coming? I open that up to Matt and Mike that to answer that?
Matt Lockhart 12:37
Well, Mike, I’ll jump in. And then I think that you’ve got great perspective on this, you know, obviously COVID, forced to change for all of us in which we were all working virtually in in a distributed manner. And that’s had a, really a tremendous impact on on the overall software development, custom solutions industry, where, you know, it’s opened up, you have a really a global marketplace for talent. Now, at the same time, there’s still way more work than there are talented software development engineers and professionals to do all of that work. And so, because it’s sort of forced, you know, a new paradigm of working virtually and in a distributed manner, I think it’s really opened up the ability for firms, wherever they are, to, you know, to organize that talent and offer that talent. And again, I’ll go back, the best firms organize it in a repeatable and, and efficient way, regardless of where the resources are. Mike, what are your thoughts?
Mike Harvath 13:49
Well, thanks, Matt. I would tell you that, you know, what we’ve seen as an interesting trend has certainly been near shore firms. And they’re really remarkable expansion of providing talent to firms in North America. You know, LatAm. The LatAm market, you know, Mexico, Latin America and South America have certainly their businesses have expanded dramatically. I think there’s a direct correlation to what’s happened through the pandemic. Now, when we look at other areas of the world as you as you listeners know, you know, we work around the world and certainly a similar trend has occurred in other markets. And so we’ve seen, you know, markets where there’s been a high concentration of talent, whether that be in India or Eastern Europe, impacting markets in their regions near more close to their own time zones, in expanding dramatically it’s been a fascinating correlation between The work opportunities have occurred in a what we’ll call more near timezones, then what would be traditionally more of an offshore model? And so that certainly has transitioned the business and I think, also it has given some flexibility in the way if we look more at, you know, domestic firms or firms in North America from our perspective, you know, flexibility in their hiring and management, and challenge them in some ways in their management of where staff reside, some of our larger clients that have you know, many offices in the US have you had staff that work on development, and do custom development actually just kind of up and move away from those office locations, and choose to continue to work remote. And because they’re in such high demand, they’ve said to their employers that we will not be coming back to the office, we will be working remote, we’re happy to work with you. But if that’s not okay, then we’ll find a firm where it is okay. And I think it’s certainly changed the work dynamic and change the, you know, I know this is happening in other sectors, but we’ve seen it amplified, if you will, from my perspective in customer death.
Ryan Barnett 16:21
I totally agree. I think the acceptance of remote work is pushed how allowed companies to embrace outsourcing. And the other part is there is a global need for good talent right now. So I would love to get like your perspective on some of this switch to table a little bit here. Where what’s the lifecycle for custom solutions firm in m&a right now, like our market hot is is delayed, is it? And it kind of set the stage there? And then I’d love to get into what our pluses for valuation and minus for valuation? If you’re looking to take your firm to market?
Mike Harvath 17:04
Yeah, you know, I would say it’s as active as we’ve ever seen it for custom application, our custom solutions companies, man, as you’d put it, in at least my memory. And I would say that also includes the late 90s. So it’s exceptionally active. It is a seller’s market, it is driving valuations up, we’re certainly seeing, you know, multiples, reaching peaks. For firms that are well run and profitable and growing. I think what’s important to understand is that if you have built a quality business, and quality is defined as one that is growing in the top quartile and is profitable, above average, right, you will have a lot of interest and a lot of demand and a lot of opportunities should you want to do a transaction as a seller. I think if I put my buy side hat on, certainly there’s a lot of competition for acquiring those firms. Some of that’s driven by firms desire to just have the talent. As you mentioned, Ryan, there’s, there’s certainly there’s certainly a big talent gap, there is far more work, as you mentioned, Matt, than there is talent to do the work. And some firms are kind of, you know, approaching that and trying to solve for that by acquiring firms in the US, again, amplifying the seller’s market for custom solutions companies. I think firms that have figured out some labor arbitrage, and particularly those, as I mentioned earlier in the near shore market, are even hotter! Ones that are certainly in demand. I think many of the traditional custom solution shops that have tried to staff, their business in their office and or domestically, before the pandemic have realized that if we’re going to have a remote workforce model, then let’s certainly embrace a way to have a more nearshore or more cost efficient labor theory or model. And that’s driving margins for those companies, which certainly makes them also more attractive. So, you know, I think that you know, we’re seeing kind of interesting multiples and these businesses. As you guys know, we’ve often said that multiples are sort of a six to eight range of trailing 12 months, even though we’re certainly seeing deals that are for custom firms that are best in class, you know, at or exceeding eight and it certainly depends on the buyer. And I, I’m always hesitant to call multiples because multiples are not valuations and valuations are multiple. So, you know, you need to be sensitive to that. But if we’re simply using it as a benchmark, we certainly see accelerating multiples in a hot market.
Matt Lockhart 20:17
Hey, you know, Mike, I think that you bring up a really important point. And, you know, we could be seen as sort of self serving to say, you should have a strong acquisition strategy in this space. But let’s break it down to the reality which is, there is such, it’s so lopsided in, you know, the basic supply and demand equilibrium, so that for a firm to achieve, you know, top quartile and revenue growth in this space, well, it directly equates to their ability to bring on more talent. And, and doing that just organically, because it’s such a competitive space for that talent is really, really hard. Right? And so, yeah, whether or not you choose to work with Revenue Rocket in this space, you know, there’s other firms out there, and we were really good, because this is our specialty. And, and specialization is key, we just really believe that now more than ever, having an ongoing acquisition strategy in this space, is a competitive differentiator. And now, that’s not to say that you’re not going to not continue to grow organically. You know, I one of the things that that I did in the past was, was really further a, you know, hiring new grad school and building that talent and, and building that culture so that you’re able to retain those individuals, I do that too. But having an ongoing acquisition strategy in the space, it just makes sense. And doing it well is, is a competitive differentiation. And quite honestly, you see the smartest money out there doing that.
Ryan Barnett 22:24
Yeah, I think it’s a great point, Matt, if you’re looking for that next stage of growth, m&a is is a great way to do it. We’ve seen some interesting trends lately, and that you don’t necessarily have to be a custom solution provider today to acquire a custom solution provider. So MSPs are looking for ways to add cloud, lift and shift to their portfolio and provide more holistic solutions. We’ve seen a bit of that, we’ve seen just talent gaps being filled through acquisition. So almost Accu hire, but there’s a great way to bring developers into into the fold. And then we’ve just found that a lot of firms that are in this custom application development space, do have amazing technology process. And people that are better than what an enterprise may have itself. So the ability to put that talent to work quickly, is such a accelerator. I would love to hear what makes a firm more attractive in this space for acquisition. Matt, are there a few things that would make a just a firm really stick out or in may add a plus in the EBITDA multiplier?
Matt Lockhart 23:48
Yeah, I mean, the maturity in their delivery model, the maturity of an organization and their track record and ability to to attract talent, you know, it’s, it’s a lot of the basics that are done and fundamentals that are that are demonstrated really well. And, and that results in, you know, seeing the type of contract models that a firm has, you know, that’s the proof in the pudding, and then you go to their effectiveness of running their operation just like anybody else. And and that, you know, comes through in in, you know, they’re both ability to drive gross margin and net margin while at the same time growing. And then at the end of the day, and we just talked about this last night guys, and it’s all about the management of a firm and demonstrating, you know, management excellent, not just at the very top, you know, but throughout the organization. So many of it is the fundamentals that we see in all good firms. But you know, because of the growing need to have, you know, best in class delivery model capabilities. You know, and I think you make a good point, Ryan, from an agile delivery method and being able to contract along those lines, having a sustained delivery model and some level of maintenance and support. And then at the end of the day, again, it goes back to talent. And so being able to recruit and retain read, you know, retain the very best talent is a winning proposition these days.
Ryan Barnett 25:43
That’s questions I’ve got for you guys today. Mike. Matt. Any closing thoughts? Well, I’m
Matt Lockhart 25:49
just waiting for, you know, Mike to close this out. And so Mike, how do we do that?
Mike Harvath 25:58
Thanks, Matt. Well, as you hear in every week’s podcast, it’s time to tie a ribbon on it. So we’re gonna do that. Get you guys back to your work and your lies. Feel free to tune in next week for more interesting and thought provoking topics on mergers and acquisitions and growth strategies for IT services companies. Thanks and make it a great day.