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Software's Eve of Destruction

Salesforce.com's browser-based, pay-as-you-go software offered a starkly simple alternative to the complex, costly and daunting software platforms from giants like SAP (SAP - Get Report), Oracle (ORCL - Get Report) and Siebel (SEBL). With that change, Salesforce.com pioneered a new market called, for better or worse, software as a service.

"The whole software industry is being disrupted by the software-as-a-service approach," says Gordon Ritter, an Emergence partner and a former vice president at IBM (IBM - Get Report). Ritter says that the rise of Salesforce.com came shortly before the decline of Siebel, and its subsequent purchase by Oracle -- and it's no coincidence.

"Salesforce.com is taking down Siebel and pulling biz from it. You have a giant coming to its knees with a start-up disrupting them with a better value proposition," Ritter says. "We see new entrants coming in with this software-as-a-service approach. We see a giant industry with disruptive forces hitting it."

Late Wednesday, Salesforce announced that third-quarter revenue nearly doubled to $82.7 million from $46.3 million a year earlier. While its fourth-quarter EPS outlook was below Wall Street estimates, many investors took it as a sign of overcautiousness and bid the stock to $29.80 -- its highest level as a public company. The shares were recently up 9.5% to $29.50.

Salesforce.com grew without venture backing, but Emergence bought a 1% stake from an ex-employee for about $1 million. That investment, Emergence's first ever, is doing well. Today, a 1% stake in Salesforce.com is worth about $30 million. For now, that investment is the crown jewel of the contrarian strategy Emergence took three years ago, when it bet that services represent a good VC investment if they are leveraged by technology such as Salesforce.com's disruptive software.

Since that investment, Emergence has sought out similar start-ups that could shake up other software sectors, such as human resources and marketing management. One is SuccessFactors, which broadens the use of HR software to every employee in a company, not just the few who can endure a grueling two-week software training program. Another is Visage Mobile, which uses software as a service to allow nonphone carriers branded cell-phone service.

Of course, many of these companies will be off limits to public investors for a while, but it may be worth keeping an eye out for existing software giants to do the best job at adapting to the new software-service model. Most have spent decades building up vast sales, service and engineering teams to exclusively handle their aging proprietary software systems.

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