Maximum complexity: how critical software systems create unique and enduring value
Complexity risks create large moats ā exemplified by simulation software
A core tenet of my and Magneticās investment philosophy is backing complex transformations. For us, this goes beyond simply investing in individual companies or technologies or focusing solely on generating returns. It means funding larger, longer term, needed transformations that change how things are done in critical sectors.
The defining commonalities of these investments are:
They are complex, i.e. deal with intertwined technological and human challenges
They always need transformation, i.e. systems re-design, meaning they follow a strategic scope per company (or group of companies) that vastly exceeds single products or technologies
They take a lot of time
They often face substantial headwinds that make them unattractive at first sight, mostly because of their systemic ambition
There is a very fine line to be drawn between these constellations and moonshot-type, high-technical-risk investing. We are not speculating on outcomes or actual technical feasibility of far-off ideas, we are investing behind system re-design and lasting behavior change. Technical risk might or might not be high (often it is), but complexity always is. That plays a decisive role: when things work, the moat is substantial. In other words, complexity risk drives defensibility.
Mission-critical engineering software
One of those transformations has been in mission-critical software for physical designs. This type of software is an integral technology piece for our world ā it covers the design, modeling, validating and simulating of anything from buildings to cities, semiconductors to machines. Gabriella Garcia and Eric Flaningam at Felicis recently covered the industry in a great piece.
Physical design softwareĀ is a classic case of complexity: the industry has seen total dominance by a handful of software providers for more than 40 years. Names like Autodesk, Ansys / Synopsys, Altair, Siemens or PTC have been controlling the markets for design and simulation, commanding some of the largest account sizes and highest valuations (and multiples) in all of software. No new entrants have been able to disrupt the technology experience for reasons of complexity: technical barriers, switching risks, human psychology. While technical barriers alone can and will be overcome by upstarts, human dependencies (i.e. customers) and stakeholder system designs (internal processes, dependencies) have created enormous hurdles for new entrants.
Yet, the possible transformation in physical design software is substantial: new entrants could upgrade the entire experience and introduce design collaboration, faster iteration, automation and an expansion of the traditional scope. That is what I have been investing in since leading SimScaleās first (and third) institutional funding round. SimScale remains the only cloud-native contender in simulation, delivering all the capabilities we would expect from modern software.
While SimScale is as complex as any deep tech company, its market constellation presents a tremendous complex transformation opportunity, one that we have been committed to supporting with considerable patience and energy. The payoff potential is off the charts: Gabriella and Eric call it the āonly moat in SaaSā (though no one in simulation actually is full SaaS, so that prize would fall to SimScale). Such is the beauty of transformations. SimScale alone could be one of the most significant venture opportunities in all of software, driven by a team with the utmost dedication and patience. It gives me great energy to know that similar constellations exist in complex markets like healthcare, defense or financial services.
Complexity moats
So what wisdom can we read into all of this?
For me, it looks like this:
Complexity constellations like physical design software (or defense technologies or healthcare tech) have always been centered on the complete service, not just the software piece ā a major differentiation to low-complexity SaaS where the basic software is the central concern (thus āsoftware as a serviceā). Complete service mostly means highly individualized and fine-tuned total deliveries.
This gives these constellations a much higher total product risk than your standard SaaS: upstarts would have to show that they can deliver at the same (or better) total product quality to an incumbent, on all accounts, from features to actual technical results or outputs. This is the opposite of other software domains; obviously MVPs are not an option to begin with.
By definition, this is a vastly different standard than simple cloud software or point technology (or even modern AI service deliveries) as failure tolerances are zero and delivery expectations at 100%. It also goes against conventional disruption theory which used to rely on a "good enough" product to disrupt inert incumbents.
It also needs significantly longer time horizons to get to gold. But the patient entrepreneur is rewarded by real, enduring, systemic moats for those who succeed.
So this is where complexity risk therefore leads us:
š¾ Low complexity risk ā> simple software (or technology) provision often is enough ā> low moat (and fast replacement or commoditization)
š¤ High complexity risk ā> total service provision and quality are key ā> high and enduring moat
This simple framework helps me to navigate such constellations, irrespective of sector or technology. It also helps to avoid falling into technology traps (difficult technology risks with little complexity in their markets) that we often see. Ultimately, it is the system that matters for true and lasting value.
It also turns conventional venture wisdom around. We used to assume that modern software comes with low technical risk and high market risk; we knew what could be built but we didn't know who would buy it. Complex transformations are different: they carry high technical risk AND high market risk. Thus, itās a natural consequence that substantial moats follow those that succeed. This ultimately makes them worthwhile pursuits, even if the playbook and determination are vastly different.
We will keep funding transformation in critical and complex industries. If you are building, reach out to me: dr_at_mgntc.com
