What happens when software costs go to zero?

Coding is one of the first areas where LLM (Large Language Models) based products have found product/market fit. Github copilot is a huge success; not only that, one of the most prominent use cases of ChatGPT is helping with coding tasks. Those systems can't substitute a programmer yet, but there is a clear trend of improvement in systems capable of writing code. If this trend continues, the cost of producing software will decrease. What happens when the cost of producing software goes to zero?

Intellectual Property is a powerful economic engine. Famous characters and stories have generated billions in revenue for IP owners. J.K Rowling, the creator of Harry Potter, is richer than England's late queen ever was. Writing could be a good place to understand a world of zero-marginal software.

Writing is one of the few professions in the modern world where a single individual can still make a huge impact. In most areas, you will need a team, sometimes a big team, to make something impactful. In writing, a single individual can produce a masterpiece. 

We have examples of small teams producing great outcomes in the software world. A good example is Whatsapp. It has a team of 55 serving 900M users when sold to Facebook for US$19B. This remains an exception, but we are moving towards becoming the rule.

Software will become more like writing. A single developer will be able to have a big impact. This has happened to some degree in the past. At the beginning of the PC revolution, many apps were created by single developers or small teams. Something similar happened during the initial mobile era. With increased competition and the maturing of platforms, it became harder and harder for solo developers to generate revenue.

We need to consider a distinction between the writing world and the software world. Stories and characters are unique and protected by IP. You can't simply create a new Harry Potter novel without permission. You can, however, create software that delivers the same functionality as other software. 

In software, utility is the most important factor. If two apps deliver the same utility, they are interchangeable. This is not true for stories, you can choose Lord Of the Rings over Harry Potter, but there is no perfect substitute for either since what you buy is the experience. No two books will ever feel the same. However, If you can reproduce the utility of any software at no cost, you can substitute it effectively. 

Convenience and differentiation are the main forces protecting value capture in a zero-marginal software world. 

Convenience

A good framework to think about convenience is piracy. Before the age of mobile and app stores, piracy was a big issue in the digital world. It was not completely obvious that people would prefer to buy digital products like software and music instead of pirating them for zero cost. Many court battles were fought over IP piracy. In the end, convenience and usability won the day. It's far more accessible and safe to buy a subscription to Spotify than to download and organize music by yourself. Another force that changed the game was cloud computing. Pirating software running on the cloud is far harder than one running locally. Today, piracy is still an issue but a shadow of the issue it was in the past. 

When software goes to zero, Convenience will become a function of Price and Complexity. The more complex a software is, the less convenient it will be to create it through AI. Even if you only need to describe what you want for an AI, if it's complex, it will take your time actually to get it to work. Price is the second important factor. The higher the current price of the software, the bigger the incentive to use AI and build your version. 

To be competitive, a software will need to strike a balance between complexity and price so that it would not be convenient enough to build a substitute using AI given the price of the market solution. 

Differentiation

Another framework to think about zero marginal software is differentiation. Software companies must continue to differentiate to be competitive against copycats. Once software starts to be successful, people will try to copy it. There are many potential sources of differentiation, like network effects, distribution, and switching costs. Network effects is why products like social networks and marketplaces can resist competition. The more people in the network, the more value you have. You can copy the software, but you can't copy the network of people using the product. 

Companies with strong differentiation will not be heavily affected by the cost of producing software going to zero. This is already a reality in the B2C software world. Successful B2C companies rely on powerful differentiation effects besides the pure utility of the software provided.

Some types of differentiation could lose power. Sales-driven differentiation in B2B could take a hit. Zero Marginal Cost software will empower internal tools teams to create solutions on par with market ones. Switching costs also can become less powerful since zero-cost software will mean zero cost data migration as well.

Winners 

The first winners of the zero marginal software world will be consumers. Software will become abundant like content is today. Anyone with a computer will be able to create software like anyone with a computer today can write a blog post. Software today is extremely hard to customize. In a zero-marginal software world, consumers will have the option of highly customized software for their specific needs. 

Operational Systems (OS) will initially benefit by delivering more utility out of the box. However, there is the possibility of reduced network effects. Current Operational Systems like Windows and iOS benefit greatly from network effects. The more apps you have, the more valuable your OS. It is hard to port software from one platform to the other, but with AI-generated software, these costs can go to zero. This implies the winner takes all dynamics in software platforms could change. 

Software is the natural complement of Hardware. With software costs going to zero, the utility of any kind of computer will grow exponentially. There is a chicken and egg problem when you introduce new devices. The iPhone would not be that useful if there were no apps.

Games are notoriously hard to develop. To produce even an indie game is a tremendous endeavor. You need to put in thousands of hours in coding and to make assets to produce a competitive game. Not only that, you need to combine many disciplines as well. Building a game usually involves sounds, music, visual assets, coding, animation, etc. A zero-marginal software world means small teams or even single individuals can build AAA games. This will completely change the Gaming industry.

Losers

Not everybody will win in a Zero Marginal Software world. Tools that provide simple utility will be easily cloned unless the convenience of getting them is bigger than just creating your own version. Many small apps will be hit hard by this change.

The B2B SaaS market size is huge. There is a myriad of software used to run the day-to-day operation of companies, for example, CRMs, ERPs, and ATS, to name just a few big ones. A trade-off in the B2B world has been the "Build versus Buy". A company can decide to create its own software to its needs or use a market solution. The SaaS wave of companies turns the scales in favor of buying readily available solutions rather than the painful effort of building them yourself. Because of this, we saw an explosion of B2B Saas companies in the last decade. 

Zero Marginal Software will pressure down the maximum price B2B software companies can charge. The ability to make software at zero cost will tip the scales to the side of "build" in the "Build versus Buy" decision. Before the SaaS era, the bias was to build internal tools, and it took a lot of evangelizing sales to get us to the current era. Now, B2B sales organizations will need to fight not only external competitors but internal teams building customized tools.

These dynamics will push B2B software companies to differentiate through methods similar to B2C companies. One big example of this is network effects through data aggregation. Being able to connect and anonymize multiple customer data will lead to a golden age of benchmarking and improved decision-making. 

Conclusion

AI-generated code could lead to a world of zero marginal cost software. End-user "programming" through AI and internal tools teams in companies will emerge as a powerful force in the software industry. Convenience and Differentiation still will be the main force driving value creation for companies building software. Still, companies will need to work hard to deliver value above end-user custom solutions.

I didn't discuss in this piece another interesting possibility. That software, as we know it, will not exist at all, but this is a topic for a next essay.