Is AI Eating Software? A Deep Dive into Tech Valuations
For two decades, the mantra was “software is eating the world.” Now, a shift is underway. Artificial intelligence isn’t just changing software; it’s starting to disrupt it, and the market is taking notice. Recent performance of large software companies suggests a cooling of investor enthusiasm, with PE ratios beginning to compress.
The Numbers Advise a Story
Technology, as a sector, has underperformed the broader market, and within tech, software has been the weakest link. Examining Price-to-Earnings (P/E) ratios without non-recurring items reveals a significant drawdown. Over the past five years, several business-oriented Software as a Service (SaaS) vendors have experienced a decline of over 60% from their peak valuations.
Consider these examples:
- Adobe (ADBE): PE ratio has fallen from 53.67 in 2020 to 14.13 currently, a 74% decline.
- Salesforce (CRM): PE ratio decreased from 45.85 to 19.71, a 57% drop.
- ServiceNow (NOW): Experienced a 65% decline, from 109.65 to 38.3.
- Workday (WDAY): Saw a 72% decrease, moving from 77.66 to 21.53.
- Constellation Software (CSU): A 59.31% decline from 120.06 to 60.75.
Price-to-Sales (P/S) ratios show a similar trend. Despite relatively strong growth in revenue and operating earnings, investor sentiment is driving these valuation compressions.
Growth Remains, But Concerns Loom
Whereas valuations are shrinking, the underlying businesses aren’t necessarily failing. One-year operating income growth rates remain positive for companies like Adobe (18.5%), CRM (22.5%), and ServiceNow (38.2%). However, the market is anticipating a future where AI fundamentally alters the software landscape.
Several factors are fueling this concern:
- Erosion of Seat-Based Pricing: AI is pushing a shift towards usage-based and outcome-based pricing models.
- Increased Productivity: AI tools are boosting employee productivity, potentially reducing the need for numerous software licenses.
- New Competition: Companies like OpenAI and Anthropic, along with a surge of AI-focused startups, are challenging established software giants.
The Rise of AI-Powered Startups
AI programming tools like GitHub Copilot and Claude are dramatically lowering the barriers to entry for software development. Non-technical founders can now rapidly prototype and launch MVPs using no-code/low-code AI platforms, reducing engineering costs by as much as 40-60%. This is leading to a surge in AI-powered startups, disrupting traditional SaaS markets.
This trend is impacting even large players. Adobe, ServiceNow, and Salesforce are experiencing slowing growth in Annual Recurring Revenue (ARR) and revenue metrics, suggesting a shift in how enterprises are consuming software.
What Does This Mean for Investors?
The market is signaling uncertainty. Investors are reducing exposure to software, valuing terminal values less richly, and increasing discount rates in their Discounted Cash Flow (DCF) models. While AI won’t entirely eliminate the need for software, it will likely evolve the business model, moving towards hybrid structures that combine seats with usage-based pricing.
Microsoft (MSFT) and SAP are currently less affected by PE compression, potentially due to their strong positions in the AI revolution and established market presence. However, the long-term impact of AI on all software companies remains to be seen.
Frequently Asked Questions
Q: Is AI going to replace software developers?
A: AI is more likely to augment developers, automating repetitive tasks and accelerating development cycles, rather than completely replacing them.
Q: What is seat-based pricing?
A: Seat-based pricing charges customers a fee for each user or license of a software product.
Q: How is AI changing software pricing models?
A: AI is driving a shift towards usage-based and outcome-based pricing, where customers pay for the value they receive from the software rather than a fixed fee per user.
Q: Are software companies still good investments?
A: The software sector remains a key part of the technology landscape, but investors should carefully evaluate individual companies and their ability to adapt to the changing market dynamics driven by AI.
Did you understand? The number of pricing changes in the SaaS industry surged to over 1,800 in 2025-2026, signaling a widespread shift away from traditional seat-based licensing.
Pro Tip: Keep a close eye on companies that are successfully integrating AI into their products and services, as they are likely to be better positioned for long-term success.
What are your thoughts on the impact of AI on the software industry? Share your insights in the comments below!
