But the software-as-a-service (SaaS) market has become very crowded. Just take a look at some of the various landscapes published here and here and your head will spin. There are numerous excellent venture-backed companies in every software category. Many are great companies that are here to stay.

The general consensus is that the SaaS ecosystem will eventually begin to consolidate. And yet, we have seen very little evidence of it happening. Software M&A has been very tame over the past few years. Part of the reason may be the high valuations in the private markets. Part of the reason may be that the acquirers have become rather concentrated themselves. And part of it may be that something fundamental has changed, which is my belief and the premise of this post.

Over the past decade prior to joining VC firm August Capital, I held leadership roles at many exciting SaaS (and traditional) companies, including Salesforce (CRM), Box (BOX), Lifelock SA, and HP (HPE). I was primarily responsible for driving strategy and finding new opportunities for growth, which naturally leads to inorganic initiatives (M&A and investments). I was responsible for more than 25 acquisitions, which allowed me to experience first hand the unique challenges of making SaaS deals successful.

The Golden Days of Software M&A

In the early/mid 2000s, the large software vendors and private equity firms undertook a massive consolidation of the software industry. The driver behind this for the strategic buyers was the ability to achieve large revenue synergies through their distribution reach. Whether you were selling an appliance or a software application, the extensive distribution capabilities of the large software vendors allowed them to create a lot of value by acquiring applications and pushing them through their channel (direct sales, partners, distributors, integrators, VARs, etc.). The on-premise, perpetual license business model also afforded buyers the opportunity to materially cut costs. For example, I doubt Oracle (OCRL) invested a dime of R&D into PeopleSoft after the acquisition.

Another reason this strategy worked in the on-premise world was that customer success was the responsibility of the customer, not the vendor. If you wanted to buy an ERP system, you would purchase a license from the vendor and then work with a systems integrator (companies like CSC or Accenture) to customize the application to your needs, integrate it, deploy it, and help you manage it. And if you failed… well, that would not be the vendor’s fault!

The Challenge with SaaS

The challenge with SaaS is that it’s a lot more complex and difficult to create value via acquisitions. The on-premise playbook does not work in the SaaS world, and scaling a SaaS application has proven difficult. The key challenges every acquirer grapples with include:

1. Supporting and scaling multiple clouds is daunting. Managing and scaling one cloud application is a massive engineering challenge. Managing multiple clouds, on different technology stacks, in multiple data centers or geographies becomes an overwhelming challenge even for the most sophisticated engineering and operations teams. There certainly are no cost synergies to be had in this model. To the contrary, managing multiple clouds leads to substantial inefficiencies.

2. Customer success is the vendor’s responsibility in SaaS. The moment you acquire a SaaS company, the customers will ask about your plans. And they will also demand that the acquired application work seamlessly with you other applications. Customers have options and they will leave you if they sense that you are not making sufficient investments in the product and are not committed to making them successful.

3. Distribution in SaaS is much less impactful. Reseller arrangements generally do not work. You have to rely on your own salesforce to sell an application. There are very few examples of successful reseller/channel arrangements in SaaS.

4. Sales productivity does not get better. Putting another SaaS product in a sales reps’s bag generally does not lead to improved sales productivity. Instead, what tends to happen is that the mix of products they sell changes, but the aggregate productivity does not. Acquirers hoping to see a bump in aggregate sales tend to be disappointed.

What is Next?

It is my view that the tepid M&A environment will continue for the foreseeable future. I do not believe large software vendors will embark on ambitious consolidation strategies. The IPO markets will continue to be the path to liquidity for the select few companies that are able to build escape velocity to reach $100 million in revenue, focusing on large addressable markets, and are still growing at more than 40%. SaaS vendors with between $20 million and 100 million in revenue, growing +/- 30% will never reach the IPO milestone. Nor are those companies getting acquired. They will have to become profitable and create value for their investors in the absence of a liquidity event.

We will continue to see tactical small acquisitions intended to fill product gaps, bring key technology capabilities and talent to larger organizations. On the other extreme, I believe we will see some of the larger SaaS vendors be acquired in the coming years. This strategy makes sense because, if you have to do the hard work described above, you should at least make it worthwhile and impactful. SAP (SAP) has adopted this strategy and has concentrated their efforts on few large acquisitions (SuccessFactors, Ariba, Concur).

The lack of liquidity in venture SaaS portfolios is probably just starting to raise concerns. It will be interesting to watch how the venture community responds to this new reality. I doubt early-stage VCs will change how they evaluate investment opportunities, but the calculus for growth investors may have to change.

Villi Iltchev (@VilliSpeaks) joined August Capital in 2016. Prior to joining, he was a member of the leadership teams at Box and Lifelock where he was responsible for driving strategy and inorganic initiatives, including acquisitions and investments.