Custom software development market to grow to $120 billion by 2026

18 May 2023 2 min. read
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The global custom software development (CSD) market is projected to have a compound annual growth rate (CAGR) of 8.5% to reach $120 billion in 2026, according to a report from investment bank Equiteq.

Overall IT spend, meanwhile, is expected to grow by 6.2% to reach $6.2 trillion by 2026.

Companies are increasingly turning to bespoke solutions as off-the-shelf offerings don’t satisfy their specific needs. The CSD market is, however, facing labor shortages and increased salary costs, as well as market erosion from competing technologies. Low- and no-code software (such as Appian or Quickbase) is a growing alternative to bespoke solutions, with a forecasted market of $60 billion by 2026.

CSD firms, however, are expanding their higher-value strategic consulting capabilities to respond to this trend.

Heatmap of custom software development headquarters by country

“CIOs are using more IT services to assist in the lack of skilled IT staff. Tasks that require lower skill sets tend to be outsourced to managed service firms to alleviate staff time, while critical strategy work, which requires high-end skills unobtainable by many enterprises, will increasingly be fulfilled by external consultants,” said John-David Lovelock, research VP at Gartner.

Equiteq identified approximately 24,000 CSD firms globally, with 28% in North America, 28% in APAC, and 15% in Central and Eastern Europe. The market is still highly fragmented, with 55% of firms having under 50 employees.

The CSD M&A market

Deal volume saw a CAGR of 23% between 2019 and 2022, with last year seeing a slight decrease to 129 deals from 2021’s 143 deals as M&A demand softened from strategic buyers.

Equiteq says strategic buyers and PE investors have been equally active – driving the majority of transactions in 2022 through both direct investments and bolt-ons. Buyers are primarily based in North America and Western Europe.

Breakdown of customer software development transactions

Facing historic volatility, publicly traded CSD firms are trading at below their pre-Covid averages. After the initial Covid shock, CSD equities rebounded but were later curtailed by inflationary pressures and Russia’s invasion of Ukraine.

Public valuations in 2022 were in the range of 12-15x the next twelve months of earnings before income taxes, depreciation, and amortization (NTM Ebitda). Equiteq says this represents a marked decline from 2021, which saw assets trading as high as 30x NTM Ebitda on a median basis.

Recent instability has led investors to use Ebitda-based valuations instead of revenue growth, as profitability is deemed a safer metric than growth in the current climate.