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Turbocharged initial growth is essential to surviving in the software industry. But what comes next? Here are four lessons so leaders can write their organizations’ second act.

Software companies must constantly evolve and capture new growth opportunities or risk slowly declining into irrelevance. Only 3 percent of start-ups grow into companies boasting annual revenue of at least $1 billion. Yet that achievement is only the end of the beginning. Act II involves developing into a multibillion-dollar company, and the odds are slim: our latest research shows that of the 3,197 public software companies launched between 1980 and 2013, just 19 have reached $4 billion in annual revenue.

Fewer than 1 percent of software start-ups reach $4 billion in annual revenue.

We’re not suggesting that “only” having revenue of $1 billion annually is a problem or that all companies aspire to get larger and larger. Yet no company can afford to stand still. Business leaders often struggle to determine when, where, and how to move their organization beyond its initial growth spurt. Through our research into the role of growth and our extensive work in the software sector, we’ve identified four lessons:

1. All companies need a second act. As companies scale, they periodically need to look beyond their core business to identify new sources of growth. How soon depends on the size of the core market and the speed of market saturation.

2. Emulate the best. We’ve found three models of success that companies can emulate: rocket ships, adjacency buyers, and reinventors.

3. Timing is critical. Moving too early will detract from Act I, while moving too late will stall the company. Companies that successfully navigate Act II employ “headlights” to pinpoint the right time to move.

4. Keep your balance. The right growth market isn’t necessarily the largest or the fastest growing or the most adjacent. Successful companies strike a balance between aspiring on attractiveness and anchoring on familiarity.

All companies need a second act

Our previous research highlighted the importance of achieving and maintaining high growth rates in software and online services. In fact, we found that fast growth is the best indicator that a company can beat the odds: organizations that are “super growers,” with revenue rising at a compound annual rate of more than 50 percent, are eight times more likely to reach $1 billion in sales than those growing at less than 20 percent annually. We believe this rapid pace of growth is essential to survive the hypercompetitive gauntlet of software and online services. (See “The reality of growth: Synopsys CEO Aart de Geus,” a video excerpted from three interviews with Silicon Valley CEOs on the issue of sustaining growth. For more, see “The reality of growth in the software industry.”)

We also know that software companies cannot be one-trick ponies. While they typically enjoy an initial wave of fast growth in markets they enter or create, they eventually hit a wall. In the best-case scenario, the market matures and growth is limited by overall macroeconomic conditions. In the worst case, companies face disruption and rapid decline. And even though organizations can press for a dominant share of a specific market, the ability to grow faster than the core-market rate ends at some point. The electronic-design-automation (EDA) market is a good example of one that has reached maturity and is now limited by growth in the semiconductor market—all design engineers already use some form of EDA software and the number of new engineers is limited based on market-growth prospects.

Consequently, key players such as Synopsys, Cadence, and Mentor Graphics have all been exploring alternative paths for growth outside their core EDA-software business. Synopsys ventured into Internet Protocol (IP) licensing, optics, and more recently into software testing. Cadence expanded into IP licensing. Mentor Graphics diversified its business with embedded-software tools, mechanical computer-aided design, and automotive subassembly-design software.

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Here is a direct link to the complete article.

Rishi Kant is a consultant in McKinsey’s Silicon Valley office, where Eric Kutcher is a director, Mitra Mahdavian an associate principal, and Kara Sprague a principal.