As an authoritative source, the ISG Index has delivered independent, fact-based insights for 94 consecutive quarters, supporting Wall Street, service and software providers and enterprises in tracking key technology and market shifts.
From my perspective as Chief AI and Software Analyst, Q1 reinforces a clear trend: the software economy (XaaS) remains the primary engine of growth across the technology industry, as enterprises standardize on cloud-first and increasingly AI-driven operating models.
The broader context of the quarter presented contrasting signals. The technology sector experienced more than 70,000 layoffs, the highest level since Q1 2023, while investment surged to approximately $300 billion across 6,000 companies. AI accounted for nearly 80% of that total, led by major rounds from OpenAI, Anthropic, xAI and Waymo.
The ISG Index shows that ACV for Q1 2026 reached approximately $28.2 billion, up 44% year over year. Infrastructure as a Service now accounts for 82% of total XaaS ACV, driven by large-scale AI infrastructure investments and accelerating enterprise adoption. Software as a Service also reached a milestone, exceeding $5 billion in ACV for the first time, although growth remains uneven across segments.
Infrastructure as a Service (IaaS)
Demand in IaaS continues to be driven by sustained investment in AI infrastructure, large-scale cloud expansion and enterprise modernization. In the first quarter, the segment generated $23.1 billion in ACV, up 57% year over year and 21% sequentially. This marks the strongest growth since Q4 2021 and the first time the market has exceeded $20 billion in a single quarter, extending the streak to nine consecutive quarters of year over year growth.
On an absolute basis, ACV increased by more than $8 billion year over year and $4 billion sequentially, with seven consecutive quarters of double-digit growth. Regionally, the Americas and EMEA saw significant acceleration, growing 77% and 72% respectively, while Asia Pacific remained positive but more moderate, representing 24% of total ACV.
The hyperscalers, including AWS, Microsoft Azure, Google Cloud and Oracle Cloud Infrastructure, were the primary beneficiaries. Collectively, they grew 75% year over year and now account for approximately 85% of total ACV, outperforming the broader market by about 1.3 times.
At the same time, the segment is beginning to encounter constraints. Growth is no longer limited by demand, but by the ability to scale supply. Capital intensity, resource availability and construction timelines are slowing expansion, while access to land, power and cooling infrastructure is becoming a clear limiting factor, particularly in the United States. These constraints are also driving increased local resistance in the U.S. to large-scale data center expansion and consumption of natural and energy resources.
To address these challenges, hyperscalers are accelerating investment in AI-optimized silicon, including AWS Trainium, Google TPUs, Microsoft’s Maia 200 and Oracle’s AmpereOne. These efforts both complement and compete with NVIDIA, as the market shifts toward more vertically integrated AI infrastructure.
AI economics vary across the stack. Hyperscalers are benefiting from strong demand for model training, while for LLM model providers, training remains a cost and revenue is driven primarily by inference. As a result, much of the first quarter activity focused on expanding AI infrastructure and platform capabilities to capture this shift in value.
Among the leading players, AWS is expected to surpass Microsoft in IaaS ACV in the second quarter, supported by its European Sovereign Cloud and continued expansion of Bedrock and AgentCore. Google Cloud remains highly competitive on pricing while advancing Vertex AI and Gemini. Microsoft continues to build momentum through investments in Fabric, Foundry and Confidential Computing, while Oracle is gaining traction with hybrid and sovereign offerings and AI-driven demand from its applications and data platform.
Overall, AI value is emerging from the bottom up, led by infrastructure, followed by software, with services still in the early stages.
Software as a Service (SaaS)
In contrast to infrastructure, SaaS presents a more complex and evolving picture. Enterprise SaaS continues to evolve as providers embed generative and agentic AI capabilities into their platforms and architectures, laying the foundation for new digital labor models.
SaaS ACV reached $5.1 billion in Q1, up 5% year over year and marking the sixth consecutive quarter of growth. However, growth has moderated over the past five quarters, reflecting a normalization after earlier expansion. The Americas accounted for approximately 59% of total ACV, while Asia Pacific showed faster growth but remains a smaller share of the market.
Performance across providers is beginning to diverge. The top 10 SaaS vendors saw a slight decline in ACV, reflecting portfolio maturity, pricing pressure and ongoing cost optimization. At the same time, enterprises are reassessing spending as AI consumption costs increase, particularly with token-based usage models that are often difficult to predict and control.
SaaS providers faced continued pressure in the quarter, with declining valuations driven by uncertainty around how AI and LLM-based models will reshape their economics. At the same time, enterprises are encountering gaps in FinOps, governance, security and orchestration required to manage AI at scale. The core challenge is not demand, but clarity. Many providers have yet to clearly define how their platforms, agentic capabilities and pricing models will evolve. Adapting also with hybrid pricing models that combine seat-based, platform-based and consumption in token-based approaches were evolving further in the quarter.
SaaS performance showed steady but uneven momentum. AI and data software, excluding LLM providers, led growth at 12%, while the broader applications segment grew 11% to a record $3.9 billion in ACV. LLM providers such as Anthropic and OpenAI are scaling rapidly, although their growth is not fully transparent. While they operate outside traditional SaaS models while using it to operate their own business, they represent a growing source of disruption, challenging long-term growth assumptions across the segment. But AI Is Software: The Honest Reality and should be recognized as such.
At a segment level, growth patterns varied. Front-office and middle-office applications each grew 10%, though performance was mixed, with strength in AI-driven customer engagement offset by declines in commerce and sales, while CRM, CX, and contact center applications grew 16.2%, driven by increasing adoption of AI-driven customer engagement and service automation. Continued innovation in conversational and agentic AI capabilities from vendors such as Zoom and Salesforce is expected to support future expansion in this segment as use cases mature.
Back-office applications showed the strongest acceleration, with HCM growing 22% and ERP 20%. In contrast, IT software declined 22%, reflecting pricing pressure and early AI disruption, although top 10 cybersecurity providers remained resilient with modest growth.
Across industries, overall demand remained strong, with all major verticals growing more than 33%, led by consumer services, business services and healthcare. However, this growth was largely driven by IaaS, while SaaS performance was more mixed across sectors. Although AI capabilities are increasingly embedded into enterprise applications, their impact on SaaS growth remains early and has yet to materially influence vertical ACV trends.
ISG Leaderboard
At the provider level, these trends are reflected in the ISG Leaderboard. The ISG Leaderboard highlights software providers based on ACV signed over the past 12 months, with momentum driven by AI, platform expansion and strategic deal activity.
In the Big 15, which includes providers with revenues above $10 billion, AWS, Google Cloud, Microsoft, Oracle and SAP define the leadership group. SAP joined the leaderboard with major enterprise wins, while AWS continued to lead with large-scale agreements across financial services and digital platforms.
The Building 15, representing providers with revenues between $3 billion and $10 billion, includes Autodesk, CrowdStrike, Databricks, Equinix, Iron Mountain, Palo Alto Networks, Snowflake and Workday. Databricks moved up a category following its $4 billion fundraise, while CrowdStrike continued to demonstrate strength in cybersecurity demand.
In the Breakthrough 15, Cloudflare, HubSpot, Rubrik, Shopify, Veeva Systems and Visma represent emerging leaders. The Booming 15, including DigitalOcean, Nemetschek and Vantage Data Centers, reflects the next wave of growth, with DigitalOcean expanding through a $700 million investment in AI infrastructure.
ISG AI Index on Software Economy
The new ISG AI Index, anchored to the December 2022 AI inflection point marked by the release of ChatGPT, highlights how unevenly AI impact and value is being realized across the technology stack.
In infrastructure (IaaS), the index is up roughly 160%, driven by a more than 260% increase in capital expenditures, along with strong gains in revenue and profitability. This reflects a continued build-out phase, with hyperscalers capturing the first wave of AI-driven value.
In software (SaaS), the index is up around 50%, with strong revenue growth and increasing backlog, as measured by cRPO. While demand remains strong, uncertainty around pricing models and long-term economics is beginning to influence growth expectations.
Overall, the data shows that AI is already a measurable growth driver, with demand and backlog outpacing market sentiment and value creation continuing to expand from infrastructure into software as the next phase of the cycle.
Summary
The software economy continues to expand, driven by record IaaS performance and steady, though moderating, SaaS growth. Hybrid pricing models and new AI-driven applications are expected to support continued SaaS expansion in 2026.
AI is a measurable growth driver, but its impact is uneven. Infrastructure is capturing the first wave of value, software is following, and services remain early. Enterprises are also facing new challenges in managing AI consumption costs and adapting to evolving pricing models.
Financial management in the AI economy will be a discipline that is necessary sooner rather than later.
Despite geopolitical uncertainty, war in Middle East and energy prices, workforce costs and reductions and macroeconomic pressures, demand remains resilient. As a result, ISG is raising its software industry growth forecast to 25% for 2026, up from 20%, driven largely by continued expansion in IaaS.
Watch the replay of the Regional Results: ISG Index 1Q26 Quarterly Webcast.
Regards,
Mark Smith