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As Chief Software Analyst, my view of third quarter is that the software economy (XaaS) remains the center of financial growth for the technology industry as enterprises standardize on cloud-first and now AI-enabled operating models. The average contract value (ACV) is around $61B, up 29% YTD and 31% YoY in Q3, with XaaS representing roughly two-thirds of total ACV. Infrastructure-as-a-Service (IaaS) is the primary engine, fueled by AI infrastructure buildouts and broad enterprise adoption, while Software as a Service (SaaS) continues to expand in ITSM, collaboration and analytics. As budgets rotate to the cloud, the managed services and outsourcing industry continues to contract substantively. AI is also pushing a difficult shift toward consumption and value/outcome pricing that could reshape software economics.
IaaS returned to broad-based growth this quarter as hyperscalers posted triple-digit AI revenue. Looking toward 2026, the watchpoint is whether supply constraints ease as providers ramp AI and cloud capex for more servers and data centers. Scale wins: the largest players are best positioned, and the next leg should come from enterprise cloud consolidation and sovereign-cloud deals, where control of GPUs, power and land will set pricing, pace and M&A. The Q3 IaaS performance reached a record $16.8B ACV (+35% YoY), the fourth straight quarter of 30%+ growth. YTD, IaaS is $46.4B (+33% vs. 2024), well above last year’s +15% and a full reversal from –16% in 2023. Regionally, Americas +42% and EMEA +50% (both accelerating vs. 2Q25), while Asia held a steady 12–13% YoY for the fourth straight quarter.
The Big 3 (AWS, Azure and Google Cloud) are +42% YTD in ACV; Azure is outpacing AWS and could overtake on a quarterly run rate if trends hold. The field is effectively a Big 4 as Oracle’s backlog swells on multi-billion AI deals. Rising sovereignty demand is pushing EU and global providers to expand sovereign clouds (e.g., SAP’s Delos Cloud on Azure and its STACKIT partnership), while U.S. data centers enter an AI-compute arms race and make record capex investments, NVIDIA partnerships and mega-projects such as the proposed Microsoft and OpenAI “Stargate.” ISG Buyers Guides in Sovereign Cloud rate Google, Microsoft and Oracle as Overall Leaders with Exemplary standing. Cybersecurity remains in strong double-digit growth, with leaders like Palo Alto Networks, CrowdStrike and SentinelOne expanding amid consolidation. I observe fragmented categories converge, and this is reflected in our research and ratings in the ISG Buyers Guides on Cybersecurity.
For SaaS, enterprise software stack complexity—with platforms and the security, compliance and integrations—makes wholesale AI “replacement” unlikely. Generative AI is boosting productivity via agentic capabilities, not displacing core platforms. SaaS is executing and financially growing well with Q3 ACV $4.8B, +18% YoY, the fourth straight double-digit gain; YTD $14.4B, +16%, led by ITSM, collaboration and analytics as AI augments workflows. Regionally, EMEA is +22%, Asia is +20% and Americas is +13% (still ~60% of the market). The Top 10 SaaS providers are +17% YTD ACV growth, slightly ahead of the broader SaaS segment performance, and remain confident that AI-enhanced offerings will translate to revenue as deployments scale.
Across SaaS categories, financial performance is diverging: AI/data/analytics platforms are at +24% YTD ACV (>$1B segment) after a flat 2024, with Databricks, MongoDB and Snowflake outpacing the market. Front-office/CRM is at +1% YTD (commerce –3%), with ServiceNow entering CRM (expanding with Logik.io). Middle-office apps are +23% YTD (collaboration/content/project management), while ERP cooled to +6% as migrations (e.g., SAP S/4HANA) remain the gating factor. HCM is -18% YTD but +19% QoQ. ITSM/IT platforms surged +55% YTD led by ServiceNow, as Salesforce moves into the category. Collaboration is +50% YTD with Google, Microsoft and Zoom who were all rated Exemplary and Overall Leaders in the ISG Buyers Guides on Collaborative AI. As AI lifts digital labor potential with fewer seats, software providers face a tough transition from subscription to consumption and increasingly value/outcome-based pricing, echoing past model shifts.
Our vertical analysis of software industry shows broad strength: every segment grew 20%+ ACV YTD. BFSI is 19% of ACV, while the fastest growing industries were Healthcare (10% of ACV; +29% YTD, IaaS +34%), Retail and CPG (15% of ACV; +32% YTD, SaaS +18%), and Business Services (16% of ACV; +36% YTD, IaaS +40%). Growth is fueled by verticalized clouds and AI spanning many software provider examples like: Microsoft (Dragon Copilot, Cloud for Retail), Oracle (Oracle Health EHR, Retail Merchandising Cloud), Salesforce (Einstein Copilot Health Actions) with sustained multi-year momentum as providers like NiCE, Oracle and Salesforce invest in targeted industry solutions.
On the ISG Leaderboard for the software industry, the Big 15 with revenue over $10B (AWS, Google Cloud, Microsoft, Oracle) remain steady, with hyperscalers continuing to lead growth. In the Building 15 with revenue from $3B to $10B, AppLovin and Autodesk join for the first time. The Breakthrough 15 with revenues from $1B to $3B highlights new entrants 21Vianet and OVH moving up alongside Databricks, Palantir and Zscaler. Databricks signed a Series K term sheet at >$100B valuation, surpassed a $4B run rate with $1B+ AI run rate, and announced an OpenAI partnership for Agent Bricks. In the Booming 15 with revenues less than $1B, CyberArk joins for the first time alongside DigitalOcean, Kingsoft Cloud, Nemetschek and Vantage Data Centers.
Macroeconomic signals remain mixed with tariffs, longer enterprise decision cycles, US H1B visas and geopolitical uncertainty (especially in Europe) all weighing on parts of technology industry. But impacts are more limited in the software economy compared to the services economy. We’re watching how AI-infused applications lift SaaS ACV as enterprises gain confidence in outcomes. The shift is clear: AI isn’t an add-on; it’s foundational. Based on continued IaaS strength and consistent SaaS delivery, ISG is raising the software industry forecast from 21% to 25% for 2025.
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Regards,
Mark Smith