A New Business Called "Software"

Chapter Two

Types of software businesses - differentiated by 5 eras:

1. Independent programming services
2. Software products
3. Enterprise solutions
4. Packaged software for the masses
5. Internet and value-added services

Differences between Enterprise solutions and Packaged software:

1. Enterprise solutions always need customisation.
2. Substantial time and effort to get it up and running.
3. ERP software cost - 30% on licence 70% on professional services to implement product
4. ERP sell far fewer copies

Business Dynamics - Case study

CUC started offering software products in addition to individual programming services, it also entered into the hardware market.

1 year later it lost $430k.

In 1985, CUC posted $2.4M in LOSSES on $1.5M in revenues.

Why did CUC fail?

Because CUC failed to address the differences in managing software SERVICES and managing software PRODUCTS.

What are the differences?

a. cost structure
b. demand volume
c. competition intensity
d. geographic presence
e. relationship management

Enterprise solutions firms must address the above continuously as both the product and services are linked to product installation.

Product business - Business Dynamics

a. Low barrier to entry
b. Low capital investments

In software product companies, most of the cost of software is in the design and coding of it. Including marketing and sales costs too. While variable costs are low, there is a LARGE upfront fixed costs for development of the product.

Therefore, in the case of Microsoft, Microsoft must sell millions of $209 operating systems to recover its billion-dollar investment in cost of development.



Dosmetic markets even the size of the United States may be too small to reach such high sales volume.



Case study:


Intershop a German software start up moved to the U.S. just two years of its founding.



MANY SOFTWARE PRODUCT FIRMS KNOW ONLY ONE TARGET: THE WORLD!



Only a tiny fraction will succeed in that market.



Important to note: LAW OF INCREASING RETURNS



The law states that a product that advances in market share tends to get even FURTHER ahead and sell even MORE copies, while the one that falls behind tends to fall even further BEHIND. Advantage and disadvantages tend to magnify rapidly. This law leads to a very high market concentration after a short time, leaving FEW WINNERS and many losers.

Why?

1. The ability of programs to operate together and exchange information is critical; thus people buy the same software as the people usually communicate with. Users enjoy "increasing returns" from their software as other users also begin to use it.

2. Once users are trained on certain software products, they are less likely to switch to others because they would have to be retrained.

3. Since software products are often difficult to evaluate objectively, decision makers often buy whatever is most popular.

How to achieve it?

It is crucial to reach more than 40% market share within a certain niche within 12 to 18 months.If your competitor is well behind, word of mouth in the marketplace starts spreading the message that you are the market leader and once that happens, market share can be expected to increase beyond 50% of the following 12 months' sales.

So, you have to move with speed with carefully laid out plans!



Business dynamics - Professional services business



The law of increasing returns DOES NOT exist in the service business.



But it shares similar traits of a product business.


- Low entry barriers
- Constant threat of new entrants
- High pace of innovation



However, the service firm business model is radically different.



Case study:



A 1996 McKinsey analysis of 22 companies showed that the cost of revenue is MORE THAN 4 TIMES as high at software services firms than at product companies.



Why?



If Anderson Consulting builds a custom made software solution for a customer today, and a similar one for another customer tomorrow, the cost of both of them is NOT radically different.

It is quite different from the radical cost for the second CD-ROM copy in the product business.



Market leadership


There is NO RACE for market leadership. Since every product is custom made, the customer's desire to remain with a market leader is not as strong as with software products.

For these reasons, smaller local professional services providers can be very successful.

Case in point: Andersen Consulting with revenues of $6.6 billion in 1997 reached a global market share of LESS THAN 6%.

Challenge of managing the two business types simultaneously


The enterprise solution companies CANNOT address these issues by coping with ONLY ONE business type. Organisational separation and different marketing approaches for EACH business within the company must help solve the problem.

Case study:

ADV Orga a leading enterprise solution company in Germany in the early 1980s with more than 500 employees failed to do cope.

There were NO CLEAR ORGANISATIONAL separation between their product and service businesses.

Whenever there were many service projects, developers were pulled off the product business to support those projects. As a result, product development was often put on hold and market launches were delayed.

Furthermore, marketing was handled similarly for both products and services.

In 1989 ADV Orga was sold with heavy losses. Their main competitor SAP addressed those differences mainly via partnering in professional services and rose to global market leadership.

Leadership is important - leaders must accept the uncertainty AND thrive on it. Leadership is one of the most important ingredient in software success.

- read the book for more details.