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Software products: the perfect storm

— FILE PHOTO

FOCUSSING ON CORE ACTIVITIES: Employees working at a software development centre in Cyberabad.

Wikipedia defines a perfect storm as a rare weather event wherein the simultaneous occurrence of many weather events which, taken individually, would be far less powerful than the storm resulting of their chance combination. One such perfect storm was the Halloween Nor'easter hurricane which struck North East U.S. in 1991 and became the subject of the Hollywood movie `The perfect storm' starring George Clooney. It tells the story of the fishing boat Andrew Gail who sailed out to sea ignoring weather warnings and unfortunately perished.

Similar to the Halloween Nor'easter, a chance simultaneous happenstance (happen by chance) of events is creating a perfect storm towards which the software product industry is blissfully heading. But before discussing this, let's examine what is a software product firm.

From a purist's perspective, a software product firm is one which owns the product brand and IP (intellectual property) and not who merely creates the product itself. An ideally optimised product firm could outsource all noncore activities such as product development and support, itself focusing on core activities such as product strategy, architecture and marketing. Conversely, a firm can create software IP and yet may not be a software product firm. Typically such firms either license or sell their intellectual property to firms who integrate these discrete software components to create marketable end products.

Products v services

Traditionally, the software industry has been dichotomised into firms which own products and those that perform services, including implementation of software products. Based on research of U.S. software product and services companies, MIT's Prof. Michael Cusumano's has provided some interesting postulates in his book, `The Business of Software'. According to him, the increasing commoditisation of standardised products, typically ERP and CRM is making the price of software products head downwards forcing product firms to morph into hybrid solution firms by developing services/maintenance businesses which typically have higher revenue predictability and margins. This trend has been validated by the rise of services/maintenance revenue as a percentage of total revenues and fall in product revenue as a percentage of total revenues of U.S. product firms studied by the professor. In an attempt to increase margins and achieve market differentiation, services firms have also made forays into the products business. But with the DNA of the services and product business being so different, most attempts to co-exist services and product businesses within one firm have seldom worked.

Let's now return to the perfect storm approaching the software product industry. First, availability of reliable, affordable and ubiquitous high speed internet connectivity coupled with cheap computing horsepower has transformed cloud computing aka Software as a Service (SaaS) from a technology paradigm to a viable business model. Instead of purchasing expensive products and engaging a services firm to implement the product, cloud computing allows users to procure services through a subscription based payment model, thereby moving IT investments from CAPEX to OPEX. It also allows a better alignment of IT investments with business growth to achieve a higher degree of predictability. The growing mainstreaming of cloud computing and its threat to the licence fee model is evidenced with most product companies including erstwhile naysayers launching SaaS avatars of their flagship products.

Open source software

Second, open source software is coming out from the realm of geeks into the real world. Many open source products have reached enough scale and maturity to seriously challenge their proprietary software counterparts. Claims by proprietary software firms that open source products suffer from a higher lifecycle cost and lack good quality support appear to be a case of sour grapes given the rapid proliferation of open source products such as Linux and the rise in the number of IT firms offering implementation and support services for open source products.

Third, while demand for IT adoption ratchets up in the traditionally lagging small business and household segments, the cost and complexity continue to challenge first time users. Compared to the downward bias of the priceperformance ratios for hardware, software products continue to be increasingly complex and expensive. Using a basic PC requires interaction with a minimum of three vendors - hardware, software and internet provider - with the situation being further exacerbated for small businesses which also need staff to manage their IT infrastructure. Not only is it difficult to procure software (when did you see a retail outlet selling software products), the quality of post-purchase support is often abysmal. While a TINA (there is no other alternative) factor may keep the current licence fee `sell & forget' model ticking, it will not take much for consumers to flock to viable alternatives. Already telcos are offering bundled hardware and internet connectivity on monthly fees and perhaps it will not be long before software products also get added to the bundle to provide a single user offering.

Rampant piracy

Fourth, while piracy levels in India decline, piracy continues to plague the product industry in spite of vigorous efforts by the industry and government, proving that this battle cannot be won merely through enforcement. Perhaps the only sustainable options to reduce piracy are to either make products free to avoid cost arbitrage exploitation or make it technically difficult to replicate the original product. While the open source community may say `ah ha' to the first option, it is hard to see proprietary product firms giving it the glad eye. Therefore the second option where Web 2.0 technologies make it possible for product firms to deliver subscription fee based services to users rather than delivering software in physical media and charging licence fees is perhaps a more sustainable solution. On a recent visit to China the author was told that the huge increase in firms offering Web 2.0 based solutions is simply because the traditional model of selling products was just not viable due to rampant piracy.

Ready-to-use software

Fifth, due to the maturity and wide acceptance of software interoperability standards and SOA technologies, a new genre of firms have emerged which offer `readyto- use' software components a la ready-to-eat meals. Each of these self contained `black box' functional components can be integrated with other components or existing applications to rapidly create fullfledged products by end-users themselves. Some of these firms also provide tool-kits which allow integration of discrete components through drag and drop functionality. This empowers the users to create `best-of-breed' applications based on their requirements rather than be forced to purchase monolithic applications, a large proportion of which seldom gets used.

While each of these trends may not be disruptive individually, their simultaneous happenstance will be perilous for the software product firms to ignore. While each firm follows its individual path, there are two strategic vectors to choose from. Firstly, firms can morph from a product centric to a solution centric strategy. In other words, a firm will have to move away from `this is what I have, take it or leave it' or `I will do anything you want me to' approach to a `Let me understand your problem before I offer a solution' approach. This is more than semantic wordplay and a firm will need to synergise its product offerings with a strong services and consulting capability.

IP factories

Secondly, product firms can become `IP factories' and leverage the increasing softwarisation of hardware as an extremely valuable opportunity to create technology IP which gets leveraged in multi- sector applications, for example, imaging technology IP has multi-sector usage including healthcare, consumer electronic and defence. Dolby has leveraged deep technology domain expertise to become a leader in audio technologies over multiple media and become a de facto standard in the audio industry. Dolby does not make any end-user products and a vast majority of Dolby's revenue comes from licensing of its technology to firms in the consumer electronics, TV, music, movie and software products industries. The situation is especially grave for the Indian software product industry which at a size of $1.5 billion circa 2008 continues to be at the fringes of the Indian IT industry which is over $60 billion in size. With thousands of SME firms mostly offering commoditised `me to' products; none of them have a scale to grow on the basis of the traditional licence fee model which requires huge upfront investments. Forget international, only a handful of firms have achieved a national footprint. Interestingly, the top firms of the Indian IT industry have all made forays into the product business without being successful.

Indian product firms need to devise alternative strategies which allow them to be IP centric and yet avoid the existentialist product v service debate. Firms need to leapfrog the tried and tested path to leverage the domestic market not only as a revenue opportunity for low cost `import substitution' products but more importantly for experimenting disruptive business models in a low risk environment.

Instead of a Sisyphean aspiration of creating a `globally successful' ERP product from India, product firms perhaps need to provide an ERP service for a monthly fee of few hundred rupees for the millions of micro and small firms in India. The Indian product firms can either ignore the weather warnings and perish like Andrew Gail in the coming perfect storm or they can chart a new course to avoid the storm. Status quo is not an option.

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