The Business of Software

This is not only the topic of my new blog but also the book which I just finished reading. This is a 2004 book but very relevant even today in the business of software. The author is Michael A Cusumano, Co-author of another famous title – “Microsoft Secrets”. Let me take this blog-opportunity to review this book. This is one of the very few books which I have seen talking about software business in particular and more importantly very very few which talks about software services. This book mainly talks about the software business in general, business models, revenue models, products, services and hybrids, strategy, people, management, software development and finally case studies of many such software companies some of which were successful and many closed shops. I will be quoting few things in the ensuing paragraphs and all will be highlighting mostly what the author says rather than my personal opinion but I don’t think my opinions are far from his anyways. My main goal here is to provide a detailed summary so that who don’t have time to read the book will get a good enough summary and hopefully will create enough curiosity to pick a copy!!

The author talks about the strategy and the kinds of companies that exist and the difference between them. Summary goes like this: there are broadly three types of companies, viz... Product based, Service based and the Hybrid ones. Companies must constantly pay attention to the strategies and the business models at all times continuously evolving their technical skills and core technologies. In software development, it is just as important to decide what doesn’t go in as it is to decide on what goes in. Companies should have a strategy and specific organizational capabilities to support that strategy and carry them through both good times and bad times. Product companies has higher (exponential) growth in margin but very low success rate and on the other hand service based companies has moderate success rate but the margins are very low and is highly labor-intensive and less profitable. Ofcourse hybrid model provides the best of both worlds but requires high organizational skills to manage both but he concludes that this might represent a new business model by itself. For product companies it is the economy of scale but for service based it is the economy of scope that is the Holy Grail. Economies of scope can be achieved by structuring knowledge such as how to do requirements, manage projects, customize applications, conduct testing and more importantly how to reuse this in different projects without affecting the IP of the clients. It can also be achieved from clever account management. He also talks about some of the financial metrics that conveys the measure of health of software companies – they are revenues, sales productivity or revenues per employee, expense boundaries (say 25 to 30% of total revenues), R&D budget usually, general administration budget, profit target (20 to 30% of revenues as operating income) etc. His conclusion on one of the strategy points is that, when a software company targets enterprises, it has more ways of succeeding, even if it fails to develop a best-selling product. Another point to note in strategizing is to make a selection on whether you are targeting a “horizontal offering” (broad set of customers) or focus on specific industries or applications, what is called the vertical market segments. One of the observations he makes (from data) is that rapidly growing companies have much better chances of survival. He outlines three basic strategies of rapid growth: scaling, duplicating, and granulating. Scaling is simply doing more of what one is already doing but for more of similar clients; Duplicating is primarily extending same strategy to other geographical markets or to other similar markets (as opposed to exact). Granulating is diversifying offerings and the organization structure by creating new, small business units to target new opportunities. A word of caution is that, diversification into related areas and technologies are usually good ways to grow, compared to unrelated diversification. Recurring revenue will be very helpful if one can find a way to strategize the same. He goes ahead and states that the goal of every software company should be to establish large and growing revenues that are recurring. As the saying goes – “get their data, and their hearts and minds will follow J”. He divides the companies based on strategy as one of these – platform leader (e.g.: Microsoft) or follower or complementor. Basically strategy of a company should take care of all these and be precise and in summary the strategy of a company should determine what kind of an organization you want to be.

After strategy he talks about the business model, importance of strategy over there, and the revenue model. Also are the discussions about the product versus services debate and his conclusion is that “the key choice is not simply whether to be a services company or a products company, but how much emphasis to place on one type of business over the other”. He also stresses the point about how business models may need to change with the economic times as well. A word of advice for new companies that niche applications and new platforms are the best places to look for software product and service opportunities but with a caution that one should focus on solutions rather than the technology itself.

Then he talks about software entrepreneurship as a whole which I enjoyed thoroughly and he talks about some of the very critical issues one needs to follow or atleast should have considered and is the basis for creating a bigger organization and also to get funding. Accepting VC money when it is not needed and accepting more than you need can often become what he calls the “Kiss of Death” (he analyzes this completely which I will skip and leave it those who will read this book!!). He has devised an 8-point plan to evaluate effectiveness of companies especially startups which goes as:

1. A strong Management Team
2. An Attractive market
3. A compelling new product, service or hybrid solution
4. Strong Evidence of Customer Interest
5. A plan to overcome the “Credibility Gap”
6. A business model showing early growth and profit potential
7. Flexibility in Strategy and Product offerings
8. The Potential for a Large Payoff to Investors

Finally he does a through analysis of four software product start-ups, three software services start-ups and there hybrid solutions start-ups with an equal number of failures and success through his eight-point plan, and is very educative and an eye opener is many issues.

One of the points that made me think was that his conclusion on Software services and VC funding – he says “Venture Funding is often the kiss of death for an IT services firm. It is a form of artificial wealth and the overwhelming tendency is to spend it. This is essential to create a company but more often than not it encourages a firm to expand its headcount and overhead commitments or its marketing plans to levels it cannot sustain”. But this is what I agree totally “A talented software services company should always remain profitable by managing head count and expenses carefully”. A service based company creates relationships with customers, they may build technologies but they cater to the needs of the individual clients. To be efficient, they need to learn how to leverage technology and knowledge gained in one project to other projects without compromising customer confidentiality.

Overall he has done a very good job reviewing different types of software companies and how to strategize, create business and revenue models, what are the points to watch out for, and more importantly he has analyzed many such companies giving us an insight on what works and what don’t. Overall a great book for a budding software entrepreneur and I recommend highly.

BTW I hope I was able to give a detailed summary of the book, enough to enthuse a budding entrepreneur to read this book. I constantly read such business books and I am hoping I will provide a detailed review through my blogs. Please let me know some of the pluses and minuses of such reviews so that I can better it for my next reviews.