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As
a follow-up to a previous article on evaluating
successful IT strategies within the Muslim world
and elsewhere, Mr. Anthony Mitchell provides an
overview of the successful software business models.
There
are two different types of clients that software
firms can market to:
- Consumer
clients; and
- Business
clients.
Software
firms based in Muslim majority countries tend
to focus on serving the needs of business clients,
selling or servicing what is referred to as enterprise
software.
Business
Models Serving Business Clients
There
are three types of business models available for
software firms, described below in terms of enterprise
software:
1.
Software Product Firms.
Software
product firms earn at least 60 to 80 percent (depending
on your definition) of their revenues from developing
software, licensing it for sale and receiving
maintenance fees for updating that software.
2. Services Firms.
Software
services firms provide customization, installation,
integration and maintenance services of other
companies' products, along with consulting and
other services. They may also develop customized
software applications. If developed under the
services business model, then such customized
software is owned by the clients.
Most
software companies are service firms. Service
firms can experience dramatic revenue fluctuations.
At Services firms, revenue per employee and profit
per employee are usually lower than at successful
software product firms.
3. Hybrid
Firms.
Hybrid
firms are engaged in both product development
and services work. Hybrid firms have the advantage
of being able to leverage their core technologies
so as to distinguish themselves from their competitors
and gain market advantages. Most companies that
start off as software product firms begin providing
services and thereby drift towards becoming hybrid
firms.
It
is easy for companies to make the transition from
being product firms to hybrid ones because they
have an existing client base to whom they can
market. The alternative for a product firm is
to go out and find new software customers to purchase
their products. Finding new customers is not as
affordable as upselling to existing ones, in that
it costs 10 percent as much for enterprise software
firms to develop new business from existing customers
than to bring in new customers.
The
question for hybrid firms is whether to stress
products or services. The advantage of stressing
products is that firms with a higher percentage
of revenues from software sales have higher potential
for growth and profits, particularly during good
economic times.
Strategic
Considerations for Software Firms
Becoming
a software products firm is attractive because
software is often easy and cheap to reproduce,
once it has initially been developed. The profit
per employee can be very high once software sales
begin to gain momentum. The risk for products
firms is that if there is an economic downturn
or other factors outside of their control, then
clients may suddenly stop purchasing their software
products.
Software
firms that are in the best economic position are
often those that produce their own software and
have a solid base of clients willing to provide
these firms with recurring revenue from maintenance
fees, updates, customization, and other services.
Absent
extreme price pressures within a product field,
enterprise software product firms can often charge
high prices per license. By producing multiple
copies of the same software product at little
more than it costs to produce a single copy, software
product firms gain economies of scale that enable
them to increase revenues without significantly
increasing their costs, thereby enabling them
to become profitable within short time frames
once sales begin to accrue. Service firms, in
contrast, find it harder to scale up rapidly because
their revenues are based on the amount of people
used to implement each service contract.
Economies
of scale are harder for software service firms
to achieve. Profit margins for each dollar of
revenue are lower than the gross profit margins
of successful product firms. In 2002, for example,
PeopleSoft reportedly spent only 10 percent of
its software revenues on developing and distributing
PeopleSoft's software.
Maintenance
Fees
Software
products firms can charge maintenance fees for
their software, thereby generating recurring post-sale
revenues. Payment of maintenance fees usually
entitles customers to have access to newly developed
features and patches for bugs.
Once
a software product is stable, the maintenance
fees it generates are largely profit. A feature
developed for one client (and paid for by that
client) can be made available to all customers
paying maintenance fees for that product.
Because
not all existing customers may want or need a
new feature, version controls and feature switches
are often needed to enable users to opt in or
out of new features. The ability of users to make
acceptance decisions regarding new features is
often important when the installed base spans
different countries and where different business
processes are used from one location or client
to the next.
In
the 1980s and early 1990s, software maintenance
fees of 10 to 15 percent were common. Today, maintenance
fees usually range from 15 to 22 percent of the
original purchase price. PeopleSoft was charging
20 percent until January 2005, when its new owner,
Oracle, raised it to 22 percent to match the rate
that Oracle charges for its own products. It is
common for software products firms to earn more
revenue from maintenance fees than revenues received
from initial product sales.
Market
Targeting
Once
an IT company has committed itself to the business
model for software products firms, it needs to
decide whether to build products for mass markets
or niche markets. In the enterprise software field,
the targeting of a niche market is generally the
safest strategy, at least at first.
Once
a products firm has developed products for one
industry vertical, it can expand to another industry
vertical or specialty. This is much easier than
attempting to develop mass market products, which
requires greater support capabilities.
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The
author, Anthony Mitchell, is the CEO of InternationalStaff.net
[http://www.internationalstaff.net], which manages
call center and software outsourcing projects
for U.S. clients.
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