The Changing Software Business
Presentation for OECD-METI-RIETI Conference
October 6-7, 2008
Michael A. Cusumano
MIT Sloan School of Management
cusumano@mit.edu
© 2008
Software Products Business
• Decline of New Enterprise Sales (or Prices)
– Only exceptions are hits & “platform” products?
• Growth of Services & Maintenance Sales
– Technology glut from Internet boom and Y2K
– Freeware and open source driving some prices to zero
– Customers rebel against costly commodity products
• Emergence of New Business & Pricing Models
Î Software as a Service– cheaper products, bundled
support & maintenance (e.g. Salesforce.com)
Î Free, But Not Free, Again – software supported by
advertising (e.g. Google, Yahoo, Windows Live)
2
20
04
20
03
20
02
20
01
20
00
19
99
19
98
19
97
19
96
19
95
%of Total Revenues
2
00
4
2
00
3
2
00
2
2
00
1
2
00
0
1
99
9
1
99
8
1
99
7
1
99
6
1
99
5
$m
illion
Sie be l
1200
1000
800
600
NewProd
400
ServMain
200
0
Siebel
100
90
80
70
60
50
40
30
20
10
0
NewProd
ServMain
3
20
05
20
04
20
03
20
02
20
01
20
00
19
98
19
99
19
97
19
96
$m
illion
2006
2004
2002
2000
1998
1996
1994
1992
12000
10000
8000
6000
4000
2000
0
19
95
19
94
19
93
19
92
%of Total Revenues
Or acle
New Prod
ServMain
Oracle
70
60
50
40
NewProd
30
ServMain
20
10
0
4
90
80
70
60
50
40
30
20
10
0
Products
tio
uc
So
lu
od
H
99% of 0 = 0?
yb
rid
Pr
Se
rv
ic
es
ns
Services
ts
% of Total Revenues
Business or Life Cycle Models?
Source: M. Cusumano, The Business of Software (2004)
Margins too low?
5
57
Public Software Product Firms
Listed on US Stock Exchanges (SIC 7372)
0
(mean) densityall
50 100 150 200 250 300 350 400
Number of Firms in the Industry - All Sample
1990
1992
1994
1996
1998
fyadj
2000
2002
2004
2006
6
Web-Based Enterprise Software Vendors
Year of Company Formation
25
120.00%
Frequency
20
100.00%
Cumulative %
80.00%
15
60.00%
10
40.00%
5
20.00%
0
.00%
2006
2005
2004
2003
2002
2001
2000
1999
1998
1997
1996
1995
1994
1993
1992
1991
1990
1989
1988
1987
1986
1985
1984
1983
1982
1977
1975
1972
1911
Year
Source: Andreas Goeldi survey (MIT master’s thesis, 2007) n=108
7
New Business Model Dimensions
Revenue Model
Free (revenues
from services
Free but not
free (bundled)
Transactionbased
Advertistingbased
Subscription/
Software as a
service
Up-front
license fee
Mainstream consumers
Early-adopter consumers
Small businesses
Traditional
È
Local Client Local Server Remote
Remote
Installation Installation proprietary Web-based
(e.g. hosted
SAP)
Bundled as
part of a
hardware
product
Delivery
Model
Mainstream enterprise customers
Early-adopter enterprise cust.
Customers
Source: 2006 MIT student team Krishna Boppana, Andreas Göldi, Bettina Hein, Paul Hsu, Tim Jones (Cusumano, The Software Business, 15.358)
8
108 Web-Based Enterprise Software Vendors
100
80
Frequency 60
n=180
40
20
0
Monthly Fee
89
Free
Upfront License Fee
Traditional
È
Professional Services
Open Source
29 30
16
6
7
2
Business Models
Source: Andreas Goeldi survey (MIT master’s thesis, 2007)
Advertising
Pay Per Use
9
Different Evolution Curve –
Product, Process, and/then Services?
Product Innovation
Process Innovation
Service Innovation
Focus of
Attention,
Revenues
Source: Adapted from Utterback and Abernathy
Time
10
Different S-Curve Dynamics –
Product Platform Disruptions Generate New
Services & New Business Models?
Maturity
Performance
New Services?
Takeoff New Biz Models?
Ferment
Time
Platform
Disruption
Strategy Questions
Rise in services and new business models
temporary or permanent?
• Temporary Argument: In transition phase between
platform and business model innovations (now clientserver to internet to web services)
• Permanent Argument: Software now commoditized
and prices will fall close to zero for standard products.
Future is software as a service or “free but not free,”
supported by advertising or other indirect revenues.
Many other technology-based global industries will
follow – such as consumer electronics & automobiles?
12
Software Products Company
Database Study
• Research project with Prof. Fernando Suarez (Boston
U.) and Steve Kahl (Chicago GSB)
• Identified ca. 500 public software “products firms”
(listed on US stock exchanges) under SIC code 7372 –
PrePackaged Software
• Since 2003, downloaded data from Compustat, Mergent,
and directly from 10K reports
• Over 3000 yearly usable observations
• Average 10+ years of detailed financial data from 1990
or later
13
.8
Service vs Product as % Sales - Average All Sample
.3
.4
.5
.6
.7
excluding video games
.2
Note: Services including maintenance (about 55% of services revenues for firms breaking this out)
1990
1992
1994
1996
1998
fyadj
(mean) servpctsales
2000
2002
2004
2006
(mean) prodpctsales
14
including video games
15
Histogram of Service as
% of Sales - All Sample 1990-2006
154154
145
140
137
121
121
109
101
145 144
138
135133
132
120
115
108
Frequency
91
81
77
64
63
58
41 40
45
45
42
32
18 17 20
.1
.3
.2
.4
.6
.5
.8
.7
.9
01
24
0
100% product
.2
.4
.6
servpctsales
.8
1
100% service
Service/Maintenance vs. Product Revenues
17
17
Service/Maintenance vs. Product Revenues
18
18
Service/Maintenance vs. Product Revenues
19
19
20
.2
Average Pct Services over Sales
.3
.4
.5
.6
.7
.8
Service Percent of Sales vs. Firm Age - All Sample
0
2
4
6
8 10 12 14 16 18 20 22 24 26 28 30 32 34 36
Age of the Firm
21
Why do Most Software Product
Companies Shift to Services?
(Regression Analysis)
Services as % of total sales rise as…
• Firms age (services rise 1.8%/yr)
• Product sales growth slows down
• Industry consolidates (maturity, price
competition)
• Industry recession (2001-2003 – prices fall)
• Internet products (disruption?) introduced
¾though firm effects – age, product growth lag, total
sales lag – most important effect
22
Services
Growth index
Products
A: Case of a firm
where products and
services revenues
reinforce each other
Time
Services
Growth index
Time
Products
B: Case of a firm
where products and
services revenues
do not reinforce
each other
23
Some More Data Analysis
• Services have positive impact on operating profits of
product companies when reach about 60% of total sales
– About 70% product sales optimal for profitability
• Hybrid firms generally have (1) higher and more stable
profits and (2) higher market valuations than the average
“pure” (100%) software product firm
– But pure product firms disappearing in software industry
• Maintenance about 55-60% of service revenues, for
software product companies, with high gross margins
– Each 10% increase in maintenance as a % of service &
maintenance revenues = 5% increase in SM gross margins
24
Scale/Scope
Economies Begin?
Stuck
in
the
Middle?
Products
Services
60%
So
lu
od
tio
uc
ts
ns
20%
Sweet
Spot?
H
yb
rid
Se
rv
ic
es
90
80
70
60
50
40
30
20
10
0
Pr
% of Total Revenues
Services Impact on Profits & Market
Value: Sweet (vs. Sour) Spots
Sample: Software Product Companies
25 25 7
Impact of Industry Change
on SI and IT Services Firms?
• Client server to internet led to major increase in public
IT services firms in US
• But consolidation of industry and products business
also seen in IT services firms
– Number of publicly listed firms in our database dropped from ca. 550 in
2000 to under 400 in 2005 (preliminary estimate, multiple SIC codes)
– Product sales used to be 20% of service firms’ revenues; sharp decline to
3% today (estimate)
• Software product and other technology companies
could have taken more of the services business for
themselves – and probably will in future!
26
Public IT Services Firms
600
Listed on US Stock Exchanges
N u m b e r o f firm s
500
400
APAC(***) firms
300
EMEA(**) firms
NA(*) firms
200
(SIC codes 7370,
7371, 7373 for
computer services,
and mgt consulting
IT services 8742)
100
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
0
27
* North-America including Caiman islands and Bermuda. ** Europe and Middle-Eastern. *** Asia-Pacific
2004
2003
2002
2001
2000
1999
1998
1997
1996
1995
1994
1993
1992
1991
1990
$ B illio n
Revenue Mix in IT Services Firms
120
100
80
60
Services
Products
40
20
0
28
Services % of Sales at Select Hardware Firms
60
IBM
HP
40
Sun Microsystems
30
EMC
20
Cisco
10
Dell
0
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
% S ales
50
29
Conclusions
• Pure software product firms are disappearing, except
some platform leaders or hit product companies
• “Pure” IT services firms also disappearing, and under
threat from low-cost-good quality services in India, etc.
• IT services firms, former partners of the product firms,
now must compete for the same services revenues!
• But services remain essential to de-commoditize product
technology and add new sources of revenues & profits:
ÎHybrid Business Model
– Products remain the “engine” that drives new service and
maintenance revenues
– All firms must develop stronger services capabilities
30
Impact of Industry Change
on IT Services Firms?
• Client server to internet led to major increase in public
IT services firms in US
• But consolidation of industry and products business
also seen in IT services firms
– Number of publicly listed firms dropped from ca. 500 in 1999 to ca. 250
in 2006 (preliminary estimate, multiple SIC codes)
– Product sales used to be 20% of service firms’ revenues; sharp decline to
3% today (estimate)
• THE BATTLE: Software product companies now
fighting with current/former partners (IT and SI
services companies) for the same services revenue!
31