The (only) Three Aspiration Options Available to the Software Industry
The software industry is unique. Unlike almost any other industry there are barely any manufacturing and logistics processes and cost. [slider title=”Note on Cloud”] Although this is changing with the introduction of cloud based services, where the software vendors also assume responsibility for most of the operation. However, the software industry value chains are still a long way from most other industries’.[/slider]
Some software solutions can be promoted, sold, delivered and used without any physical human interaction at [slider title=”all”] Have you ever talked to anyone from Microsoft, Google, Skype, MailChimp, SurveyMonkey, Amazon, eBay, Facebook, 37Signals, EXRO etc.?[/slider]. Other software solutions require sales people on the street, customization and implementation services from the software vendor or his channel partners.
The three aspiration options
Regardless of the type of software, owners of software companies have basically three kinds of aspirations from which to choose:
- Scale and IPO
- Scale and sell (get consolidated)
- Scale and become the consolidator (optionally through an IPO)
The fourth option available in most other industries “Stay small, profitable and manageable (by the founder)” is not really available to software companies.
The research and development required bringing and keeping a quality software product on the market combined with the low cost of operation cries for scaling. However, the nature of the market also cries for scaling.
The law of diffusion of innovation
But when it comes to trying something new, the situation is completely different. When there is no one available to recommend, most people simply hesitate and wait.
As soon as the gadget freaks and early adopters have tested the new stuff and someone you know uses and recommends it, then the majority of people slowly start adopting it too.
The first one in any category making it past the critical point will benefit tremendously and may even hit the [slider title=”tornado”] Demand increases faster that you can supply the market.[/slider]
Other software vendors in the same category will suffer and most will die or be consolidated (on unfavorable terms).
The impact of the law of diffusion of innovation is even tougher on software affected by network effects: The value of the software increases with the number of people using it. It is for example hard to see where a competitor to Skype or Facebook should come from. The only options seem to be from someone with a huge user base already or someone offering a disruptive solution that Skype or Facebook hasn’t thought of.
However those inertia barriers hit the software industry harder because software is invisible and the value of software is created when using it.
A user has to invest at least time and energy and maybe even money checking if a software product will provide any value. Obviously software vendors will try to explain what their software does. However, history shows that software vendors notoriously have a very hard time explaining what their software does and the value it generates.
Combine the software companies’ inability to clearly describe what the software does with the mainstream customers’ reluctance to try new things and you have a really poisonous cocktail.
You will see that almost all successful software companies move from product focus to customer focus in their communication activities. Take a look around and you will see a combination of simple product illustrations and happy customers (37signals, XERO, Survey Monkey and MailChimp).
Because software is invisible it is obvious for most people to conclude the biggest must also be the best.
Software which is easy to use is difficult to make
Software, which appears simple and easy to use, is normally very complex “inside”. Customers don’t want to spend time and effort learning and understanding software. They want the software to be intuitively comprehensible as they progress through the task at hand. Making such software is difficult and often very expensive. Economy of scale is required to sustain ongoing development.
Does scaling make software companies big?
Software companies don’t have to build warehouses and factories.
Some software companies don’t even need marketing, sales and support people in locations all over the globe. Software companies with little need for proximity to their customers enjoy a tremendous advantage. Business models with no need for proximity can scale very fast and efficiently. However, they are more vulnerable to new competitors as the barriers to entry are low.
Building and managing operations in different locations, time zones and cultures is extremely complicated and expensive. However a lot of software companies have no choice. The nature of their business model requires people and proximity proportional to their revenue growth. The companies that succeed in getting market coverage first will enjoy a tremendous advantage over any newcomer. The sheer presence close to the customers becomes a major barrier of entry for any new player, irrespective of how sexy his product may be.
Scale or die
Check out Silicon Valley and you will find an almost religious obsession with scalability. It is not because they have different genes in the Valley than the rest of us. It is because they lose an awful lot of money on business models that do not scale.
If you are a software CEO and you do not have an aspiration for world dominance, you may be in the wrong business. You may find a more comfortable life in another industry.
In the management consulting industry we have an “up or out” rule.
The rule in the software industry is not much different. It’s “scale or die”.