The End of an Era In Software

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All rights reserved.</I></div> <bR> <div> <I>Draft 4.0 June 27, 2001</I></div> <bR> <div> Over the past few years, I have worked with, evaluated or advised numerous software companies. Most are going to fail, causing great personal costs to the founders and losses to their investors, disappointment to employees and bad receivables to their suppliers.</div> <bR> <div> The widely accepted explanation for this high failure rate is the so called dotcom meltdown, the aftermath of a speculative bubble.</div> <bR> <div> I have come to believe that the problem is actually larger. <B>We have come to an end of an era in software.</B> At least for the B2B area of the software business, software is no longer very important. Software <I>by itself</I>, has become to all intents and purposes a commodity with limited upside. Launching software products will never be the same as it was in the early days of Lotus 1-2-3, Word or dBASE. However, many software companies still have these historical examples in mind when they plan and implement their launches.</div> <bR> <div> <B>As a result, venture capital firms with large numbers of software investments are likely going to experience an even higher rate of loss than they anticipate. Ironically, there is an exit strategy for such portfolios, but one that is currently not being pursued.</B> </div> <bR> <div> In brief, my conclusions are that startup software companies typically need to stop thinking of themselves as tool or package vendors and start provide turn-key solutions and out-tasking.  Venture capital firms will have to fund a new channel of distribution, a Solution Channel, to preserve and grow the value of their investments in many software companies.</div> <bR> <div> Future software success is more likely to be based upon solution selling and delivery than the traditional sale of tools and packages.</div> <bR> <div> <B>Why B2B Software is History</B></div> <div> In the 1990s, I was very involved in looking at the question of how do you best exploit information technology from a strategic perspective. The results of our work were published in the book <FONT SIZE="3" COLOR="#0000FF" FACE="Arial" ><A HREF="http://www.amazon.com/exec/obidos/ASIN/1571120998/alistadavidsshom" TARGET="_top" TITLE="http://www.amazon.com/exec/obidos/ASIN/1"><U><I><U>Riding the Tiger</U></I></U></A></FONT> (Davidson, Gellman and Chung, HarperCollins Canada 1997 and Jist Publications 1999).</div> <bR> <div> One of the observations we made when writing the book and also selling performance and resource tracking software, was the major shift in the role of the CIO in the organization. In large organizations, CIOs were rapidly becoming overwhelmed by five trends:</div> <bR> <div> <IMG BORDER="0" SRC="Symb075c00b700f000000000.png" HEIGHT="16" WIDTH="24" ALIGN="bottom" HSPACE="0" VSPACE="0">The Y2K problem was causing organizations to invest massive amounts in integrated ERP systems. This task is still incomplete today because such systems are enormously complex to install, optimize and maintain.</div> <div> <IMG BORDER="0" SRC="Symb075c00b700f000000000.png" HEIGHT="16" WIDTH="24" ALIGN="bottom" HSPACE="0" VSPACE="0">The explosion of the Internet simultaneously was placing enormous pressure upon companies to develop the e-interface side of their business. And the technologies required for such e-commerce activities were not necessarily the ones that had been staffed for.</div> <div> <IMG BORDER="0" SRC="Symb075c00b700f000000000.png" HEIGHT="16" WIDTH="24" ALIGN="bottom" HSPACE="0" VSPACE="0">Staff shortages were magnified by the move of talented developers away from traditional big business to entrepreneurial ventures.</div> <div> <IMG BORDER="0" SRC="Symb075c00b700f000000000.png" HEIGHT="16" WIDTH="24" ALIGN="bottom" HSPACE="0" VSPACE="0">The high percentage of committed projects essentially ate up all the time and budget allocated to MIS staff. Typically more than 80% of the person-years were already allocated before the year began.</div> <div> <IMG BORDER="0" SRC="Symb075c00b700f000000000.png" HEIGHT="16" WIDTH="24" ALIGN="bottom" HSPACE="0" VSPACE="0">With the decentralization of organizations and the drop of software and hardware costs, massive disorganized investments in subterranean projects was being made without the knowledge of the CIO. Eventually such projects surfaced as new unplanned needs that only the CIO had the ability to support, migrate, integrate or improve.</div> <bR> <div> The unparalleled explosion of investment in software for the Internet by venture capital firms triggered a massive investment in software development and software based services. So just as the CIOs were in resource crisis, the palette of available development tools, component frameworks, packages and ASP-delivered (application services provider) services exploded, making any selection process even more difficult.</div> <bR> <div> All of these trends started to merge because the integration of information and applications was required for successful e-business. And integration is never a simple task. There are always questions, choices, different implementation approaches, difference performance measures that you can optimize for. When you deal with integration, you are no longer dealing with a narrow technical issue, you are actually dealing with strategic priorities and business outcomes, the heart and soul of how a business makes money.</div> <bR> <div> So here we stand in 2001 with a landscape that looks very different than the early 90s or the glory days of the 1980s for software.</div> <bR> <div> <IMG BORDER="0" SRC="Symb075c00b700f000000000.png" HEIGHT="16" WIDTH="24" ALIGN="bottom" HSPACE="0" VSPACE="0">We see behemoths such as IBM, Microsoft, Oracle, SAP, PeopleSoft, Hyperion, Rational, and Adobe with dominant positions in their markets.</div> <bR> <div> <IMG BORDER="0" SRC="Symb075c00b700f000000000.png" HEIGHT="16" WIDTH="24" ALIGN="bottom" HSPACE="0" VSPACE="0">We see huge consulting firms such as Accenture, EDS and IBM providing outsourcing services.</div> <bR> <div> <IMG BORDER="0" SRC="Symb075c00b700f000000000.png" HEIGHT="16" WIDTH="24" ALIGN="bottom" HSPACE="0" VSPACE="0">We see promising Internet-based companies such as BEA, Ariba, CommerceOne and Amazon.</div> <bR> <div> <IMG BORDER="0" SRC="Symb075c00b700f000000000.png" HEIGHT="16" WIDTH="24" ALIGN="bottom" HSPACE="0" VSPACE="0">We see new hybrid companies such as AOL-TimeWarner.</div> <bR> <div> <IMG BORDER="0" SRC="Symb075c00b700f000000000.png" HEIGHT="16" WIDTH="24" ALIGN="bottom" HSPACE="0" VSPACE="0">We see an enormous number of software and Internet companies whose future is, at best, difficult to predict. Many are failing startups with little hope of growing their businesses because of their lack of capital and inability to afford broad skilled management teams.</div> <bR> <div> Technologically, the Internet has increased the trend towards Lego-blocks solution development. Technological trends have moved from object oriented programming to the availability of component frameworks, to standards for integrating different object frameworks, to integration of ASP services with corresponding standardization of data exchange standards vis SQL and XML.</div> <bR> <div> But what has not changed in all of this evolution is the need for expertise. If I may coin a new information technology law “<I>Increased usage trumps increased standardization</I>.” Or in other words, “<I>Integration needs and expanded use of technology continually add more complexity faster than emerging standardization and interfaces can reduce complexity</I>.” The result of this law is that just about every company developing software, whether a Fortune 500 company, a software or Internet company, cannot afford to retain on staff all the expertise necessary for building and maintaining a complete enterprise infrastructure. Out-tasking will be increasingly the entry strategy for small firms and account control will require management of multiple out-tasking relationships.</div> <bR> <div> This problem is not really surprising. The evolution of business over the past 200 years has been towards increased specialization. Making business more efficient has typically involved outsourcing or automating tasks done in less efficient way. Carbon paper replaced having to type documents more than once. Xerox machines replaced carbon paper. Laser printers are replacing many applications of copiers. Web sites and Palm Pilots replace laser printer output.</div> <bR> <div> Information technology is, therefore, following a predictable path that has been gone down before in all developed economies. Tasks that can be done more effectively by others will tend to be outsourced or out-tasked or automated by purchasing solutions/services/equipment whose R&D/operating costs can be allocated over a larger volume than a single company.</div> <bR> <div> So where does this leave my claim about the end of an era in software and negative outlooks for software portfolios?</div> <bR> <div> Well, the first corollary of this trend is that the role of software tools has changed. There used to be a good market for software development tools. Yes, the market is larger than it has ever been, but one of the consequences of software reuse is the availability of more “value added” software solutions than reduce the need for programming. And with the need for integration, only the top or second player can be big enough that everyone will decide to support or intergrate their solution or standard. The cost of selecting a second tier player can be exceptionally high.</div> <bR> <div> The second corollary is that no firm can do everything. New firms with innovative solutions have typically spent many person-years developing (and as a result understanding) their solution and the problem it addresses. Users typically have not. So as solutions become more specialized, the chance of finding solution expertise within a client organization shrinks dramatically. A simple example of this problem is the huge problem of security software and practices. It is hard enough building an integrated front end to service clients and suppliers. Having to develop a security system is the straw that often breaks the camel's back.</div> <bR> <div> In other words, the majority of niche B2B players today, typically the ones who cannot obtain funding, are running into a “technology indigestion” problem at their prospects. The prospects are unable to absorb any more technology and cannot implement many highly specialized solutions by themselves because integration is now so broad in its requirements.</div> <bR> <div> <TABLE BORDER="2" CELLPADDING="1" CELLSPACING="1" WIDTH="605" BORDERCOLORLIGHT="#C0C0C0" BORDERCOLORDARK="#808080" FRAME="BOX" RULES="ALL" HSPACE="0" VSPACE="0" > <tR> <tD VALIGN=TOP HEIGHT= 38 WIDTH="195"><IMG BORDER="0" SRC="1x1.gif" HEIGHT="38" ALIGN="bottom" WIDTH="195" HSPACE="0" VSPACE="0"></tD> <tD VALIGN=TOP WIDTH="195"><div> <I>Stand alone </I></div> <div> <I>package/tool</I></div> </tD> <tD VALIGN=TOP WIDTH="195"><div> <I>Embeddable or integrated solutions or service</I></div> </tD> </tR> </TABLE></div> <div> <TABLE BORDER="2" CELLPADDING="1" CELLSPACING="1" WIDTH="605" BORDERCOLORLIGHT="#C0C0C0" BORDERCOLORDARK="#808080" FRAME="BOX" RULES="ALL" HSPACE="0" VSPACE="0" > <tR> <tD VALIGN=TOP HEIGHT= 57 WIDTH="195"><div> Low complexity</div> </tD> <tD VALIGN=TOP WIDTH="195"><div> Traditional software business e.g. Lotus 1-2-3, AutoCad, Acrobat</div> </tD> <tD VALIGN=TOP WIDTH="195"><div> Middleware</div> </tD> </tR> <tR> <tD VALIGN=TOP HEIGHT= 76 WIDTH="195"><div> <I>High complexity, requiring additional services</I></div> </tD> <tD VALIGN=TOP WIDTH="195"><div> ERP systems e.g. SAP, Oracle, Peoplesoft</div> </tD> <tD VALIGN=TOP WIDTH="195"><div> Highly integrated work-flows e.g. CRM, e-commerce, web-based  business services</div> </tD> </tR> </TABLE></div> <bR> <div> In the glory days of ERP systems, installation of such ERP systems required massive consulting and reengineering expenditures. It was not uncommon for a dollar of software licenses to trigger $10-20 of consulting and reengineering work. The addition of e-commerce is typically even more complicated because it requires both internal cross application integration and also an external interface to a wide variety of users.</div> <bR> <div> <B>The Venture Capital Perspective</B></div> <div> So what do you do if you are a venture capital firm or incubator with a portfolio of specialty software/Internet based businesses that are having difficulty obtaining clients?</div> <bR> <div> One clear solution is to ignore them, let them die and write them off to the old adage, “We only expect a one in ten success rate with perhaps two out of ten having marginal success.”</div> <bR> <div> I think, however, that there is another solution - to recognize that a paradigm shift in software has occurred.</div> <bR> <div> The consequences of this paradigm shift are that most small software companies with good to excellent technology are going to fail unless a different market approach is pursued.  The rules of the new market approach are, I believe, the following:</div> <bR> <div> <IMG BORDER="0" SRC="Symb075c00b700f000000000.png" HEIGHT="16" WIDTH="24" ALIGN="bottom" HSPACE="0" VSPACE="0">The business sales model must be based upon short, low cost sales cycles.</div> <div> <IMG BORDER="0" SRC="Symb075c00b700f000000000.png" HEIGHT="16" WIDTH="24" ALIGN="bottom" HSPACE="0" VSPACE="0">Acquiring customers early on in the launch process is critical to developing effective evolving solutions. Most product innovation is customer driven so early acquisition of customers needs to be accompanies by formal strategies for customer feedback monitoring and incorporation into the product planning process.</div> <div> <IMG BORDER="0" SRC="Symb075c00b700f000000000.png" HEIGHT="16" WIDTH="24" ALIGN="bottom" HSPACE="0" VSPACE="0">The more mission critical the software, the less likely it is that a large firm will purchase from a small startup. Small firms need to move to a service offering based upon guaranteed performance. In many cases, this will require merging with other small companies and the development of a solution oriented selling and delivery infrastructure. </div> <div> <IMG BORDER="0" SRC="Symb075c00b700f000000000.png" HEIGHT="16" WIDTH="24" ALIGN="bottom" HSPACE="0" VSPACE="0">Given that clients are suffering technology indigestion, the marketing and sales skills of technology-based companies needs to be significantly improved. In reality, most customers don't really care very much about the features of a software package. They just want a solution, preferably yesterday, preferably from someone who is perceived as low risk and having a track record of success. Ideally, the solution should be testable and usable immediately and not lock the client into long term arrangements.</div> <bR> <div> For many venture capital firms, the composition of their portfolio is such that they:</div> <bR> <div> <IMG BORDER="0" SRC="Symb075c00b700f000000000.png" HEIGHT="16" WIDTH="24" ALIGN="bottom" HSPACE="0" VSPACE="0">Cannot afford to inject enough money to create adequate marketing, sales, project management, service delivery management in each company they have invested in.</div> <div> <IMG BORDER="0" SRC="Symb075c00b700f000000000.png" HEIGHT="16" WIDTH="24" ALIGN="bottom" HSPACE="0" VSPACE="0">Don't have enough companies in their portfolio to create a shared solution oriented delivery front end marketing and distribution organization.</div> <bR> <div> My recommended solution, is therefore, to <U>invest in setting up a new channel of distribution </U>- one that combines the role of market management, launch planning, project planning, sales, service delivery, value added consulting, account management and customer relationship management. Let's call it a Solution Channel.</div> <bR> <div> <B>Solution Channels</B></div> <div> A Solution Channel, is different than the Accentures, VARs and OEMs of the world. Its job is to <I>take solutions to market</I> that incorporate technologies from early stage firms that cannot deliver solutions.  The advantage of a solution channel is that (1) it has a lower cost structure than a knowledge intensive SI (systems integration) shop, and (2) there are huge opportunities for synergy (sharing of overheads, learning curves, queuing advantages) (3) a focus upon project management and assembly of consulting firm/suppler consortia, when a Solution Channel has to assemble a solution to provide an out-tasked service to customers.</div> <bR> <div> A Solution Channel can also engineer its management of the sales funnel to take advantage of technology by using an appropriate mix of viral marketing, web marketing, in-house sales, direct response advertising, commissioned sales reps and direct sales forces.</div> <bR> <div> Traditional system integration firms will not generally adopt new technology until many companies have purchased and implemented the technology and made it popular. For new companies, this lag in time to market has a huge cost and consequence. One study suggests a 32% PAT loss over five years with a 6-month late product launch. The time to market advantage of a Solution Channel should convince investors of the merits of pairing their technology development company with a Solution Channel for market launch.</div> <bR> <div> <IMG SRC="146a6d20.png" border=0 width="678" height="210" ALIGN="BOTTOM" HSPACE="0" VSPACE="0"></div> <bR> <div> This new channel of distribution will still be important when the product takes off, because any emerging channels such as systems integration firms, VARs and OEMs still need support. They need account management. However, my belief is that the provision of service revenues is, in fact, an attractive business in of itself and that there are opportunities for a Solution Channel to become a component service in the solutions delivered by e.g. systems integration firms whose focus is more mature technologies.</div> <bR> <div> Fundamentally, Solution Channels create value for new software companies by allowing them to be incorporated into an out-tasking or “solution sell” at an early stage of its product life cycle. The capital structure of a Solution Channel will look different than traditional VARs or consulting firms. First, it will need to be capitalized so that it can offer the management and infrastructure need to provide the service of rapid delivery to market. Second, it will need to charge fees to startups for whom it will be their proxy marketing organization. A Solution Channel's third source of revenues will come from sales commissions and consulting fees.</div> <bR> <div> Does a Solution Channel make sense for startup companies? Well, for an answer, we need look no further than the major players in software.</div> <bR> <div> IBM in a larger segment of the market, under Lou Gerstner, IBM has transformed its business to become the leading prototype of a Solution Channel. It does around $30B a year in providing solutions to its clients.</div> <bR> <div> Microsoft is attempting to evolve its Office software to more of a service. And Oracle is rapidly moving its business to a service model renting software to smaller businesses. They all recognize that technological overload is here to stay.</div> <bR> <div> <B>The Author</B></div> <div> Alistair Davidson is the founder and CEO of Eclicktick Corporation, a strategic consulting firm with particular expertise in high tech firms, whether startups, in growth stages or needing turnarounds. He is the author of three books and numerous articles on strategy, strategy tools, IT strategy, and entrepreneurial high tech strategy. His latest, “<I>Turn Around! A brief guide to starting, growing and turning around your software or Internet company</I>” is available as a free e-book at <FONT SIZE="3" COLOR="#0000FF" FACE="Arial" ><A HREF="http://www.eclicktick.com" TARGET="_top" TITLE="http://www.eclicktick.com"><U><U>www.eclicktick.com</U></U></A></FONT> . He has been the CEO of five high tech firms and a business incubator. He has brought 20 software projects to completion and been involved in over a dozen product launches. 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