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Loosely Coupled weblog

Thursday, July 21, 2005

Industry myopia

The software industry has always been useless at understanding what it's selling. Over the years this effect has been compounded because many of the IT managers it sells to have been contaminated by the same lack of real-world perspective. Vendors get understandably excited about the technology they have on offer, and eventually a whole ecosystem of sales and marketing teams, industry analysts, journalists and technology-focused buyers ends up getting totally absorbed into a closed debate about which product, system or architecture is better than another.

When someone finally comes along and points out that there's a wider context in which all of this operates, it's been so long that anyone's noticed that it seems like a breath of fresh air rather than simply stating the bleeding obvious. Over on the SOA blog on ZDNet, Britton Manasco last week cited an Economist article about software pricing and business models, concluding: "Could it be that software-based value models are all doomed? Could it be that software companies will have to begin charging for — dare I say it — business results?"

The issue of value-based pricing has come to the fore because of a confluence of industry trends, of which the advent of dual-core processors has become the final straw. The sudden uncertainty as to how many processors there are in a single processor chip has fatally undermined the existing pricing model used by software vendors, which bears absolutely no relation to the utility of the software to an individual customer, being completely arbitrarily based on the number of processors it is installed on. Thus for example one customer lumbered with a badly designed implementation that scales poorly could easily pay four or five times as much as another for the same features and performance. Whereas hundreds of customers of an on-demand application provider like might share the lower of the two costs between all of them, reducing it to a fraction of the on-premises equivalent. The software-as-services example clearly shows up the absurdity of the model. Emerging service-oriented architectures and grid computing will soon make processor-based pricing universally untenable.

Richard Veryard at CBDI has taken up the same theme in a commentary this week on Service Economics, arguing that no form of resource-based or input-based pricing is going to work as we become more service-oriented: "For the service economy, output-based pricing makes much more sense. Consumers pay for what they actually get, rather than what the service provider uses. There are various ways of calculating this, at different levels of granularity, with different distribution of risk." I'm sure this sort of talk fills software vendors with horror, but if airlines can manage value-based pricing, why not the software industry?

The problem of course is that software vendors have been doing what they've been doing for so long that they've forgotten what it's really all about. To adapt Ted Levitt's famous formulation from his HBR article on Marketing Myopia, they think they're in the software business when really they're in the business automation business. No enterprise buys software for the sake of owning software (or none should, at least). The true reason for buying software is to have some element of your business operations run better, faster or more cheaply. That, after all, is the supposed justification for making elaborate return on investment (ROI) calculations: in order to estimate when (if ever) the anticipated business results will actually deliver a payback.

But as Britton Manasco suggests in the blog entry mentioned above, why not shortcut the whole darn process and just charge the customer according to the actual results achieved? As I uncovered in the course of compiling a pair of research reports on software-powered services for Summit Strategies earlier this year, that's the hidden secret of the on-demand application business model pioneered by the likes of NetSuite,, RightNow Technologies and others. Providers don't charge for software — in fact they drive their cost of software as low as possible. Instead, customers "buy access to the functionality the software provides. This difference in design intent is the key to understanding the true nature of [the on-demand applications model]."

Interestingly, Britton's very next blog entry references an example of the kind of business model this ultimately leads to. A article by former McKinsey & Co partner Mike Nevins on The Next Big Thing ... Really concludes, says Britton, that "the 'next big thing' will, in fact, be software companies that combine software, content and services and take responsibility for outcomes." Wow, imagine, "software companies that ... take responsibility for outcomes." Whoever would have thought?

But wait a minute, isn't there an extremely old and well-established business model lurking behind this future scenario? Let me see, companies that "take responsibility for outcomes." Isn't that what any reputable business service provider does? And the only difference here is that these business services happen to be software-powered. Of course, that's exactly why I settled on the term "software-powered services" as the generic name for the on-demand application sector because this is where it ultimately and inevitably leads, to an endpoint where software is simply the infrastructure that powers automated business services. In that scenario, the only way to price is in terms of business results and their perceived value to the customer. Forget about dual core or single core. The questions that matter are, is it up and running? Does it do the job? Can I get the same or better functionality cheaper elsewhere?

Naturally, it's not conceivable that an entire industry can have its business model served up as someone else's omelette without breaking a lot of eggs. I listen to a lot of vendors talking about the migration to SOA and everyone says how evolutionary it all is. Well, that's a load of bull. One of Actional's customers went public with its SOA story this week and IDG has a nice write-up that several titles have carried including InfoWorld. Several of the details in its story, Starwood nears end of SOA revamp, serve to illustrate some of the home truths about the impact of SOA migration, as experienced by real-life early adopters:

  • It takes a long time. Starwood started in 2001 and won't have finished the infrastructure before next year.
  • You can get some early tactical gains. Starwood's first processes went into production two years ago.
  • It slashes integration time and cost. In one recent project, app-to-app integration using SOAP XML took just 24 hours.
  • Open source software plays a key role. Starwood uses JBoss alongside IBM WebSphere.
  • It has to be managed. That's where Actional comes in.
  • It lets you rip out legacy. "By this time next year, my mainframe will be very idle," says Starwood's CTO Tom Conophy. "In September, we'll be having a sledgehammer party in the parking lot."

Starwood steps up to SOA and the result is that it junks its mainframe while turning to open-source J2EE server software and cutting its dependence on highly skilled integration experts. All that, though, is just the beginning — what it foresees before it even gets started. Later on, I predict, it will examine outsourcing some of its inter-site integration to network providers and consider using third-party on-demand services to operate functions such as its loyalty programs. Perhaps it will become more willing to consider acquisitions because of its improved integration capabilities.

It may find its revenue growth accelerates as a direct result of its shift to SOA. Here's an interesting finding from some research commissioned by network kit vendor Juniper, as reported by Olga Kharif on her Business Week blog: "Companies with certain IT-related characteristics constitently showed 30% higher revenue growth ... The fast-pacers typically supported mobile workers, the use of Web services and an Internet Protocal (IP) network ... The fast growers also had 45% more IT projects (eight vs. five or six projects) going on at a given time than the slow-growers. Essentially, instead of implementing five very large IT projects, taking years and, thus, offering highly uncertain outcome and benefits, the go-getters broke down their projects into little bits ..."

The straws are blowing in the wind but large sectors of the established software industry still can't see the stormy disruption that's heading their way.

UPDATE [added July 22]: Loosely Coupled speaks, the industry acts. Well no, not really, this is just coincidence — or a shared meme perhaps — but according to CNET today, Oracle's president Chuck Phillips has revealed that the software vendor is looking at moving from processor-based pricing to something more closely related to business metrics:

"We'd love to get to a mode where we're looking at the number of employees served, the number of checks processed — you name it, some business metric — and take it out of the technology realm and tie our success to their success in terms of business," Phillips said.

So Oracle at least seems to realize which way this wind of change is blowing.

posted by Phil Wainewright 7:02 PM (GMT) | comments | link

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