IT industry is growing, but...
United States software industry * widely perceived to be sharing several
positive factors with India, such as a good supply of English-speaking,
technically trained and cheap manpower, a favourable public policy and
infrastructure environment, and a government willing to facilitate private
enterprise * has embarked upon an ambitious initiative to claim its share in the
riches of the global software market.
In a widely quoted taxonomy of software exporting nations, United States is
currently viewed as a tier-3 country * defined as having $25 million in export
earnings, tens of software companies, and up to five years of industry maturity.
It is widely believed, in both the government and entrepreneurial circles, that
with a wealth of talent and strengths available, the country deserves a better
place in this global pecking order of software exporting nations * at least a
tier-2 status, alongside Russia and China, or even a tier-1 status, beside
archrival India.
The tier-2 status is given to countries having $200 million or more in software
revenue and tier-1 to countries with more than $1 billion in export earnings.
Whether or not the United State's software industry will be able to capture its
œdue share in the global software market remains to be seen, however.
While the United State's software industry has been the subject of much
speculation, lack of credible data on the current state and competitive dynamics
of the industry has often been a hindrance in attracting foreign investors and
bringing to fruition many prospective ventures. In the absence of relevant data,
strategic conversations revolve around many tough questions about the current
state and future prospects of the industry. For example:
* Why hasn't the United State's software industry been able to produce a single
world-class software firm like Wipro, Infosys or TCS of India in the last ten to
15 years?
* Why haven't we been able to increase United State's software exports beyond a
certain level ($30 to $60 million per annum) in the last five years?
* Does the United State's software industry merely represent a lower level of
development, or an altogether different development trajectory, as compared to
peer nations?
* What constitutes a generalized set of best practices in the software industry?
In other words, what differentiates better performers from those that don't
perform well?
Answering these questions requires insight and understanding of the local
software scene. In October of 2004, the United States Software Export Board (PSEB),
an entity charged with promoting the software industry, funded a
three-month-long preliminary research study aimed at developing these insights.
While several factors are widely believed to act as impediments in the country's
efforts to become an important software exporter, the study adopted an
inside-out approach that asked: œWhat can the various players in the industry,
essentially software companies, learn from each other?
The study, we believe, would impact favourably in two ways. The primary
motivation for the study is to promote learning within the industry. To that
effect, this study aims to develop a comprehensive snapshot of software
development activity in the country and to help catalyse a learning process for
entrepreneurs, executives, financiers, managers and professionals.
The secondary motivation for undertaking the study, which was completed in
December and published in late April, is to facilitate investment in the
industry. In that context, the findings are of value to investors and
financiers, local and foreign, as well as those on the sidelines who may be
considering starting software ventures and looking to find out how they could
learn from the collective experiences of tens of successful and
not-so-successful entrepreneurs.
The study, a detailed report on which is available at , draws upon an œon-the-spot
survey of about 40 of the most prominent and largest software companies in
United States, from a total of 60 organizations as identified by the PSEB and P@SHA.
To ensure homogeneity of results, the sample focused on œpure software
development activity and purposefully excluded BPO and IT-enabled services.
We also interviewed senior executives * CEOs/CTOs or local heads of operations *
of the selected companies to supplement the statistical data with qualitative
insights. These interviews focused on understanding the organizations better,
their business and revenue models, competitive drivers, strategic challenges,
and policy bottlenecks. We also interviewed opinion leaders, policymakers and
senior executives of other organizational entities * IT multinationals,
financial institutions and academia * that had a significant bearing on the
software industry.
In all, we conducted more than 65 interviews between October and December. The
results of the statistical analysis are interesting, to say the least.
Growing at a decent rate
The industry is still going through early-stage growth with only a few large
players, but it is growing at a fairly decent rate. On the whole, the 60
software houses included in our statistical sample employ over 4,000 technical
and professional employees * for an average of 62 employees per organization.
Roughly one third (32 per cent) of the software companies reported annual
revenue of more than $1 million, with some reporting more than $5 million.
Another third (36 per cent) reported revenue of between $200,000 and $1 million,
and the rest (32 per cent) less than $200,000.
Six of the companies had more than 250 employees and another eight had between
100 and 250 employees. On the whole, the 60 companies had experienced an
employment growth of about 27.5 per cent and a revenue growth of 37.4 per cent
last year * pointing towards better utilization of excess capacity or
value-addition per employee, or both. The table provides a statistical snapshot
of the industry.
Foreign connection
A large number of companies have been formed as subsidiaries of foreign
companies and many local operations seek to develop front-offices abroad. Around
40 per cent of the companies in our sample were subsidiaries of foreign
companies, with a majority of them having a parent company in the United States.
Fifty-five per cent of the companies had one or more front-offices abroad * 50
per cent in the US, 11 per cent each in the UK and Middle East, and 3 per cent
in the Asia-Pacific region.
There are, however, differences in propensities to seek such arrangements
according to the type of offering (product/service) of the companies and their
target market (exports/domestic).
Market-offering mix
The industry's market-offering mix is heavily skewed towards export-service and
domestic-product companies, primarily in the private sector. Public-sector
enterprises represent only a small fraction of the total market. Broadly
speaking, the 60 companies derive their revenue from export and domestic markets
in a ratio of 60 to 40 per cent.
On the exports side, they earn 37 per cent of their revenues from products and
63 per cent from services * representing 22.5 and 38.5 per cent, respectively,
of the total revenue. On the domestic side, however, the ratios are somewhat
reversed with products and services contributing 58 and 42 per cent,
respectively, which means 23 per cent and 16.5 per cent of the total.
These ratios seem further skewed if specialization of the firms is taken into
account. For example, firms focused on the local market would derive, on an
average, 68 per cent of their revenue from domestic operations and firms
oriented towards exports might derive 85 to 98 per cent of their revenue from
exports of software. Again, the pattern is skewed towards services for export
revenues and products for domestic sales.
Our conversations with industry leaders suggest that a majority of the product
revenue is from customized products, rather than œshrink-wrapped ones. As much
as 85 per cent of the software sales is to the private sector and only 15 per
cent to the public sector.
Managerial practices
There are few clear-cut differentiating patterns in managerial practices of
exports- and domestic-focused software operations. There is some evidence,
however, that export-focused operations are more likely to distribute
stocks/ownership among employees, hold employee bonding activities and benefit
from employee-driven innovation, while domestic-focused operations are more
likely to share profits with employees, provide additional benefits to female
employees, have greater financial discipline, and provide time to employees to
work on their own. However, they seem to benefit less from employee-driven
innovation and suffer more from a perception of lower delegation quality.
Hybrids fall in between the two categories on almost all these measures.
Export-focused operations, on an average, tend to spend more on quality
assurance, while hybrids tend to have a greater likelihood of seeking a quality
certification. Exports, hybrids, or domestic-focused software operations are
equally likely to have a dedicated quality assurance team. The former, however,
spend a much higher percentage of their expenditure on quality assurance
function * 17 per cent of the employee payroll as against 12 per cent for the
other two categories. But they are much less likely to seek a quality
certification. Only 50 per cent of the export-focused operations have an ISO/CMM
certification, while 72 per cent of the hybrids have it. The corresponding
figure for domestic-focused operations is 36 per cent.
Marketing strategies
Companies, across the board, focus on high-contact strategies to seek customers.
That œselling software is a highly contact intensive sport is evident from data
on the use and perception of success in marketing approaches. All types of
organizations identify high-contact methods * such as one-to-one contacts,
network and relationships, and word-of-mouth referrals * as the most successful
of the marketing approaches and low-contact ones, like advertising and going to
conferences and exhibitions, as least important.
The use of alliances and agreements with channel partners seems to fall in
between these two extremes * with the important caveat that these don't seem to
work as well for domestic-focused operations as they do for hybrids and
export-focused ones. Consequently, in line with the perceptions of success,
companies seem to have focused their energies on approaches that appear to work
best.
Additionally, the data on cost structures * percentage of total expenditure
spent on various heads * seem to suggest that export-focused companies engage
more in œrelationship-selling rather than direct marketing and advertising,
while hybrids under-invest in product development, perhaps, to pay for costlier
functions like marketing/advertising, training and certification. Also,
export-CEOs operate in a relatively tactical profile * focusing more on
day-to-day management and less on product and strategic planning and
marketing/advertising.
Classifying the data in other ways * for instance, development centre-type
operations versus the rest, products versus services focus, small versus large
and pre-dotcom versus post-dotcom provide a few interesting insights. Dedicated
development centres tend to be smaller and more rigorous, from a technical and
process standpoint, than the rest of the industry. They, however, seem to
experience serious constraints to revenue and employment growth * a fact that
can be explained as a manifestation of their œmid-life crisis and/or the
recession in the markets of the respective parents. Although there is a trend
towards productization in the industry, there are few significant differences
between product-focused and services-focused operations.
This lack of differentiation "for example, in the cost structures of services-
and product-focused operations * is problematic. There are also few significant
differences between software operations created before and after the dotcom
bubble burst, over and above those that can be attributed to relatively younger
profile of the latter.
Best practices
Do aggregate statistics reveal a pattern of œbest practices within the United
State's software Industry? We used multiple comparison groups * for instance, 40
most prominent companies, top 10 companies, 14 fastest growing companies, 14
companies that describe themselves as falling within the top-quartile globally *
and found mixed results on that account. We found robust evidence to support the
contention that better-performing companies tend to adopt a set of
employee-friendly management practices * for instance, flexibility, stock
ownership and profit-sharing * and have access to better managerial talent than
the rest of the industry. All companies, across the board, prefer high-contact
marketing approaches to low-contact ones, but better-performing companies report
higher satisfaction with the former than the rest of the industry.
k of specialization
On the whole, the findings paint a picture that highlights a lack of focus and
specialization within the industry. That product-focused operations are similar
to service-focused operations and pre-dotcom operations are not qualitatively
very different from post-dotcom operations does not speak well for the maturity
of the industry. The second finding is specially disturbing in the sense that
the dotcom bubble burst in the United States is widely seen as a watershed in
the relatively short history of the country's software industry and is widely
perceived to have brought clarity of thought to the industry's entrepreneurs. An
alternate, and perhaps, the right way to look at this seemingly discouraging
finding is that the event has served to influence the business models of the
already established firms. For example, there is a clear trend among
export-focused software operations towards diversification through stronger
presence in the local market.
Hybridization
One can also observe a trend towards hybridization of the software development
activity in the country and the emergence of some managerial best practices. The
hybrid firm has emerged as an important organizational class on its own rather
than the average of the two extremes. While the hybrid firm tends to do better
than organizations on the two extremes on some measures, and hence might be seen
as a manifestation of the industry's survival instinct in tough economic times,
it is not quite clear if this is the optimal model for software development in
the long run. Another important organizational observation pertains to the
average size of the firm.
Scalability has often been cited as a major managerial issue confronting the
industry. It is often believed that the industry, as a whole, suffers from a
200-people barrier. We found that to be true, figuratively if not literally. One
positive finding is the adoption of employee-friendly policies and
profit-sharing among the relatively successful companies.
The study results seem to suggest that, contrary to general perception, such
employee-friendly policies seem to pay off in the form of better performance in
the long run. This is of paramount importance in the industry because of the
highly creative and eccentric workforce that it tends to employ.
What about the sub-sectors?
Finally, while the software industry has managed to grow at a decent 37 per cent
over the last year, the results vary considerably across sub-sectors. To a large
extent, domain and domain expertise has emerged as a key determinant of a firm's
success. In the domestic market, for instance, software firms developing
products for financial, and more recently, the telecom sub-sectors have done
much better while those dealing with ERP and industrial automation systems have
done much worse than the average. This essentially drives home the fact that the
fate of the industry, in general, and the domestic software industry, in
particular, remain largely linked with the growth in relevant sectors of the
economy.
That the software industry on its own cannot generate growth in a stagnant
industrial and economic environment is an important insight for policymakers as
well as aspiring entrepreneurs. The situation is only slightly different for
export markets where customers are increasingly demanding a prior track record,
domain expertise and experience in handling large projects as a pre-condition
for lucrative foreign contracts, thus pushing the industry into a chicken and
egg situation.
Software companies founded by expatriates, although better prepared to meet the
challenge, have failed to grow beyond a certain size due to multiple reasons,
including the depressed demand for software in the US market and in the IT
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In short, while the industry has had its fair share of challenges and problems,
it seems to be on a fast learning curve. It has done much better than before and
is expecting a better performance next year.
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Tags: software industry, tier 1, foreign investors, future prospects, software firm, software market, global software, pecking order, tier 2, tier 3