Why there's nothing special about the business of software

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Software businesses should be infinitely scalable, right? You've done the hard work. You've built your product, your money making machine. All that's left is to turn its frictionless handle and churn out uncountable quantities of dollar bills. After all, the cost of shipping your creation's sweat-filled bits and bytes to your next customer, and the customer after that, is zero.

But that's not what happens in real life. Take a look at this graph of revenue per employee*, generated from the 2008 Software 500 data:

The median annual revenue per employee is around $160,000. Almost all (90%) of software businesses generate under $300,000 / employee. By comparison, General Motors has revenue of $600,000 per employee; Walmart $200,000; Intel $450,000; Exxon $5,000,000. It turns out that shipping electrons is no easier than building cars, selling cereal, building chips or drilling for oil. There's nothing special about software.

How come?

In 1980, Theodore Levitt - Harvard Business School superstar professor - wrote that there is no such thing as a commodity (or more accurately, there need not be such a thing as a commodity). In 1986, Bill Davidow - erstwhile product crusader for Intel's 8080 and 8086, now venture capitalist - expanded this theme beyond commodities and wrote about the concept of 'device' vs 'product'. In Davidow's terminology, a device is the good that, at first glance, you sell. It's the coffee beans, the silicon chips or the bits and bytes of your software. But the product is what you really sell:

• Trivially, bits and bytes
• Reassurance that you won't rip off your customers and that they're doing the right thing ('nobody ever got fired for buying IBM')
• Reassurance that your software will work as advertised, and that you will be there for customers if they get stuck (Rackspace's fanatical support)
• Reassurance that there is a roadmap, that you will continue fixing bugs, refining the product and releasing new versions (Intel's chipset)
• A statement about your customers (anything from Apple)
• The chance to belong (ditto)

Of these, only the first is scalable and easy to supply. The rest require people to deal with customers, communicate with the market, investigate new opportunities, build brands, grow communities, write documentation, create a company culture and so on. Those are the activities required to decommodify the bits and bytes. They're not cheap and they don't scale.

But if you want to grow, they're the most important things you need to do**.

I'd like to hear what you think. Post your comments here, or carry on the conversation on Twitter (I'm @neildavidson).

(* Yes, I know that revenue per employee isn't as important as profit, but they're the numbers I've got. Also, these numbers are from the Software 500 so may not be truly representative. But they illustrate my point that software businesses don't, on the whole, scale).

(** Assuming you've done the hard - and it is extremely hard - work of building the bits and bytes already).

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Comments

[Marc P. Goodman]

Hey, interesting blog and post. I will definitely be subscribing to your feed. I hope I can contribute something in the near future.

Thanks for posting tho, and keep up the good posts.

[Giulio]

So what you're saying is that people are at the core of whatever you're selling and s/w is no different. It's merely an instrument for your people to demonstrate their value in the context of the customers' needs that they have invested into by buying your software ?

[Online CRM]

Some very interesting points. Just think about how many software companies actually use their own product in house. Example, CRM (Customer Relationship Management) software, development houses use their own product to track their customers, sales, marketing and support issues. Not only a good business sense, but the added benefit of actually becoming a real user of your own product allowing you to refine, see where enhancements are need and find those little quirks that hide during QA.

Bill Q

[Zero Cost Profits]

You cant just look at the profit ratio per employee. Software costs diminish to practically zero as the product is only produced once. The cost diminishes each sale. This is different to physical goods that have a certain fixed cost for each unit produced. Add to this that software can even be download distributed.

[.Net Software Development]

Well..good survey and research! I think a software company can grow only when it has good innovative ideas to collaborate with the consumers for business and good support after selling their software to the consumers.
If company is having such employees which help the company in generating high revenues then the company also takes care of the employees' remunerations and this should happen..