The Rails Edge Denver

Tomorrow I will be attending the Day 1 of The Rails Edge series presented by the good folks at Pragmatic Studio.

Choice of Language and Framework

Our company is solidly behind web applications as the future of software delivery, especially as Internet connectivity becomes ubiquitous. We are also commited to Ruby on Rails as our development environment of choice. Nothing else has met the speed of development and, more importantly, the joy of development than that which I have experienced with Ruby and Rails. We have developed (but not yet deployed) our first application using Rails.

You can read more about Ruby and Rails in my review of David Black’s book Ruby for Rails.

Choice of Business Model

While choice of language is largely a matter of personal preference, choice of business model is a result of studying the industry; especially looking at other software companies’ experiences in the both product markets and services markets.

Products or Services?

Services provide more chances for recurring revenue

In his book, The Business of Software, MIT Professor Michael A. Cusumano states that he used to believe it was better to be a products company. But as of the writing of the book (2004 – which I know is an eon ago in tech years) he says he “no longer think(s) this is true”. Why?

The key is in recurring revenues. Services companies can sell support and consulting services even during times when customers are not buying software.

Services companies excel at showing that they can provide value (by saving costs, by finding hidden money, etc) even during times when their customers are having a hard time. Professor Cusumano posits that when customers feel that their IT partners understand their needs better than any other service provider, customers will be more likely to continue to do business with them – even in times of downturns.

Service providers seem to be in demand even when on the product side customers decide not to purchase an upgrade during tight times, a customer may no longer be growing so needs no additional seats, or a product may simply become commoditized or fully matured, offering customers no real motivation to make additional purchases.

… yet …

Products Provide Dramatically Improved Profit Margins

The kicker though is the “striking” difference between software companies and service companies: gross profit margin. He cites examples of large software companies that report 99% gross profit margins on their software product business, yet only 61% gross profit margins on services business! Wow! Who wouldn’t want 99% gross profit margins!? (It turns out that there are many companies not saved by their high profit margins – but that’s a different article).

This makes sense and is a basic reason that many of us have the big dream of riches from our software creations: for each additional piece of software that is sold, the incremental gross costs are very little. Mr. Cusumano appropriately compares this to the book business and I would add the music business. One hit and an artists or author can be set for quite some time. While for each additional hour of services provided, there is an almost linear increase in labor cost to the company providing the service.

The goal for a strictly product company would be to create a product or products and then do not perform any customizations or consulting services for individual customers. All customers get the same product. When one customer looks and interacts with the company just like every other, Product companies have no incremental costs with each new customer. Directed at individuals more than companies Steve Pavlina
refers to this as ensuring that your income is not tied to your time.

But – before you head all cylinders down the product road remember the issues with a product strategy are that 1: product sales can quickly fall short of expectations in down times and 2: just like with authors and artists, it can be difficult to produce that hit single.

How about a hybrid?

(and not the kind you drive to save the planet – but maybe a strategy to save a company)

Professor Cusumano’s study is, of course, much more detailed and well-spoken in his book than my ramblings here – but hopefully you get the point up to now and can follow along to the finale. I introduce it here in order to lead up to where I think that Software as a Service (SaaS) might fit in.

Professor Cusumano does not let readers of his book off with the easy choice of a hybrid company that offers both products and services – but I would. And I believe Software as a Service is one way to do so. I don’t claim SaaS as anything revolutionary, I’m not asking you to jump on the Web 2.0 bandwagon, and I hope not to sound like a “me too” lemming waddling toward the cliff. It just jumps out as an answer and I will write more about why in the next installment on this topic.