cusumano presentation

7/24/2019 Cusumano Presentation

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Products vs. Services::Which is the Better Business Model,Which is the Better Business Model,

in Software and Other Industries?in Software and Other Industries?

Michael A. Cusumano

MIT Sloan School of Management

[email protected]

2006


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The Global Software Industry

0

20

40

60

80

100

120

140

160

180

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002

Year

Value

in

$B

3rd Party Services

Products

Software Servcies

x10


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State of the Business

Overall Recovery (esp. in 2005)

But Collapse of Traditional Products

Rapid Growth of Services/Maintenanceas % of Revenues for Product Firms

Future: Intense Battle between ProductsFirms & IT Services Firms?


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The Big Questions Rise in services & maintenance revenues

temporary or permanent?

Will most software firms become services firms?

Temporary Argument: We are in a transition phasebetween platform innovations (client-server to internet toweb services & wireless)

Permanent Argument: Software, like hardware, hasbecome commoditized and prices will fall close to zero forstandardized products. Future is software as a service.


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Role of Services in Life-Cycle Dynamics& Platform Transitions?

Performance

Time

Ferment

Takeoff

Maturity

Disruption..Services.?


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Typical View of Services in High-Tech Companies?

Services will be the graveyard for old tech

companies that can't compete."

Scott McNealy

CEO, Sun Microsystems

Referenced in N.Y. Times, 9-16-04


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The Problem withThe Problem withManyMany ServicesServices

Much more labor intensive than products

Hard to scale without adding people

SAP example (1:1) Costs not as easy to control compared to

standardized product dev & production

Hard to attract VC funding or do an IPO Low-cost competition from India and

elsewhere pushing margins down further


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Business Objects: Gross Margins

0

20

40

60

80

100

120

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

Products

Serv ices


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The Problem withThe Problem withManyMany ProductsProducts

Hard to write best-sellers (killer apps)? Products can become commodities?

Example: Price for same (actually better) software

product $1.5 million in 2000 but $250,000 in 2004 Products more subject to discretionary spending.

In bad economic times, product sales more likely to

fall off a cliff ? E.g. Siebel, i2, Oracle

Only guaranteed revenues services/maintenance?

These under downward pressure as well

For products business:99% of 0 = 0


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Siebel

0

200

400

600

800

1000

1200

1995 1996 1997 1998 1999 2000 2001 2002

$million

Products

Services

Siebel

0

50

100

150

200

250

300

350

1999 2000 2001 2002

Products

Services

Total

Siebel

0

10

20

30

40

50

60

70

80

90

100

1995 1996 1997 1998 1999 2000 2001 2002

%ofTotalRevenues

Products

Services


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PeopleSoft

0

50

100

150

200

1999 2000 2001 2002

Products

Services

Total

PeopleSoft

0

10

20

3040

50

60

70

80

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

Products

Services

P e o p l e S o f t

0

2 0 0

4 0 0

6 0 0

8 0 0

1 0 0 0

1 2 0 01 4 0 0

1 6 0 0

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

P ro d u cts

S e rvice s


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Oracle

0

1000

2000

3000

4000

5000

6000

7000

1992

1994

1996

1998

2000

2002

$million

Products

Services

Oracle

0

50

100

150

200

1999 2000 2001 2002

1999=100

Products

Services

Total

Oracle

0

10

20

30

40

50

60

70

1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002

%ofTotalRevenue

Products

Services


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S A P

0

1 0 0 0

2 0 0 0

3 0 0 0

4 0 0 0

5 0 0 0

6 0 0 0

199

2

199

4

199

6

199

8

200

0

200

2

m

illione

uros

Pro d uc ts

S er v ic e s

SA

0

50

100

150

200

1999 2000 2001 2002

Products

Services

Total

SAP

0

10

20

30

40

50

60

70

80

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

%ofTotalRevenues

Products

Services


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IBM

0

10

20

30

40

19

92

19

94

19

96

19

98

20

00

20

0

$billion

Software

Services

IBM

90

95

100

105

110

115

120

1999 2000 2001 2002

1999=100

Products

Services

Total

IBM

0

10

20

30

40

50

60

70

80

1992

1993

1994

1995

1996

199

1998

1999

2000

2001

2002

%ofTotaRevenue

Software

Services


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Business Objects

0

50

100

150

200

250

300

1993 1994 1995 1996 1997 1998 1999 2000 2001 2002

$million Products

Services

Business Objects

0

50

100

150

200

250

300

1999 2000 2001 2002

1999=100

Products

Services

Total

Business Objects

0

10

20

30

40

50

60

70

80

90

1993 1994 1995 1996 1997 1998 1999 2000 2001 2002

%ofTotalR

evenue

Products

Services


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B u s i n e s s O b j e c t s P r o d u c t s v s . S e r v i c e s

0

2 0

4 0

6 0

8 0

1 0 0

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

P ro d u c ts

S e rvi c e s


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Services & Maintenenance as Percentage

of Total Revenues

0

10

20

30

40

50

60

70

80

90

100

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

Business Objects

i2

Seibel

PeoplesoftOracle

IBM S&S

SAP

Compuware


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Three Business/Life Cycle Models

010

203040

506070

8090

Produc

ts

Hybr

idSolut

ions

Service

s

%o

fTotalRevenues

Products

Services


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Typical Breakdown Per $1.00 of Enterprise

Product Revenue

100 %20 %50 %30 %

$3.15$0.60$1.55$1.00TOTAL

$0.15$0.15Year 5

$0.15$0.15Year 4

$0.40$0.15$0.25Year 3

$0.45$0.15$0.30Year 2

$2.00$0.00$1.00$1.00Year 1

TotalMainte-nance

SoftwareServices

SoftwareProduct


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Initial Research Questions

Products not as good as previously thought? 99% of 0 = 0, especially in down economies?

Platforms products and some niche products do better?

Butnew products drive services & maintenance?

Services not as bad as previously thought? Candouble or triple a firms sales and profits?

Butmaintenance much better than other services?

Services help createstickierproduct solutions?

Hybrid the best business model? Most stable performance & strategy re commoditization?

But requires most complex combination of skills?


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New Database Study

MC with Steve Kahl and Fernando Suarez, and

undergrad students; earlier Vikram Mansharamani

Identified 463 public software products firms under

SIC code 7372 PrePackaged Software (NAICS #51121)

Financial information from Mergent Database & 10K

reports. Avg. 9, maximum 15 years of detailed financial

information, from firms listed in 1995 or later.

3788 total yearly observations (4449 including no-breakout firms).

Now doing exploratory analysis

Also starting database of non-software firms


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Public Software Product Companies Listed in US(% Annual Product Sales, 378 firms & 3314 yearly observations)

Notes: -- Excludes 86 packaged software firms with no sales breakout and unclear status.

-- 1 (100%) includes some product firms that did not break out revenue mix (MSFT, Adobe,

SPSS, Visio, Symantec, and Fair Isaac, and game software firms).

0

100

200

300

400

Frequenc

y

0 . 2 . 4 . 6 . 8 1p r o d p 2

100% Product

100% Service

Hybrid Balanced, 34-85%

Hybrid

Service

Hybrid

Product


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Data Analysis

Broke out hybrid using standard deviation. Distributionapproximated normal. Used 1 standard deviation tocalculate the middle group. The mean is .6 and standarddeviation is .257

Total observations for the 5 groups:Services: 76

Product: 330

HybridS: 464HybridB: 2206

HybridP: 302

Total: 3378


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1702451019132004

19645211312152003

25535716610192001

296103820817231999

31373420734311997

24081916226251995

Total100%

ServiceHybridService

HybridBalance

HybridProduct

100%ProductYear

Software Product Firmsby Business Model


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Percentage Breakout By Year

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

Year

%o

fTotal

Service

Hybrid Ser

Hybrid Bal

Hybrid Prod

Product


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Average Revenue Breakout by Age

0%

10%

20%

30%

40%

50%

60%

70%

80%

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30

Age

AveragePercen

tage

Products

Services

Average Revenue Breakout by Year

0%

10%

20%

30%

40%

50%

60%

70%

80%

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

Year

AveragePercentage

ProductServices


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Service-Maintenance % by Product Type and Firm Age

0%

10%

20%

30%

40%

50%

60%

70%

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26

Age

AverageServiceContr

ibution

Total

Infrastructure

Pre-packaged Apps

Service-Maintenance % by Product Type and Year

0%

10%

20%

30%

40%

50%

60%

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

Year

AverageServiceContribution

Total

Infrastructure

Pre-packaged Apps


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Revenue Mix & Performance (1)

Shift to services-maintenance driven by (1)declining product revenues/prices, (2) aging ERP

firms/fewer new customers, (3) platform shifts

(e.g. client-server to Internet)

Hybrid solutions firms generally have (1)

higher and more stable profits and (2) highermarket valuations than software product firms if

we exclude Microsoft.


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Revenue Mix & Performance (2)

Service-maintenance revenues generatehigher and more stable profits than product

revenuesfor all software product firms if we

include the costs of R&D against productrevenues

Optimal mix for profitability: 73%productrevenues, but hard to achieve. Very high

maintenance revenues another strategy?


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Growth

index

Time

Services

Products

Growthind

ex

Time

Services

Products

A: Case of a firmwhere products and

services revenuesreinforce each other

B: Case of a firmwhere services

as % of revenuesrise becauseproducts businessis falling


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Product profitability = (product sales (product cost + R&D)) / product sales

Service profitability = (service & maintenance revenue service & maintenance cost) / service & maintenance revenue

Notes: Product profit mean corrected for outliers, eliminating values outside 1 standard deviation

Mean Profi t Contr ibut ion by Revenue Type & Firm Age

-140%

-120%

-100%

-80%

-60%

-40%

-20%

0%

20%

40%

60%

80%

1 3 5 7 9 11 13 15 17 19 21 23 25

Age

MeanP

ercentContribution

Product Profit MeanService Profit Mean

Mean Profit Contribution by Revenue Type & Year

-10%

0%

10%

20%

30%

40%

50%

60%

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

Year

MeanPercentCon

tribution

Product Profit Mean

Service Profit Mean


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Median Operating Income by BM and Year

-50%

-40%

-30%

-20%

-10%

0%

10%

20%

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

Year

MedianOperatingIncome

Products

Hybrid Product

Hybrid Balanced

Hybrid Service

Total Sample

Note: Service group not included because small sample size median was always negative and below the group


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Market Value by Business Model

NOTE: Excludes Microsoft and Services group

Mean Market Cap by BM and Year

0

500

1000

1500

2000

2500

3000

3500

4000

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

Year

MeanMarketCap($M)

Product

Hybrid Product

Hybrid Balanced

Hybrid Services

Total


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Survivor/Exit Comparison

* Means significantly different at 5% level

For all % except product growth, eliminated outliers by taking all values within 1 S.D.

Survivors Exited Firms

Total Sales $371M $104M *

Total Sales Growth 0.69 0.77

Product Percentage 0.60 0.59

Product Growth 0.60 0.72

Service Growth 0.73 0.88

Gross Margins 0.66 0.64 *

R&D % 0.27 0.35 *SGA % 0.84 1.03 *

Operating Margins -0.68 -0.85 *

T-test of Difference of Means for Product Firms

Product firmswho exit are

smaller and

spend more to

generate similar

growth


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Maintenance Contribution?

Sample: 598 data points of firms per year that broke outmaintenance from other service revenues (i.e. probably a

biased sample favoring firms with large maintenance %)

Mean of 61% maintenance as % of total service revenues

Adj. mean of 55% if eliminate 75 data points of firms per year

reporting 100% maintenanceRan random effects regression using all observations in which maintenance was

broken out.

Dependent variable: service margins

Explanatory Variable: maintenance as % of services

Control Variables: age, size, market, year

Maintenance comes out significant with a coefficient of .53.

10% increase in maintenance as a % of

service = 5.3% increase in service margins!!


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Strategic & Operational Challenges

How Manage the Crisscross? Best balance of products vs. services & maintenance?

What new products to generate services & maintenance?

How Servitize Products? How add special value and revenue opportunities? How make products stickier, less commodity-like?

How Productize Services? Create two organizations within one?

How develop standardized products, platforms, or customized

solutions more efficiently reusing components, leveraging

knowledge, tools, & best practices across customers/projects


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0

100

200

300

400

500

600

1977

1979

1981

1983

1985

1987

1989

1991

1993

1995

1997

1999

2001

2003

#of companies

Public IT Services Firms in US

Projection


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Revenue Breakdown (estimate)

0%

20%

40%

60%

80%

100%

120%

1977

1979

1981

1983

1985

1987

1989

1991

1993

1995

1997

1999

2001

2003

% service % product

Projection


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Comments on Preliminary Data

IT Services business also undergoing similar

shakeout and commoditization?

Number of publicly listed firms in our database

dropped from ca. 550 in 2000 to under 400 in

2005 (preliminary estimate, multiple SIC codes)

Product sales used to be 20% of service firms

revenues; sharp decline to 3% today (estimate)


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Challenges for IT Firms

Product revenues shrinking for Western software

product companies, so they will challenge IT

services companies for service & maintenance

revenues, both from onsite and off-shore centers

IT service companies in India, Japan, US, and

Europe must figure out how to compete beyondprocess & quality competence or low wages

(India) or growth rates & margins will decline


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One Key Option

Develop more Japanese-made products or

semi-products, for license fees and to drive

service & maintenance revenues (full products +

tools, or reusable frameworks, components) US & European enterprise products not so well suited

to developing markets in Asia

But beware of collapsing product prices; so the

business model should be HYBRID


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Second Key Option

Find ways to differentiate services Indian IT services companies differentiated from US,

Europe & Japan competitors by process maturity,scale, technical skills, English language, low (butrising) labor costs.

But to outsiders, the Indian IT firms all look alike,except for different sizes & slightly different prices

How can Japanese services firms differentiatethemselves and prevent copying of their bestpractices or prevent Indian competition?


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Path Towards Differentiation

Complex management of multiple variables Executive leadership, marketing & sales capabilities,

recruitment strategies, training techniques, process & qualitymanagement, technology depth, knowledge management,one-to-one customer relationships, semi-products business

through tools or reusable platforms Need to have a primary base but also be global & local

Need to think harder about Services R and D

Need to impact the brand (= higher prices),scope economies (= lower costs), and ability tolead the future (= thrive, not just survive)

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