THANKS TO DISASTROUS MARKET CONDITIONS many software companies are surviving by the skin of their teeth. Global business has changed to the point that enterprise customers are now shying away from any software or related service purchases unless they directly boost revenues, drastically reduce cost of operations, and/or improve customer satisfaction. Large software companies such as Microsoft, SAP and Oracle are responding aggressively to any and all bids. Formerly only entertaining sales opportunities of over $250,000, they are now competing rather aggressively for even small $25,000 opportunities. The only relatively small software vendors not being squeezed out are those that have mastered the art of survival in this harsh and dry economic climate.

For today’s software vendor, strategic analysis, proper positioning, and a customer centric approach to thinking are prerequisites for survival. With giants like Microsoft, SAP, and BEA selling solutions at $25-$50K a pop, it is hard for relatively smaller players to compete if it takes them $6-$10M to develop comparable products. Microsoft’s grand entry into the enterprise application space makes you wonder how far they really are from getting into “report generation” and “performance monitoring” space for instance. Will it warrant the incumbents to move up the value chain just to survive and are their business models nimble enough to handle this change? Many of these companies are in fact going through an identity crisis not knowing whether they are morphing into an applications ISV, a solutions or a services company.

While it is true that many software companies are doing a decent job of tightening their operations and cutting costs with offshore development, what’s next? With license revenues steadily falling, R&D costs too high for any profits, and revenues stagnant, companies are reduced to competing for low-margin outsourced operations contracts. History has taught us that price alone cannot be used as a long-term competitive differentiation. How then can these companies survive in this dog-eat-dog environment?

Though the answers to these problems vary, they share a common theme: innovation—in strategies, sales models, operations and technology.

Attacking Niche Markets
Countless niche markets exist worldwide and companies like Neoforma have attacked them effectively. Niche market solutions (with some services) are a great answer, if you can perceptively identify them. Consider the following areas:

•Electronic component-specific business intelligence can move outsourced manufacturers from 1% margins to 3% margins
• Patient centric practice management can be sold to thousands of U.S. practices for $250 p.m.
• Railway telematics-based data integration and business intelligence will save a few hundred lives every year in India

Choosing the Right Niche
Targeting the one right market niche is the critical first step. Depending on the company’s long-term business strategy, it is technically possible to produce 5 to 6 products for the cost of two. This efficiency is not dependent on offshore outsourcing or even cheap contracting help; the answer lies in utilizing existing resources and technology more efficiently and creatively. Unfortunately, most application solution deployments still warrant major customization efforts at the time of deployment, that affects the software vendors’ bottom-line.

With recent advancements in technologies and R&D methodologies, it is possible to drastically reduce the need for major customization efforts at the time of deployments, hence allowing companies to attack specific verticals with as much “canned” technology as possible. This ensures reduction in development time and capital for building “new solutions.” With this approach, software companies can build and market products for multiple niches at incremental costs.

“Vitamin” verses “Pain-killer”
Few enterprise customers today will spend their limited IT dollars on anything that does not deliver their business immediate benefits. Thus, the greater the “intensity of pain” being alleviated, the easier and quicker the sale for the software vendors. Enterprise customers are in the market not for “vitamins” but the next generation of “pain-killers.” Consider what is happening at many outsourced manufacturing companies like Solectron or Flextronics—these companies still cannot make data from different applications work together. Until this problem is solved, these companies cannot focus on second order issues such as real-time analysis. Solectron cannot be accused of a lack of effort: they’ve spent millions of dollars on every possible data integration product on the market—all to no avail.

This is a clear case of not applying innovative technologies to solve the problem. Such technologies do exist and have existed for a decade, but few companies have aggressively employed them. A similar case occured when one of the largest banks in the world wanted to move their customer services from an internally-developed closed environment to an open system supported by third-party vendors. Unfortunately for the bank, all the bidders tried to retrofit their existing products to the bid, none of which met the customer’s needs. As a result, the bank is still looking for a good solution, three years later.

Many such first-order business problems have good strategic solutions that enterprises will pay for, but in each case, these demand innovative uses of technology.

Innovative Selling
Many companies must completely overhaul and renovate their sales tactics. Selling through shared risks and returns (Risk/Return Shared Model) works well for some companies. However, selling engineering services up front is out, while selling very specific solutions—almost as the product itself—is in. Customers buy pitches that specify cost savings, such as: “We will improve the accuracy of your Bill-of-Materials (BOM) by 40% and save you at least $500K per quarter, guaranteed.” Customers do not as readily buy a pitch based on perceived competitive pricing, such as: “We will offer engineering services at $10 less per hour.” In short, companies must change what they’re selling and how customers value the sale price. When customers feel “pain,” they are willing to pay for the guaranteed best “pain-killer.”

Outsourcing the Right Way
Outsourcing and offshoring as done by most companies proves more expensive than necessary and is almost always done wrong. In fact, one particularly large multi-national company would often spend $40-$50k per engineering resource in India, while comparable services were readily available for half the price. Regardless, management of outsourcing—from strategy to tactical execution—has to be done with care and caution. It may be worthwhile to bring in someone highly experienced to manage this operation. Almost always, outsourcing selected repetitive parts of the off-shoring operations to lower-cost vendors is recommended. In such cases, a two-level out-sourcing occurs. Such a system ensures both smaller operations and better-designed products, due to the formal nature of such collaborations.

Target Market
It is sometimes advantageous to build products that can be marketed worldwide with very little localization effort. Software companies building geographic sensitive products may be at a higher risk depending on local economic conditions. A good example would be medical insurance related software company targeting the U.S. market. Such a company would have very little or no chance of selling its products in other countries because of local regulatory laws and business processes. Without understanding the peculiarities of the Indian or Chinese markets, it is impossible to design appropriate products. For example, the differences between factory automation in China and India for auto-parts manufacturing (a booming industry) lead to very different supply chain automation products.

Keiretsu Model Works
Forging relationships, partnerships and JVs with other companies in all areas—including technology, marketing, and even sales and support—will invigorate and enrich your solution’s value proposition for customers. In addition, these forged relationships will cast a larger net, improving a company’s chances of luring more customers.

Despite the current harsh and dry economic climate, there is rain in the forecast for a few companies, such as Crystal Decisions (www.crystaldecisions.com), a little known British Colombia firm specializing in business intelligence products. Not just a survivor, with revenues exploding 34% in the last year (ending March 2003), CD has recently announced their acquisition by Business Objects for a whopping $820M—a good example of what innovation can bring about. On the other hand, gloomy weather is predicted for another business intelligence vendor, Brio, whose revenues through license fees have dropped almost 16% and was recently acquired by Hyperion for a dismal $142M. Their lack of innovation would not have taken them far on their own, anyway.

For three years now, cost cutting has been the mantra that some companies chant as their long-term success strategy. Innovation has been ignored, as companies drastically cutback their relative R&D expenses. For software companies, ignoring innovation is the kiss of death. Since the IT world continues to change in quantum leaps, software companies must stay ahead of the herd or be crushed underfoot.