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Software Products: Realignment needed

Jan 1, 2002

VisualSoft and Hughes Software, have a lot in common. Both were the darlings of the bourses and now are almost untouchables. Once they were the symbols of the brave new software companies that had ventured into products and today are avoided due to the low visibility in revenues due to the product sales. What went wrong? Due to a significant contribution to the revenues from products, the companies were enjoying high operating margins. And then suddenly both the companies posted disappointing numbers. The reasons were the same - steep sequential decline in product sales. Product sales had fallen a victim to the weakness in global demand for IT services and products.

Hard times…
Particulars VisualSoft Hughes Software
1QFY02 2QFY02 1QFY02 2QFY02
Growth in product sales (QoQ) -57.3% -79.9% -8.0% -59.3%
Products (% contribution to revenues) 19.2% 4.7% 73.0% 87.0%
Services (% contribution to revenues) 80.8% 95.3% 27.0% 13.0%
OPM 33.9% 22.0% 34.4% 17.4%

The reason for the severe decline in products sales could be that these product offerings are not proprietary in nature and are just an automation of general business processes, which can be replicated easily. For example, one of VisualSoft’s product offerings is software components. Components are small software programs, which perform a specific function. The components can be used as building blocks for comprehensive software. These products being general in nature and do not require very high technology or domain know-how (these are coding intensive and not domain knowledge intensive). Consequently, the entry barrier is low.

Another reason for the disappointing performance could be the fact that these products do not satisfy critical business requirements. For example VisualSoft’s PSA (Personal Services Automation) software is an integrated family of applications, which improve productivity especially for the services industry. These help perform better but companies can actually do without these.

Hughes Software on the other hand, had stuck to products in the area of communications. The company's product offerings included protocol stacks and application software. The stacks have to be standards compliant and therefore, there is a limited scope for the company to create pioneering technology. Consequently, the products could have seen sales declining due to intense competition from competitors.

A comparison with successful software products companies across the globe like Microsoft, Oracle, Check Point and SAP brings out one striking difference. All these companies have some kind of proprietary know-how, which makes the barrier to entry into their area of operation very high. Microsoft is a leader in a number of areas like Desktop operating systems, GUI (graphic user interface) based application software. Oracle is the number one player in the markets for database platform. Both these companies are pioneers in their areas of operations.

Products key to margins.
Microsoft 86.3% 46.1% 25.0%
Oracle 74.8% 35.6% 23.7%
Checkpoint 94.1% 62.8% 59.7%

But perhaps the best example is an Israel based company called Check Point, a leader in the firewall market. The company has changed the way firewalls are implemented. It has pioneered a technology called ‘stateful inspection’ that is fundamentally different from traditional approaches for building firewalls. The technology enables better compliance to security policies. But more importantly it is faster than traditional methods of implementing firewalls. It holds approximately 52% of the market share for firewalls. Check Point's size of US$ 425 m (Rs 20.4 bn) is almost equal the size of Infosys.

Thus, products are undoubtedly the key to better operating margins. However, the only way a company can survive in the products market is by having products that are pioneering in nature or are very critical to the company’s operations. The Indian software companies could therefore, keep these strategies in mind while vying for the lucrative markets. And before, investing in software product companies, investors need to evaluate whether these companies have the critical competitive edge.

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