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Software products: A tough job

Mar 10, 2003

The Indian software sector still has a long way to go before revenues from software products become a sizeable part of the industry’s revenues. In FY02, the software sector had revenues of US$ 10 bn of this only US$ 400 m was from software products (0.4% of total revenues). However, within this small segment, we have success stories like i-flex solutions that is recognized to be one of the best solutions providers globally. i-flex solutions’ flagship product FLEXCUBE has been consistently ranked to be the world's among the best selling universal banking solution in the past by International Banking Systems (IBS), UK – an independent research firm. But this is at one end of the spectrum. At the other end we have companies like VisualSoft and Hughes Software have posted significant decline in revenues from products. The stark difference in the performance could give us some clues to what it takes to be successful in the products business.

Companies selling software products offer a more attractive investment opportunity as compared to services companies for a number of reasons. The margins are significantly on the higher side due to the fact that effort put in once is sold over and over again. This means that the incremental sales post break-even are added straight to the bottomline. Also, the software companies that have managed to successfully create and sell products are placed higher up the value chain (and therefore could be accorded higher valuations) since, selling products that can run independently require a significant amount of technology related understanding and maturity.

Products: Higher margins
  VisualSoft Tech Hughes Soft.
% Contribution FY01 FY02 FY01 FY02
Products 47.3% 7.8% 28.0% 23.0%
Services 52.7% 92.2% 72.0% 77.0%
OPM 48.9% 28.1% 36.4% 28.4%

So what is the secret behind i-flex’s success? The company was incorporated as Citicorp Information Technology Industries Limited in 1989. It was only in 1996 that the company’s wholesale banking back office product MicroBanker gained recognition. Infact, FLEXCUBE was only launched in 1998.

Two things are very apparent from the company’s history. Firstly, it has spent a significant amount of time developing its products. But more importantly, the company’s promoters Citigroup are one of the best when it comes to the banking business. What makes the company’s products so successful is the kind of domain expertise that has gone into creating the product. A probable reasoning is that i-flex was able to bring in best practices in the banking business from its promoter, Citigroup, thus giving its product a cutting edge compared to competition.

i-flex: Leading the products pack
(Rs m) 2QFY03 3QFY03 Change
Products      
Revenues 1,085 1,134 4.5%
% Contribution 64.7% 65.1% -
Operating margins 52.3% 49.3% -
Services      
Revenues 592 607 2.5%
% Contribution 35.3% 34.9% -
Operating margins 17.9% 19.9% -
Total 1,677 1,740 3.8%

Another very interesting aspect of the product is that is supports the core banking operations. This it is critical to operations of a bank. If there are technical snags in the product, day to day functioning of the client will be affected. This is a stark comparison when VisualSoft’s products offerings are compared. The company’s product offerings included personal productivity enhancement tools, which are not mission critical and therefore, the spending is discretionary. Also, most of VisualSoft’s products are 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 and the companies like VisualSoft face tough competition and threat of new entrants. However, for products like FLEXCUBE the domain expertise required is significantly higher and therefore, the barrier to entry is significantly high.

Therefore, for those investors, who are attracted to invest in companies on the back of higher margins in the products business, should also take into considering criticality of the product and the amount of domain expertise required to create the product before making their investment decision. As lessons from the past show that only products that have a significant element of domain expertise and best practices will sell in the long run.

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