The Software and IT Services Industry - Term Paper Example

In this paper we shall analyse the software and IT services industry with a special focus on the United Kingdom (UK). The UK software and IT servicesindustry could decidedly be said to be a mature market, though this does not remove room for lots of change and opportunity to be harnessed. For while the top-line expectations in terms of growth may not be that high for the coming years there is plenty of change afoot in the key service lines and vertical sub-segments that make up Software and IT Services (Codling, n.d.). Key markets that are sustaining UK software and IT services are largely the UK government which accounts for up to 30% of the total UK market, banking, retail and wholesale markets. To aid us in analysing the competitiveness of this industry we shall look at strategy with regards to industrial organization, marketing style, resource-based view and the Political, Economic, Social, Technological, Legal and Environmental (PESTLE) approach. Under industrial organization we shall use Porter’s five forces model and under marketing we shall utilise the value-chain approach. Industrial organisation Industries have generally used three generic strategies to gain strategic advantage over their competitors namely: focus, differentiation and low cost leadership (Porter, 1980). The objective of low cost leadership is to achieve and sustain a low cost position so as to increase profit margins (Pearce & Robinson, 2007). Firms have been able to achieve this through injection of efficiency into their value chains through techniques such as developing low cost distribution systems and automation of processes to reduce staff overheads. Companies in software and IT service industry however have the ubiquity of internet to thank for the distributed low cost of production. According to Metzger and Rockville (1995) the major cost for software comes from development in the form of tools required, technology utilized, very high staff costs and management. Learning curve economies are also difficult to sustain in the software industry because of the rapidly changing technology and ease of imitation. On the other hand, the differentiation strategy is concerned with creating unique products or services for various market segments (Pearce & Robinson, 2007). Uniqueness which could be real or perceived by customers is based on a company’s marketing and distribution abilities, innovative abilities, and production abilities. Like low cost leadership, differentiation in the software business is hampered by the ease of imitation. Nevertheless, other strategies have been used successfully to enforce differentiation in the software and IT service industry. Varian (2003) cites mass customization, personalized pricing, versioning and bundling as some of the approaches that software and IT service companies have successfully used to differentiate what they offer to their customers. This means that the investors or company that seeks to enter this industry has the option to follow either of the techniques listed to differentiate their products or they could innovate a new way. Focus as a generic strategy is achieved when a company aims to meet the needs of a particular market segment. According to Pearce and Robinson (2007) the focus generic strategy could be associated with either low cost leadership or differentiation. Within the software industry some examples of software companies that have chosen the focused approach include Cisco in Networking, Symantec in security software, VeriSign in internet security and SAP in Enterprise Resource Planning (ERP) solutions. Industrial organization however is best viewed under the Porter’s five forces model. In a revision to his groundbreaking work of 1979, Porter (2008) states that to sustain long-term profitability, which is the ultimate goal of any business, you must respond strategically to competition. And whereas it is natural to keep tabs on your established rivals looking beyond one’s direct competitors is the trick to survival. Porter (2008) continues to state that the underlying drivers of profitability in all industries are the same. An industry’s structure and the nature of competitive interaction within that industry is shaped by the extended rivalry that emanates from the five forces which are: power of suppliers, power of buyers, threat of new entrants, threat of substitutes and industry rivalry. Powerful suppliers capture more of the value for themselves and squeeze profitability out of an industry that is unable to pass on costs in its own prices (Johnson, Scholes & Whittington, 2007). At the moment, there is a huge pool of talented software developers, architects and managers. Talent can be obtained all over the world with the option of telecommuting being practical. There is also a diverse range of tools, programming languages and software to choose from proprietary to open source. Switching costs are low because the specialised software such as ERPs are not utilised by software and IT service companies. Add to this a large pool of suppliers thus we can conclusively say that within this industry supplier power is moderate. Therefore, in so far as supplier forces are concerned the software and IT service industry is conducive for a new entrant. On the contrary, the software industry’s buyers seem to have a high bargaining power. Most of the technology has been commoditised and supply has been increased tremendously. A majority of buyers of software or IT services could easily change vendors because of low switching costs (Carr, 2003). Buyers also pose a real threat to integrate backwards; in fact most organisations have employed in-house IT personnel to cater for the development and maintenance of many of the internal non-critical software. Exceptions to this exist for instance if you are dealing in software and IT services whose complexity and cost deter buyers from making them in-house e.g. software for Enterprise Resource Planning (ERP) and for information security. In such cases supply is often low and customers prefer working with recognised brands because of the sensitive nature of the tasks done by those software. In software and IT service industry, the threat of new entrants is falsely believed to be high. Significant developments within the industry have increased the barriers to entry for example an entrant today would have to battle established brands. In fact the top 10 software companies control 58% of the market. New entrants are also disadvantaged by network effects. As Porter (2008) postulates, buyers prefer procuring products or services from companies with a large number of customers. Buyers trust larger, established companies for critical products such ERPs, data warehousing and IT security. New entrants are thus forced to reduce their prices, while they simultaneously incur huge unrecoverable expenditure such as R&D, advertising so as to attract a large base of customers (Porter, 2008). However, if the industry is a high growth industry with a potential for sustained profitability in the future newcomers could convince investors to supply the capital necessary to compete with established firms (Porter, 2008). As Carr (2003) states being first or having proprietary software does not guarantee success in today’s world of IT. As we have just mentioned, there are certain software that perform critical functions that buyers are obliged to procure from established brands. However, since many organizations are also seeking to differentiate their products the trend today is to contract software and IT service companies to create bespoke software that organisations could use to leverage their activities and differentiate themselves from other companies. OTISLine software for OTIS, UPS and Wal-Mart supply chains and others are using custom-built software to sustain their competitive advantage. Threat from substitutes is low for such software vendors. Such software have higher switching costs thus further lowering the potential threat from substitutes. As Brown and Hagel III (2003) state, software may have become ubiquitous but the insight required to harness its potential will not be so evenly distributed, which is why we should not be swayed by the threat of substitutes. So the question now would be how intense is the competition within the software and IT service industry? After the dot.com bubble, of between 1995 and 2001, that was fueled by irrational spending on Internet stocks without considering traditional business models (Friedman & Friedman, 2009) growth has stabilized within the industry. Fixed costs have increasingly gone up especially in the developed world because of strong patent laws and high salaries. However, industry growth is moderate and therefore players are still able to rake in handsome profits. The entry of players from the low-cost developing world, and the ubiquity of the internet have positively influenced the market because instead of focusing on rivalry, the software companies have began focusing on value-added services, differentiating products and increasing features. By serving diverse customer segments, vendors have in essence expanded the scope of the industry to the extent that it can support more players while sustaining the industry’s average profitability (Porter, 2008) at a high level. This is a classical instance of industry rivalry being used to shift competition in a positive way. A summary of Porter’s five forces therefore shows us that in the software and IT services industry: rivalry has increased albeit with a corresponding increase in market size and segments, entry barriers are moderate because investors are still willing to provide the huge capital outlay required by new software companies, supplier power is low especially with the proliferation of the open source movement, threat of substitutes is low due to customers especially businesses customers seeking bespoke software and high buyer power – buyers know what they want and are demanding for it. Basing my argument on Porter’s five forces model, in the above industrial organization analysis, I would advise the individuals or organization to strongly consider entering the software and IT services industry. Marketing style strategic thinking The competitiveness of an industry could also be looked at from the point of view of marketing because it encompasses all the controllable activities that are directly involved in winning and keeping customers. Kotler and Armstrong (2008) go further to state that it is only through marketing that companies can go about to create value for customers and build strong customer relationships while capturing value from customers in return. Under the marketing strategy the emphasis is on cost efficiency and critical success factors. Cost efficiency is derived from economies of scale, learning curve experience, low supply costs and quality product or process design (Johnson, Scholes & Whittington, 2007). Product design is for manufacturing industries while process design is for services industries. According to Johnson, Scholes and Whittington (2007) critical success factors are “those product features that are particularly valued by a group of customers and, therefore, where the organization must excel to outperform competition (79).” The importance of marketing strategy is revealed when you seek an answer to the following question: Are successful products better made or better marketed? Products of exceptional quality can be made easily for example through copying of technology, licensing of technology and contract manufacturing. However, for products to be successful they require better marketing (Kotler & Armstrong, 2008). Marketing strategy becomes vital in the following areas: creating demand where there is none, managing latent demand, reversing declining demand, managing seasonal demand and sustaining full demand. A new entrant in the software and IT services industry may indirectly have the capacity to implement cost efficiency because there is the possibility of attracting capital investment enough for ensuring economies of scale and hiring of top talent with the experience and technique for superior product design. The success of a new software company would therefore hinge on its ability to attract large amounts of capital. It would also be necessary for the new entrant to be able to differentiate itself from the incumbents by business model and not just by technology. Modern businesses have adapted to the drivers of the new economy by focusing on: customer segments, customer lifetime value, customer satisfaction measurement, emphasizing brand performance, marketing as an integrative function, and stakeholders. Based on our discussion here on the importance of marketing strategy, I would advise the investors or company that seeks to enter the software and IT to prepare a thorough marketing plan if they hope to excel in their new business. Resource Based View Grant (1991) defines resources as inputs into the production process. He views them as the basic unit of analysis for a business. The resource based view is often used to examine how well a company uses its resources. However in our case we shall stretch the idea to help us analyze how a company’s resource base could be used to raise its competitiveness within its industry. The software industry is a competitive industry that requires resources of a highly technical nature. Success would generally be defined by how an organization is able to explore and exploit its resources to create a sustainable competitive advantage. Exploration is the experimentation with new alternatives while exploitation is the refinement and extension of existing competences technologies, and paradigms (Grant, 1991). One approach to creating a sustained competitive advantage is via resource heterogeneity. This implies that the software company must seek resources that are: valuable (in terms of efficiency and effectiveness), rare, inimitable and non-substitutable (Barney, 1991). There are four isolating mechanisms that make resources difficult to imitate: physical uniqueness, path-dependency, casual ambiguity and economic deterrence (Pearce & Robinson, 2007). A software and IT services company can acquire physically unique resource through Research and Development (R&D) that results in patenting of its software such as what the major software developers e.g. Microsoft, Cisco, Oracle and others, have done. It is difficult to imitate certain brands of software. Path-dependent resources are hard to imitate because of the learning curve expertise. Path-dependent resources require developing a sustained advantage because of a process or procedure that the company has perfected over a long duration. Causal ambiguity is the subtle combination of the company’s tangible, intangible assets, culture, processes and other organizational attributes to make it unique. Economic deterrence is the large capital investment required in scale sensitive industries such as the personal computer manufacturing industry. Certain software applications have also grown to the extent that the capital required for Research and Development (R&D) or to win customers so as to remain competitive is a barrier to entry. I would therefore advice the investors or organisation that seeks to enter into the software and IT service industry to consider the value, the rarity, inimitability and non-substitutability of the resources they have before they embark on the venture. They would need to consider everything from their hires; organisational structure, culture and business model so that they can create a sustainable competitive advantage over the incumbents within the industry. A good example is the way Google built itself. PESTLE analysis PESTLE stands for Political, Economic, Social, Technological, Legal and Environmental analysis. PESTLE was the most common approach used to examine the external environment of an organisation though you could argue that Porter’s five forces presently offers us a more comprehensive approach with regards to evaluating industry competitiveness. With the world coming out of its first global recession since World War II, the economic climate is still fragile and both industry and individuals are expecting governments to come up with interventions to prevent such a disaster from occurring again. According to the McKinsey Global Institute (2010) experience has shown that government intervention has yielded mixed results in terms of helping industries to become more competitive. The McKinsey Global Institute (2010) attribute the mixed results of government intervention to use of ineffective policy making approaches that look at competitiveness in terms of comparisons between countries instead of focusing on sector to sector competitiveness. They propose a bottom-up, sector-based approach to policy making. Governments in the world are currently focused on increasing capacity to sustain growth through either increased productivity or expanding employment. For that reason, this is a ripe period for setting up companies. That means that I would advice the investors or company to consider doing so while the political, economic and legal environments are so accommodative. Moreover, this is a service sector job and according to the McKinsey Global Institute (2010) in high-income economies such as the UK, the service sector has been responsible for all net job growth between 1995 and 2005. Thus I believe the UK government will look favourable on any investor or company that seeks to boost its service industry. With the high inflation the behaviour and expectations of the labour pool in the UK has also changed. People are wiling to work at more reasonable wages thus labour and related costs for a new entrant would be favourable at this point in time. Luckily the global recession did not quite affect the technological developments. The only hindrance in the software and IT service is the rapidly changing pace of technology which translates to upgrading costs, staff retraining costs and threat of substitutes as a result of new technology and threat of new entrants due to disruptive technologies (Varian, 2003). Success in business today comes from the interplay between competition and cooperation. Business should be looked at as a game where the players are customers, suppliers, competitors and providers of complementary products and services (Nalebuff & Bradenburger, 1996). Avoid differentiating your products and services solely on price because rivals will use the low price you helped create as a benchmark. Porter (2001) gives the example of some companies that used Internet technology to shift the basis of competition from quality, features and service to price, thus ending up making it difficult for anyone in their industries, including themselves, to turn up a profit. Nalebuff and Bradenburger (1996) state that success in business does not have to come at another’s expense because competition nowadays takes place between the entire value-delivery network created by different competitors (Kotler & Armstrong, 2008) and not between individual companies. In conclusion, I would highly recommend an investor or company that seeks to enter the software and IT service industry to do so now considering that the political, economic, social and technological factors all favour participation in the industry. The key thing is to ensure that you have the right resources for the venture (valuable, rare, inimitable and non-substitutable) and that you develop an effective marketing strategy. Successful products are not better made products but are better made and marketed products. The industry rivalry is high but expanding with a diverse market segment, supplier power is low and threat from substitutes is also low. Under what circumstances does strategy matter? For you to understand why strategy matters for business you have to go to the fundamentals goal of any business. A business exists for three purposes: survival, growth and profitability. Strategy, therefore, is central to the well-being of any firm. It involves industry analysis, planning, setting of goals, committing of resources, monitoring, evaluation and re-planning. The formulation of strategy compels businesses to critically evaluate themselves in readiness for change in the foreseeable future. Strategy is the framework for managerial decisions (Pearce & Robinson, 2007) which means that there can be no management without strategy. Employees of any organization need to be provided with a clear vision of what the purposes and objectives of the firm are if the firm is to achieve any success. This cannot be done if members of management do not participate in the daily process of monitoring and evaluation. Question such as where are we now? How are we doing with regards to our company mission and vision, are not answered by static replies because business is not static. Change is the only constant in business therefore businesses need to not only react to it but also predict it so as to benefit from it. Strategy could be categorised into two broad groups that is corporate strategy and competitive strategy. Corporate strategy is used to handle decisions such as which line of business should you venture into and once you have settled on your chosen line of business, competitive strategy comes into play. Competitive strategy’s core purpose is to understand and cope with competition (Porter, 2008). No business exists without competition and competition like the business environment is constantly changing. Applegate (2008) tells us that new technologies provide opportunities to radically change business and industry economics thus there is a need to frame strategy and its execution within the framework of a business model if we are searching for opportunities to create and exploit game-changing innovations. Furthermore, strategy allows the firm to plan its capital budgeting. Companies have limited funds to invest and must allocate capital funds where they will be most effective and derive the highest returns on their investments. Need for investment is also affected by competition and the changing business environment. In conclusion, it is evident from our discussion that for a business to experience survival, growth and profitability it must utilise its strengths, reduce its weaknesses, exploit its opportunities and diffuse its threats. For this to happen in an environment that is characterised by the constantly changing Porter’s five forces, strategy is vital. Strategy enables the business to do the following: exert control over its desired direction for growth, to continuously improve, to tackle competition and change, and to exploit any game-changing innovations. A business therefore needs strategy as long as it exists. References Applegate, L. (2008, January 10). Crafting business models. Crafting Business Models online tutorial. 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