Embracing The Software Service Economy

By Paula Klein  |  Posted 08-04-2008

Embracing The Software Service Economy

A quiet, complex revolution is underway in the software world. The changes and new models of development and delivery are percolating up from the consumer Internet into the corporate environment, and they're already having profound effects on the data center and the role of the CIO. Rather than considering them a threat, CIOs need to embrace and lead the charge to the new software models. That's the logical next step in creating IT business value, according to Timothy Chou.

Chou knows enterprise software--its past, present and, very likely, its future. As the president of Oracle's On Demand business from its formation in 1999 until 2005, he was thinking about, and creating, new models of software delivery. Chou also sits on several corporate boards, teaches at Stanford University and speaks frequently about software trends. He most recently co-founded Openwater Networks, and his latest class at Stanford is about software as a service.

The End of Software (Sams, 2004), Chou's first book, was considered a primer to the on-demand model of software delivery and its benefits. The just-released sequel, Seven, expands on this topic and provides a roadmap for success--and pitfalls-- in the ever-changing software business.

From Chou's perspective, every business is a software company--whether managers realize it or not. As such, CIOs are in an ideal position to lead the next-generation businesses that can result from embracing new software service models.

Once they offload the burden and costs of software development and maintenance, Chou says, businesses can focus resources on their core competency--being best at their market strengths. They don't have to reinvent the software wheel for transaction-based systems, such as human resources and customer relationship management (CRM), or back-office functions.

CIO Insight contributor Paula Klein recently spoke with Chou. What follows is an edited, condensed transcript of their conversation.

CIO Insight: Discuss your second book relative to the first. What's changed for CIOs?

Timothy Chou: The first book was written to convince people that this movement to software as a service and on-demand software was going to happen. Now we're there, and a lot has changed. When The End of Software was published, Salesforce.com, RightNow Technologies and Netsuite were all privately held companies. The new book starts by talking about nine public software companies, which all issued IPOs after 2000. These nine (Concur, DealerTrack, Kenexa, Omniture, RightNow, Salesforce.com, Taleo, Vocus and Webex) have a combined market cap of over $15 billion.

Seven was written to help current and future software companies understand the fundamental business models, and it asks them to choose which one (or more than one) they will operate in. It's critical for CIOs to understand their new options and the software industry overall.

The book outlines seven models: from current traditional licensing [model one] to Internet software businesses like Amazon and Google [model seven]. Model two is the open-source approach, three is outsourcing, four and five are hybrid on-demand pricing models, and six is software as a service. [See list on last page.]

For CIOs, it's equally urgent to understand the financial and service implications of each model. Most CIOs realize that their budgets are dominated by spending on managing and maintaining traditional [model one] hardware and software, leaving little money for new programs and projects. While the steady revenue stream is good for the software company, it's not necessarily in the best interests of the buyer.

On the other hand, while buyers will pay less--or nothing, in the case of open-source software--with the new models, they might not be assured of support, updates and the viability of the vendor going forward. They have to understand what's driving the market and also what's best for their business and customers.

Three Tips for CIOs

What should CIOs do about this transformation?

Chou: Three things: Embrace, verify and extend the models. CIOs should first understand each of these business models as they become available. Some CIOs have already made the decision to only buy software delivered as a service; only if there is no on-demand service available will they choose the traditional route.

This may be more practical for some companies than others, but we all know there are more valuable uses of IT's time than running backups of CRM data and ensuring that the upgrade goes smoothly. That's better left to the company that produces the software.

Verify means to figure out whether a software company is just marketing around the message of software services or really doing it. For example, ask how many times they've executed the upgrade process successfully, or how long it is from the time a security patch is available until it's in the production system.

Here's what I mean by extend: You probably have some software that's unique to your business. As we all move to become information businesses, these systems could be made available to others in your industry. Perhaps the best example of this is the Sabre airline reservation system. Once it was an internal system to American Airlines; today, Sabre, which was acquired in 2006 for $5 billion, is one of only a handful of airline reservation systems on the planet.

A less well-known example is AltiusPAR, a spinout of Posadas, the largest hotel chain in Latin America. Posadas built a modern hotel reservation system, deployed it internally, and now is calling on the largest hotel chains in the world with the same kind of story Sabre told many years ago.

Some people think that if the United Airlines loyalty system could be spun out, it would be worth more than the airline. And the world's best logistics system might be buried in FedEx or UPS. What if those systems could be extended so everyone could use them? As a CIO, you have mastered the R&D and operations challenges of delivering your software as a service, but your challenge in the new world will be how to market, sell, price and create contracts for those services.

What's the role of software in a service economy?

Chou: Eighty percent of the U.S. economy is in services. Whether you're in financial services, health care, professional services, software or high tech, you're in the service business: Service is information; the more personal, the better. Amazon.com proves this daily. The company is using personal information to deliver a more targeted and useful experience than traditional bookstores could ever provide.

Does that mean that IT and CIOs are merely providing a service to the business, like HR or accounting, or is there a more strategic role they can play?

Chou: The CIO sits at the crux of the new business model. My experience has been that few executives outside of the CEO have as complete a picture of the business. Ask any CIO who has completed an ERP implementation, and he or she will tell you more about how the business really runs than any-one on the executive staff.

As the hub of the business, the CIO has two strategic roles. First, inside every business today is an Internet's worth of information. The surface Web [the part of the Web indexed by search engines such as Google and Yahoo], is estimated to be 100 terabytes. Anyone reading this article is likely in a company with many more times that much information. So, given that every business is both a service business and an information business, the way in which you choose to connect people and information is what every business is about.

The second strategic role for the CIO centers on people. A service business relies on information in computers, but it's also about the knowledge and specializations of the people in the business.

Gone are the days when any manager could manage just by walking around. The strategic challenge today is how to provide the tools and the infrastructure to manage in a world where my R&D team is in the Ukraine, my support team is in India and my headquarters is in Boston.

What new challenges do CIOs face as they move to on-demand service models?

Chou: Why should a company manage transactional HR or CRM systems? CIOs know that is not the most efficient use of resources. The biggest cost for most businesses is human labor, and going through a major software upgrade is a vastly inefficient waste of money.

You are doing it for the first time, but the software company delivering its software on demand has done it a hundred times. Which company do you think will do it quicker, better and at a lower cost? Many people think you have to pay more for reliability, but the opposite is true. If you want to buy the most reliable car, don't pick the $1 million handcrafted sports car; find a Toyota that's been produced a million times.

As author Geoffrey Moore says, know what's core and what's context to your business. A lot of software is all contextual: You don't need it to differentiate your business. You don't have to be your own power company to run a network. Once you realize this, you can turn attention--and dollars--to your real business: the information and people that differentiate you.

At that point, you can ask what new systems you need to build to bring together people and information. What do you do uniquely, and how do you monetize that? That is your business and its value--not transactional systems.

Making the shift

How long will it take for the majority to make the shift, and where will new services come from?

Chou: Technology shifts occur all the time now, and I see no reason for them to stop. Hardware gets cheaper, networks get faster and software gets more creative all the time. New businesses services will come from at least four sources: First, there will be some traditional software companies that will take the bold step of converting their entire business to Internet models. Be a student of Concur [a provider of on-demand employee spend management services] if you want to understand how that might happen.

Second, you will see traditional software companies offer some of their software using more hybrid Web-based approaches. Companies like Blackbaud already deliver their traditional products this way, and Callidus Software is advancing to become an on-demand business. In a short period of time, both companies have seen a tremendous movement to these models.

The third source of new services will come from the consumer Internet. Amazon's S3 [Simple Storage Service] and EC2 [Elastic Compute Cloud] are providing infrastructure cloud computing; Apple's iPhone platform, Facebook's F8 [developer conference] and Connect could all become the source of many new business applications. Finally, there will be new companies based totally on search instead of SQL, such as Openwater Networks and other companies, like StrikeIron, that will deliver data as a service. And these are just scratching the surface.

Nevertheless, there are tradeoffs that enterprises have to make when moving to the new models. They may have to forgo much of the customization that they're used to in order to get simpler, cheaper, more reliable applications. Service-level agreements and contract specifications may take on new importance, or they may become less necessary: It all depends on the application and the business requirements.

How is the nature of vendor/buyer relations fundamentally changing?

Chou: It's a cliché to say that the Internet changes everything, but it has. Once upon a time, enterprise software vendors sold only $1 million products, and the only channel to buyers was a human being armed with a few reports. Today, two things are different: Products are significantly lower in price--so we can't afford to have the human being in the loop--and the Internet provides a low-cost, diverse channel for information that can be used to educate anyone. Reference calls [on a product or service] have been replaced with hundreds of online forums that let you understand a diverse set of experiences with a product.

Find the people in your company who are the early adopters, engage them in a community to find out what's working--and what's not. Encourage them to network with others at different companies to learn more. We're moving from being "sold to" to a select-and-purchase model. No one was sold a plasma TV last Christmas; consumers got educated, then selected and purchased the product. There's no reason this won't be the case with business.

What does the future hold for the current leaders in the server and software businesses?

Chou: Large software and hardware businesses have been consolidating around the service of existing hardware and software--whether that's Oracle and its consolidation of the support revenue streams of Peoplesoft, Siebel and BEA, or HP with the recent acquisition of EDS. Lou Gerstner long ago successfully put IBM on this path.

The challenge all these players face is three-fold. First, internally they will be challenged to reduce service delivery costs. As most of them are in countries with low labor rates--unless there are a lot of college-educated pygmies hiding in Antarctica--the labor arbitrage game is over.

The second challenge is how to reduce the cost of service for the CIO. With no standardization to speak of, every computer, application and network looks different, which means there can be no specialization. Ultimately, this sets a floor on costs for both the buyer and the seller.

Third, as we have seen in each successive change in technology from mainframe to client/server to the Internet, new unknown players emerge to disrupt the scene. When Google presented its vision, how many investors in Silicon Valley said, "Who needs another search engine?"

The one thing we can be certain about is this: The next Google is out there.

Seven Business Software Models

Seven Business Software Models

1. Traditional: Software is licensed with a one-time price. Maintenance and support carry separate charges.

2. Open source: The software is free, and support usually comes from the open-source community or a developer company.

3. Outsourcing: Offers third-party management of software for a monthly fee.

4. Hybrid: Provides traditional licensing, with service from the vendor rather than from in-house staff or value-added resellers.

5. Hybrid-plus: Software and service are provided on demand, as needed.

6. SaaS: Both software and service are offered only as online services, such as those from Salesforce.com.

7. Internet software businesses: The software is the uniqueness of the company, such as eBay and Google.