Week 7: Clear

Software as Money Making Machine

Today’s Software Business is a very lucrative business. Not for nothing do so many different companies engage in this industry. So what are aspects which make this business so attractive and why do these companies earn so much money with it?

There are three general concepts which make the Software business so profitable and popular, namely marginal costs, network effects and switching costs.

Let us have a look at all three of them:

Marginal Costs

Marginal costs with respect to software are effectively zero. Once a software is developed and all development expenditures are paid, each additional copy of it is easy to manufacture. Just another hard drive is needed (e.g. a CD) and the code can be copied without any effort. Hence, the marginal costs is so low that it can be neglected.

Network Effects

Graphic 1: Network Effect of the Telephone

Another reason why software is considered as “money making machine” are the network effects. The network effects describe the phenomena that as more and more people are using a software, the value of the program grows. So the larger the user base the larger the value. Professor Olsen  compared it to an avalanche coming down a mountain. It starts small but get bigger and bigger quite soon.

A simple example for this is the telephone (see Graphic 1). When only two people own a telephone the value they can gain is limited as they can only call each other. However, if five people own a telephone each, the value they can gain is much larger, as each of them can not only call one other person but 4 other people. So the more people are using a telephone, the higher is the value one can gain by being connected to this community.

Switching Costs

The last concept being explained is the concept of switching costs. Switching costs are high with respect to software. Once a company has engaged in expenditures for a certain software, has installed this program on all technical devices and has for example provided training for employees to work with this software, the company is less likely to switch to another software or software vendor. The switching costs are high as significant effort, time and money has to be spend on the software itself and on the activities making the software usable.

So keeping in mind that once all accrued costs due to development are paid, the marginal costs are zero, that the more people use a software, the more valuable it gets and that once a customer has spend money, time and effort on a program, he or she is unlikely to switch, it gets clear why the Software industry is such a profitable and popular business. However, one should not forget, that it might also be hard to survive in this industry as it is very dynamic and risky.

Graphic 1 by Fernando S. Aldado on Wikimedia Commons:

http://commons.wikimedia.org/wiki/File:Network_effect.png

Week 6: Clear

Software

In today’s world of technology, there are almost as many software packages as there are textbooks available to read. We are surrounded by software everywhere. 

But what is software and what does it do?

How is it connected to hardware and the final users?

Whereas computer hardware is something physical, namely the physical components of IT such as computers, technical devices etc, software is either a single program or a collection of programs. The connection or interaction between software in form of operating systems and applications and the final users can be described with the analogy of a layer cake.

Graphic 1: Layer Cake Analogy

 

First, the layer cake needs a base, for example a sponge base, which stands for the Hardware in the IT world, as a cake as well as a technical device needs some kind of basis to exist or operate. In the cake analogy the next layer is a cream base which is put on top of the sponge base(see graphic  1). Without the sponge base the cream base could not exist. In the computer field this cream base represents the Operating System. An Operating System is a collection of programs that have control over the hardware and “tell” it what to do. The third layer in the cake analogy is another sponge layer which is build on top of the cream layer. This corresponds to the Applications in the computer analogy. Applications cannot exist without the hardware and the operating system as it is built on it. Applications can range from programs for the end-users like browsers, an office suite or computer games, to complex sets of programs such as ERP systems. The final layer is the in chocolate-dipped strawberry in graphic 1 representing the User in the computer world. The user can be either an individual person, a group of people or even a whole organization. It depends on how many people “eat from the cake”.

As can be seen in the layer cake example no layer could exist without the underlying one, and without all layers built on top of each other, the cake is not as good and valuable as it could be. The same applies to the computer world. No software could exists without underlying hardware, and hardware alone, or hardware and an operating system alone, are not as valuable as hardware, operating system and applications combined.

In the case of enterprise systems the layer cake has usually an additional layer. To ensure that applications work together and have access to the same data, a database system is needed. This database system can be understood as another layer between the operating system and the enterprise application. In the piece of layer cake being depicted in graphic 1, the thin orange layer could represent the database system building the border between the operating system layer (Cream layer) and the Application layer (Sponge layer).

Concluding one can say, the more layers the cake has, and the better the layers fit and taste together, the more the cake is liked by the end consumer. The same applies to the IT world. The more layers the system has and the better the layers fit and work together, the more valuable the technical device is, and the more it is likely that a competitive advantage can be created. However, the final and secrete “recipe” of the cake has to be determined by each user or company itself.

Original photo by wentongg on flickr.com:

http://www.flickr.com/photos/wentongg/3392082352/sizes/l/in/photostream/

Altered by Nina Maria Scherl.