Statistics
on the global production and trade in software are
notoriously inconsistent, because of difference in
coverage and methodology. Any single source can at
most provide an indication of the structure of and
trends in the industry, rather than an exact measure
of its size.
According to leading market research firm Datamonitor,
the global market for software totalled $143.7 billion
in 2004 (Chart 1). The interesting feature is, of
course, the structure of this market. In terms of
market segments the North American market clearly
dominates, accounting for slightly more than 50 per
cent of the total. Europe is a distant second (28.8
per cent) followed by the Asia-Pacific (16 per cent)
and the rest of the world (4.9 per cent) (Chart 2).
Chart
1 >> Click
to Enlarge
A large home market, among other things, has served
the US industry well. It dominates the global trade
in software as well. As Table 1 indicates the US has
accounted for a quarter to a half of global trade
in one area (packaged software) for which figures
are available in the UN's commodity trade database.
Chart
2 >> Click
to Enlarge
The industry is also highly concentrated in terms
of market shares of leading firms, with US firms dominating
the market. The top four firms (Microsoft, IBM, Oracle
and Computer Associates), accounting for 41.5 per
cent of the global market, are from the US (Chart
3). This structure belies the conventional notion
that the software sector is characterised by extremely
low barriers to entry.
Reporter
Title |
Trade
Value
|
Market
Share |
USA |
$4,549,548,849 |
27.3% |
Germany |
$2,644,021,184 |
15.8% |
Ireland |
$1,833,543,792 |
11.0% |
UK |
$1,533,462,785 |
9.2% |
EU-25 |
$1,282,913,411 |
7.7% |
Other |
$6,123,007,968 |
36.7% |
Total
Export |
$16,683,584,578 |
100.0% |
Table
1 >> Click
to Enlarge
The software sector is seen by many as characterised
by low costs of entry and an easily accessed and almost
universally available knowledge-base for innovation.
What is of special significance is that the sources
of this knowledge, such as journals, conferences,
seminars and publicly or privately financed training
programmes, are easily accessed. This makes it easy
for wholly new entrants to acquire the knowledge base
required for cutting edge technological contributions
to the industry, as was and is true of at least some
of the myriad start-ups in Silicon Valley. Thus, the
software sector is seen as one where knowledge is
easily acquired and innovations easily replicated,
requiring skilled labour but little by way of capital
investment.
This perception of the industry fails to take account
of the heterogenous nature of the industry which has
added on different segments in the course of its evolution,
driven by technological changes in hardware that have
created new demands and opportunities. Writing in
1995 Martin Campbell-Kelly classified software firms
into three distinct sectors, based on their historical
evolution: software contractors, and the personal
computer software industry. The role of software contractors
was to develop one-of-a-kind programs for computer
users and manufacturers, buying and selling expensive
computer systems with limited capabilities by today's
standards. Packaged software producers emerged in
the 1980s attempting to provide standard software
for applications needed by specific sets of clients.
These two sets of software firms either served or
competed with hardware firms, who sought to develop
software applications for purchasers of their equipment.
They were part of the computer industry establishment.
Chart
3 >> Click
to Enlarge
It was for this reason that Campbell-Kelly chose to
treat producers of software for personal computer
users as a distinct category, even though they were
involved in the same kind of business as the packaged
software producers. In his view producers of personal
computer software were in the business of generating
products that would have a large number of users,
if successful, and consisted of many firms that were
outside the traditional software establishment.
Since then software contractors (including relatively
small firms) and hybrid firms like IBM have developed
into service companies providing enterprise software,
systems integration and consultancy services to large
corporations, adding a major software services component
to the industry. However, the evidence seems to suggest
that the structure of the US software industry has
not changed very much over time.
Further, the evidence suggests that the market for
large scale public and private projects were characterised
by significant barriers to entry, with established
firms and a few successful start-ups that grew rapidly
in size dominating the market. However, entrepreneurial
firms always had a place in the industry, providing
custom programs and software maintenance services
of modest scale to medium-sized firms. According to
one estimate there were 2800 software contractors
in the US in 1967, many of whom were small firms catering
to smaller clients. In this market, the only barriers
to entry were programming knowledge, technical knowledge
of the applications domain and the availability of
a client.
With the growth of the market for packaged software
in the wake of IBM's decision to unbundle software
and hardware in 1968, it would appear that smaller
firms would have a new market. But in actual fact
the need to develop a product fully, by investing
a substantial number of programming man-hours, before
testing it and entering the market increased sunk
costs substantially. This was in itself a barrier
to entry. And, though the arrival of the personal
computer increased the scope for packaged software
substantially, the problem of high sunk costs remained.
As has been repeatedly noted, producing the first
unit of a software product requires large investments
in its generation, whereas producing an additional
unit is almost costless. The larger the sales, therefore,
the lower the average cost and the higher the return.
But that is not all. When large sales imply a large
share of the market as well, scale becomes a means
of ensuring consumer loyalty and strengthening oligopolistic
positions. This is the result of ''network externalities''
stemming from three sources. First, consumers get
accustomed to the user interface of the product concerned
and are loath to shift to an alternative product which
involves some ''learning'' before the features of
the product can be exploited in full. Second, the
larger the number of users of a particular product,
the greater is the compatibility of each user's files
with the software available to others, and greater
the degree to which files can be shared. The importance
of this in an increasingly networked environment is
obvious. Finally, all successful products have a large
number of third-party software generators developing
supporting software tools or ''plug-ins'', since the
applications program interface of the original software
in question also becomes a kind of industry standard,
increasing the versatility of the product in question
without much additional cost to the supplier. These
''network externalities'' help suppliers of a successful
software package to ''lock-in'' consumers as well
as third party developers and vendors, leading to
substantial barriers to entry.
Partly because of these characteristics successful
start-ups like Microsoft, which entered the market
at the right time, came to dominate the industry.
As a result, even though the history of Silicon Valley
is full of anecdotes of tech-savvy entrepreneurs discovering
new possibilities and new products, concentration
is the dominant feature, with most start-ups with
innovative products now being acquired rather early
in their history.
The reasons for this need to be spelt out. Take the
case of software products for mass use. Creating such
a product starts with identifying a felt need (say,
for a browser once the internet was opened up to the
less computer savvy or for a web-publishing programme
once the internet went commercial). The persons/firms
identifying such a need must work out a strategy of
generating the product, by hiring software engineers,
at the lowest cost in the shortest possible time.
Once out, the effort must be to make the product a
proprietary, industry standard. This involves winning
a large share of the target consumers, so that the
product becomes the industry standard in its area.
Once done, the product becomes a revenue generating
profit centre.
The investment required is the sums involved in setting
up the company, in investing in software generation
during the gestation period, and in marketing the
product once it is out so as to quickly win it a large
share of the market. Needless to say, while entry
by individuals or small players are not restricted
by technology, they could be limited by the lack of
seed capital. This is where the venture capitalists
enter, betting sums on start-ups which if successful
could give them revenues and capital gains that imply
enormous returns.
There are, however, three problems here. The first
is one of maintaining a monopoly on the idea during
the stage when the idea is being translated into a
product. The second is that of ensuring that once
the product is in the public domain competitors who
can win a share of the market before the originator
of the idea consolidates her position do not replicate
it. It is here that a feature of 'entrepreneurial
technologies' – the easy acquisition and widespread
prevalence of the knowledge base needed to generate
new products - considered an advantage for small new
entrants actually proves a disadvantage. Thirdly,
no software product is complete, but has to evolve
continuously over time to offer more features, to
exploit the benefits of increasing computing power
and to keep pace with developments in operating systems
and related products. Thus large and financially strong
competitors, even if they lag in terms of introducing
a product 'replica', can in time lead in terms of
product development, and erode the pioneer's competitive
advantage.
There are two aspects of technology that are crucial
in this regard. First, their source. Second, the appropriability
of the benefits of a technology. As mentioned earlier,
in the case of software the sources were in the public
domain. This was where the advantage lay for the small
operator. But once a technology is generated based
on some expenditure in the form of sunk costs, there
must be some way in which the innovator can recoup
these costs and earn a profit as incentive to undertake
the innovation. In the Schumpeterian world this occurred
because of the 'pioneer profits' that the innovator
obtained. The lead-time required to replicate a technology
itself provides the original innovator with a monopoly
for a period of time that generates the surplus which
warrants innovation.
Most often this alone is not enough to warrant innovation
and in the software sector lead times can be extremely
low, especially if the competitor invests huge sums
in software generation, reducing the lead-time substantially.
It is for this reason that researchers have defended
and invoked the benefits of patents, copyright and
barriers to entry in production, which allow innovators
to stave off competition during the period when sunk
costs are being recouped. Unfortunately, neither is
the status of patents and copyrights in the software
area clear (as illustrated by the failure of Apple
to win proprietary rights over icons in user interfaces),
nor are there barriers to entry into software production.
This has had two implications. First, the importance
of secrecy in the software business. The 'idea' behind
the product must be kept secret right through the
development stage, if not competitors can begin rival
product developments even before the original product
is in the market. A feeble attempt to institutionally
guarantee such secrecy is the now infamous 'non-disclosure
agreements' which prospective employees, financiers
and suppliers are called upon to sign by the innovator
who is forced to partially or fully reveal his idea.
Secondly, even after the product is out, since the
threat of replication remains, it is necessary to
strive to sustain the monopoly that being a pioneer
generates. This is where the possibility of locking
in users with the help of an appropriate user interface
which they become accustomed to and are reticent to
migrate away from, and locking in producers of supportive
software with an appropriate 'applications programming
interface' becomes relevant. It should be obvious
that sustaining monopoly to recoup sunk costs can
indeed be difficult.
Such strategies did help the early start-ups, resulting
in the jeans-to-riches stories (Microsoft, Netscape,
etc.) with which Silicon Valley abounds. But more
recently it has become clear that start-ups undertake
innovative activities only to create winning products
that the big fish acquire. This is because of the
possibility of easy replication and development of
an original product, which can be done by dominant
firms with deep pockets that allow them to stay in
place and spend massively to win dominant market shares.
In the event, the likelihood that a small start-up
would be able to recoup sunk costs, clear debts and
make a reasonable profit is indeed low. Selling out
ensures that such sums can indeed be garnered. And
selling out is often a better option than investing
further sums in developing the product, now faced
with a competitive threat, in keeping with industry
and market needs.
Given this feature of the software products market,
it is not surprising that small players (such as Netscape
with it Navigator and Vermeer Technologies that delivered
Frontpage) are mere transient presences in key areas
even in the developed countries. To expect developing
country producers to fare better is to expect far
too much. The latter can merely be software suppliers
or outsourcers for the dominant players.
In sum, other than in the supply of services to medium-sized
firms or serving as contractors for relatively small
projects by industry standards or serving as sub-contractors
to leading software contractors, the basic nature
of the software sector seems to be such that concentration
is the key.
This is a factor that firms from countries like India
have to confront when attempting to exploit the benefits
of their pool of skilled cheap labour. India has been
successful in breaking into this sector. But that
success is also predicated on having an extremely
concentrated industry here. Thus a recent study of
65 small and medium enterprises in the IT sector (B.G.
Shirsat, Business Strandard, July 14 2006), with revenues
ranging from Rs.10 crore to Rs.200 crore, found that
their revenues in 2005-06 amounted to Rs.3,400 crore,
which was just 8.9 per cent of the Rs.38,169 crore
revenue garnered by the top four IT firms (TCS, Wipro,
Infosys Technologies and Satyam Computer). Their profits
aggregated Rs 575 crore or 6.9 per cent of the Rs.8,386
crore earned by the top four. This concentrated structure
is sustained either through the acquisition of smaller
firms or by the exit from the industry because of
unviability. This has implications for policies aimed
at ensuring the proliferation of software firms as
part of India's ongoing IT thrust.
