First chapter Hyperscale and microcare

Introduction Thanks to open source, the Cloud and API’s, it is easier than ever before to build and release digital products to a global audience. As a result, competition is tough, prices are under pressure. The good old recipe of just adding more functionality to your product does not work anymore. In this book, we will explore what it takes to build winning digital products today. We’ll focus on the idea that one should stop building software, and build digital services instead, effectively combining Hyperscale, with Microcare: the ability to establish an intimate relationship with each and every one of your thousands of users. We will discuss the capabilities and processes you need to build such digital services. We zoom in on the kinds of assets you need to develop, and that will greatly influence the business valuation, all supported with practical advice and real world examples. If you are responsible for bringing digital products to the market, then this book will give you a head start. And this is valid independently of the context of your business, either as the core activity of a new venture, as a spin-off of an established software editor or as an additional offering of a traditional manufacturing or service company: the basic patterns of designing, delivering and monetizing the digital service are the same in each setting. Insight about those basic digital business patterns are there-fore also relevant for students, investors and counsellors. To quote Einstein “Complex things should be explained as simple as possible, but not simpler”. The challenge of understanding the digital business model is linked to the variety of domains which are affected by the digital nature of the offering. The shift to digital and its impact are easily understandable to non-experts for some domains like marketing, product strategy and business management; other impact areas are for a general audience more hermetic like software engineering, legal risk management and financial planning. The book will offer you a basic and sufficient domain set of guidelines to cope with the fundamentals of the digital model, and we tried doing this without using an expert lingo. We build our story for the reader with some general business background, but with no requirements of digital experience or specific knowledge whatsoever. Each chapter unravels step by step the business transformation that comes along when adopting a digital offering. Insight for the reader is supported by industry examples, analogies with what happened in other business areas and practical tips and best practices. Real life cases with Sirris customers tell the story of local (anonymized) companies and their struggle to adopt a hyperscale and microcare driven business. We end the chapter with a retrospective where the reader finds key questions for his or her organization. After reading the book, a basic set of insight about the new versus the old economy should be clear to you. First, you will comprehend the commodity nature of software and its impact on a digital business; especially relevant when deciding where to invest your scarce resources. Second, the digital economy is about the combination of fire and ice, the artful blend of scale and intimacy, upsetting the adages of strategy. The design and execution of a digital service are fundamentally different from what is traditionally taught. Third and finally, the success of a digital business depends on the efficient and speedy construction of some typical asset

types. The book explains when to build what type, why whom and in which way. To us, mastering these three areas is the key for a sustainable success and through our advisory services we did find out that they are counter-intuitive; most digital entrepreneurs learn them hard way. For the novice in the domain, the reading will deliver a major understanding of the digital mechanism. Experienced managers and entrepreneurs will finetune their insight about roles, metrics and assets. In both cases, we hope our work helps to lever the digital maturity of your organization. And we trust, this is not a one-way communication. We are eager to learn about your views and ideas: do not hesitate to start talking to us during presentations or to exchange your input with the reader community at https://www.hyperscale-microcare.com. An open-minded exchange of experience is the motor of the digital economy. May the digital acceleration be with you. Enjoy the reading! Peter and Nick

1. A story about three paradoxes and two métiers *Digital disrupton as the eruption of digital resource within an industry. (Peter & Antoon 2018) As any cookbook, this work contains recipes, ingredient descriptions and best practices. To us – both amateur chefs – a flaw of most kitchen guides is the focus on lists and the weak insight they bring about the basic mechanisms. The process behind a tricky recipe like sauce Hollandaise is an emulsion between an oil and an aqueous component: butter and lemon juice are bound by egg yolk, used as an emulsifier. Digital entrepreneurship (cook) books show the same weakness. They distill guide-lines without linking to the root mechanisms in digital. We base our recipes on these mechanisms. To explain them, we tell the story through the arrival of three digital paradoxes. Paradoxes intrigue, trigger curiosity, and animate a discussion between peers. That’s why they are excellent starting material to reason about a world in change. Similar to software development, cooking is a creative process with “hard” things: it is about the ingredients of nature and the chemical and physical processes to transform them. The chef, like the developer, reworks the raw material to create a new harmony. Some chefs step in the tradition of Escoffier and Bocuse and learn the métier based on the rich portfolio of French “terroir” ingredients (with the intense use of dairy and alcohol, especially cream and wine). Other adopt the métier of the New Nordic Cuisine with its focus on the individual ingredient and learn the job in Copenhagen. The identification as a separate métier is a condition to bring a domain to its full potential; it is the start of a collective trajectory of thousands of chefs perfecting the craftmanship of their maîtres. The emergence of a new métier is triggered by technology and science. Molecular gastronomy and food pairing models are recent drivers to explore beyond tradition, for instance, the use of a dessert ingredient like chocolate in the main dish, or serving a foam with a beef taste as a dessert. No domain in human history has known such an emergence of new technologies as

digital today. It is the basis for the relentless work of thousands of ventures to explore business opportunities and to realize what seemed nonlogical or impossible only a decade ago. Fundamental work has been written about the technological and creative mechanisms of this phenomenon, but less about its business patterns. So, let us start our discussion via three powerful digital paradoxes that challenge the traditional way of doing business. The first one is the Software Paradox: There is a transition currently underway in the industry, one leading away from software as revenue and towards revenue using software. It is a paradox that the economic value of software is falling even while its strategic value rises. Software that would have once generated billions in revenue per quarter is increasingly made available for free. (Stepen O’Grady, The Software Paradox) Software is a key ingredient in most industries, but the willingness to pay for it has crashed. Software and online functionality have become a commodity: the digital commodity. The second paradox is the Strategy Paradox. It is about the blurring of strategic value propositions. A digital offering combines standardized scale and customized intimacy. The second paradox renders obsolete many of the traditional strategies to build and protect market share like going for cost or product leadership, offering customer solutions or acting as a central platform for other market providers. Whatever you intended road might be, you will finally end up with a direct confrontation with the other suppliers of your market. Deciding on strategy makes little difference: your efforts to find a shelled space for your digital business will be in vain. This fact is responsible for the uneasiness when the terms Digital Transformation or Disruption come to the table. Only speed to market and a better user experience offer a sustainable market position. The last paradox is about company valuation and relevant assets, the Valuation Paradox. A digital venture seems to be asset-less. The absence of traditional assets makes the assessment of venture a shaky endeavor. The real value resides in new types of assets, outside the traditional scope of accounting. The Valuation Paradox links the company success, measured by its valuation, with the efficient construction of those new digital types of assets. Throughout history, a few commodities were able to profoundly transform economy and society. Oil, electricity, steel and coal in modern times, money and paper from the 17th century, salt in the early Iron Age. Each one of them forced entrepreneurs to reinvent their business. Coal has a lot of calories per volume compared to wood, leading to high energy devices: machines. Money made capital mobile, triggering an explosion in investment and trade. Each commodity stood at the economic center of its time: they were economy-critical. Software is today’s economy-critical commodity. Through its main attributes – 24/7 availability, scalability and customer centricity – it is transforming the world. Each new critical commodity brings along two types of métier. The first one is the métier to produce it – efficiently and with quality – like the milling of steels, the drilling of oil, the issue of money. The second type of métier is about the exploitation of the commodity in the rest of the economy or, to say it with a modern term, about the disruption of industries: the engineering of steel mechanical systems, the development of petrochemical products, the

productization of financial services. In the second métier, the effect of the commodity on a certain industry takes central stage. The first type of métier of producing the digital resource, thus software code, is Software Engineering. It is about coding a digital functionality in time, within budget and with good quality. The second type about leveraging the commodity throughout industries is the Digital Métier. It is a new and expanding area of practice which is for most companies the single most critical domain to learn and master. The digital métier is characterized by the “Intimacy at Scale” paradigm. The paradigm introduces the two main tactics of the digital métier: Hyperscale and Microcare. Both tactics are a major insight of the reading. To be successful, the business needs to combine them and master their operations and metrics. The venture scaling stages or the what to do when The right timing is essential in business. Do the right thing at the right stage: too early is a waste of effort and money, too late a waste of opportunity. We will use tools to explain the stage based activity: the Pool Chair Curve and the Digital Stage Table. We will complete both tools with the digital métier elements as we move on through the book.

The “Pool Chair” Curve and the venture lifecycle stages: at the early stage the Microcare Tactic prevails, at a further stage the Hyperscale Tactic becomes dominant and finally in the scaling stage both tactics should be combined simultaneously. Digital sustainable organizations go on the journey without a lot of baggage. The old adage that strategy is about what you don’t do is true a hundred times over in the cluttered, crowded environment of the digital age. (The Korn Ferry Institute) In parallel, we will look at the impact of the above on the cultural DNA of the company in digital transition. It is not our focus as we are a team of engineering and business coaches without expertise in sociology or anthropology. However, we sense at our customers a strong push to shift to a kind of “nomadic clan” culture. In this view, a company could be seen as a tribe of loosely coupled clans which are moving throughout the business territory. The nomadic clan metaphor offers insight into the organizational needs of digital

entrepreneurship: a lean and agile progress, a shared customer focus instead of department silos, OPEX instead of CAPEX driven asset construction, a lower relevance of corporate brand marketing versus user experience, less market impact of intellectual property from central R&D. Ultimately, the emergence of internal ventures will force the company to transition its static Plan-Check management style into a more dynamic one. 247 TailorSteel and the Merge of Digital and Manufacturing 247 TailorSteel is a Dutch company that supplies tailored steel parts. Its value proposition is the fast service of delivering custom parts. A strong digital backbone enables this daring propostion. An online configurator informs the prospect real-time of price and delivery conditions. To enable this, the company developed an easy-to-use design interface (to specify the requested parts) for engineering customers. When the offer is accepted, the software sends the order to the mill shop and the goods are processed in a fully automated way: conveyed by AGV’s, prepared and milled by digitally controlled machines, and packaged for shipment. Once the order is ready, a human truck chauffeur is informed to pick and deliver the cargo. The whole operation is reduced to a few days or the time it takes for a traditional mill to respond with a quote. Is 247 TailorSteel a software company or a steel shop? And what if the company decides to focus on service and outsources the milling jobs to an ecosystem of partners? To put things in another light, what/who is the key staff in the company? The company is a hybrid business with aspects of a job shop, a traditional service and a digital service. For instance, a large part of its staff are engineers and coders. Which part of the business model is done by software and what was its role before? The scope of software did expand from supporting internal processes like ERP and automated routines for the milling machines to all aspects of the business: selling, design (in fact, outsourced to the customer), planning, logistics and production. What is the software’s impact on the company’s strategic positioning in the niche? 247 TailorSteel is a threat for its colleagues that offer custom-made solutions by its speed and cost efficiency. Compared to the efficient steel stockers (who offer little customization), it can leverage its customer intimacy and service. Finally, the company has the potential to become a platform for all kinds of metal job services, with a Customer lock-in strategy. The company doesn’t need to make a strategic choice as it can offer each of them by default. What is the growth story behind the company and which assets are core for this? It is likely that the company will invest in subsidiaries across the continent to leverage the digital infrastructure. In fact, except for language, the same interfaces and process automation are applicable in every country of the continent (using the metric system). The main asset to drive this growth model is the technology stack, the set of digital functionality that enables the business model. A second asset that drives growth throughout Europe is the company’s online presence. The new cohorts of customers’ engineers search online for better solutions.

The digital offering of 247 TailorSteel suits itself better for web marketing than the ones of traditional competition. Is this an example of industry disruption or transformation? To us, this question doesn’t matter. Judging the difference between disruption and transformation is often more based on perception than on reality. It is clear that the company leverages the digital resource, a commodity open to everyone in the niche, better than its colleagues and this upsets the balance in the industry. The 247 TailorSteel case is both relevant for manufacturing and software companies, because digital is always about blending two worlds: a digital service for the x industry. All the topics in the book can be viewed from the perspective of the application domain or industry and the perspective of the software provider. A digital business is a blend of two worlds. About what for whom With the traditional strategies no longer valid, you have no other choice as to win the race for a niche. Throughout the book, we don’t focus on the selection of an offering for a market, but on the how, by whom and when, after the decision about the product/market combination has been made. The book is about selecting the right business, but about executing it in the right way. The playing field of the digital métier is expanding at a steady state. The reason is the viral nature of the digital commodity resource. Every functionality it transforms becomes itself part of the commodity pool. In this commoditization process – powered by open-source software, public technology standards and cloud ecosystems – the “digitized” functionality loses its genuine, intellectual property-protected nature and becomes one more digital Lego brick. This is visible in the ongoing commoditization of hardware, with the Internet of Things wave where open-source software takes over part of the previous “hard-coded” device functionality. And on a larger scale in mechanical components, with the area of smart mechanics where “plug & play” based on public standards is the new mantra. Even evident in complete machines, with electrical cars and 3D printers, where cloud services become key in using and upgrading them. This means that a book about the exploitation of the digital commodity should be relevant for a lot of people in many industries. Especially entrepreneurs, and managers or engineers of industries in (or on the verge of) transformation are part of our focus audience. We start from the perspective of a software builder because it is a helpful way to grab the impact of the paradoxes. In a software product context, the three paradoxes are easy to understand. Gradually, we will expand our story to all kind of digital businesses, as the paradoxes, métiers and stage driven focus are relevant for all of them. The digital professionals of today should understand the difference between both métiers: writing good code, or Software Engineering, is a fundamentally different activity from exploiting the opportunities of the digital commodity to build valuable services, the Digital Métier. The engineers, experts and coders involved in both kind of métiers share, however,

the affinity with digital technology and the adherence to agile, test-driven progress. They staff the hero teams behind the development of a better fit business. Software geeks, data wizards and tech entrepreneurs are the new poster kids of the economy. The mojo of the nineties glitter boys and girls from finance and sales has not survived the last decade. Engineering is finally back. We first have to understand the commodity nature of software. Made visible by the increasing pressure on prices, software is omnipresent in daily life causing an explosion on the supply side. We can envision the defensive reactions against commoditization, such as more R&D investment and a larger IP portfolio, to explain their limited effect. Next, we describe some ways out, in a merge of software with other assets, such as hardware and data. Finally, we zoom in on the real challenge in dealing with the software paradox: creating a better business balance between value creation, delivery and capture.

2. The commodity driving growth The term commodity is specifically used for an economic good or service when the demand has no qualitative differentiation across a market. In other words, a commodity good or service has full or partial but substantial interchangeability, i.e. the market treats its products as (nearly) equivalent with no regard to whom produced them. Definition and examples of what commodities are and why investors care, Joshua Kennon. (Peter & Antoon 2018)

Our journey – Prelude Something strange is going on. We have a top team of software people to build solutions while the talent pool is tight. Hiring coders, programmers and IT experts is tough, really tough. Banks and investors are confident about their money (invested in our company) as the world is screaming for digital solutions. Sometimes it even looks as if digital is the only industry that matters. But this does not translate into figures we are hardly making money. For five years, our operational profits have been in decline. Is it just us or do colleagues encounter the same? For most industries, software offers major innovation possibilities and is a primary differentiator in its ability to create value in both physical products and intangible services. But things are not always as bright as they seem. The software industry is coming out of a Golden Age. The willingness to pay for the delivered value is low. Freely available software feels as natural as air to people. This is the paradox; software is everywhere and is the main key to success while at the same time, for a software-maker, getting paid has increasingly become difficult. Software on itself has become a commodity. And the production of a commodity resource tends to be consolidated in the hands of a limited number of companies. Similar changes have happened in the past with the commoditization of steel and oil. Innovations made possible by both resources, such as plastics and engines, have changed the way we live and work. Both the production of steel and oil got controlled by a few large enterprises and state-owned organizations. The major part of the industrial ecosystems was involved in engineering these commodities into the wonders of the 20th century such as cars, machines, airplanes and modern buildings.

We are in the middle of a similar evolution, however, taking place at an increased speed. Software functionality is commoditizing faster than steel and oil did and its engineering artefacts such as mobile apps and IoT devices are getting mature in a fraction of the time it took engines or plastics. From this comparison we can distill three conclusions. First, digital functionality will keep on commoditizing fast and its offering will be consolidated by a few large companies. Second, many businesses will emerge and develop new solutions and disrupt old traditions, based on the digital functionality offered by the first group of (large) companies. Third, making a living with coding technical functionality will become increasingly tough. The “Software engineering” companies risk becoming the artisanal steel mills of this era. This evolution requires a digital business to develop a new set of skills; instead of engineering a (functional) tool, digital service design takes central stage. This is the emerging domain of the digital métier and the main topic of the book. Software hosted in the cloud: Online consumed as a service What is the main force behind commoditization? It is about the diffusion of the know-how or intellectual capacity necessary to produce or acquire the resource efficiently. The know-how necessary to develop or produce a resource is often an industry barrier to entry. Reducing the barrier attracts new industry entrants, while applying pressure on prices and increasing industry competition (as explained by Michael Porter in his Five-Forces model). A pharma drug patent expiration is a good illustration of Porter’s model. New entrants bring an identical product to the market as a generic drug. The price of the drug will now drop with double-digit percentages. The diffusion of intellectual capacity to build software application is fundamentally linked to the development of the cloud economy. It is driven by the online availability of affordable, robust and easily connectable building bricks, namely API web services, Open-source software, and cloud infrastructure. API stands for Application Programming Interface and is today’s predominant method of connecting software code and building complete applications with a modular architecture. The rich API-economy of web services and the maturity of the cloud infrastructure have led to the default creation of good and robust software. The cloud drives software’s commoditization by making functionality online available “as a Service.” This “X as a Service” is no longer limited to Software, the X might be Infrastructure, Database, Artificial Intelligence, etc. It is a virtual marketplace where supply and demand find each other. Through the service model, core digital functionality such as memory capacity, communication bandwith and processing power is abundant and can be consumed online as needed. Each of these services are used as a utility: flexibly consumed, with a low cost threshold at the start and with robust quality. A steady stream of new offering in domains such as data analytics or Internet of Things expand the online service portfolio exponentially.

“There won’t be any one device that controls us in the future. Computing will be everywhere. The Cloud orchestrates that mobility.” – Satya Nadella, CEO of Microsoft Corporation.

The graph shows the number of digital product companies started per year in Belgium from 1980. Between 2010 and 2014, more new companies were established than in the previous 30 years. The chief cause is the lower barrier for small teams with limited budget to build qualitative, scalable application. The easy access to functionality and infrastructure explains the enormous supply side of digital solutions – tens of thousands of companies in Europe are building and promoting digital products on a global scale. The “- as a Service” evolution has led to the prevalence of access over ownership. Companies and consumers seem no longer interested in owning things. For the younger generation buying a car is no longer the answer to mobility; easy access to mobility services and peer sharing are more attractive. Just watch the compassionate look of your kids to the CD collection you built so carefully. Today, product ownership is less attractive than access to service. Software-on-a-server also called on-premise software is devoid of digital’s magical trio: availability, scalability and customer centricity. This kind of software, scoped for use at the company’s server park or on the consumer’s pc, sits on an island, without real-time access to outside applications, external scaling resources or the supplier’s services. So for our purposes, when we speak about software, we are referring to the “online” version, and when we speak about digital, the “functionality delivered through online software” is key. We will use online software and digital interchangeably throughout the rest of the book.

The societal and business impact of online software lies in its online availability, scalability and customer-centricity; it is turned into a service, accessed online and consumed and paid for on demand. Cloud infrastructure ensures the 24/7 access. It is the utility backbone for the digital resource. A brief history of software commoditization Software did not become a commodity overnight. In the 195s mainframes were the only available computers: large – some of them filling entire rooms – and expensive. As a result, corporations could not afford one computer per user and the concept of “time sharing” was born. As early as the 1970s, virtualization technology was developed allowing different workloads to run at the same time on a single computer without interference. By the 1990s, advances in telecommunication and the advent of the Internet resulted in users being able to run virtual workloads remotely, while telecoms offered ubiquitous broadband facilitating VPNs (Virtual Private Networks) to connect securely. In 1996, the term cloud computing was coined for the first time by Compaq. It would take 10 years, when Amazon launched its Elastic Compute Cloud for the term “Cloud” to enter the everyday vocabulary. With the launch of Amazon’s Elastic Compute Cloud (EC2) and Simple Storage Service (S3), the commoditization of hardware was a fact: for the first time in computing history, anybody could have computing power and storage at his or her disposal with no upfront costs. Need more processing power? Just add some extra virtual machines, and throw them away once you’re done, only paying for the actual usage. The basic building blocks of IT became commoditized: IaaS, or Infrastructure-as-a-Service, was born. It didn’t stop there: virtual machines and storage are not enough: one needs databases, queueing servers, mail servers, load balancers and other middleware for building and operating IT systems. It didn’t take long before players like Microsoft Azure and many others began to offer these too. MaaS, or Middleware-as-a-Service became a reality. The next logical step was PaaS, Platform-as-a-Service: players like Heroku made deploying and operating complex software products as easy as clicking a couple of commands. As a result, developing and operating software products were dramatically democratized. Software companies and IT departments no longer heavily invest in hardware infrastructure and expensive licenses for middleware, nor do thy require extensive knowledge of these systems in-house. Most can be offloaded to “the Cloud,” with dramatically lower investment and higher speed. While most IT organizations were impacted by the commoditization of hardware, storage, and middleware, end users soon felt the advantage. From 2010 onwards, more software became available in online, pay-as-you-go offers, making SaaS mainstream. Today, there are SaaS product is all major software categories like CRM, HRM, ERP, social media, gaming, etc… with fierce competition between players, effectively putting pressure on prices. Software became a true commodity for everyone. Oil and the American Century

Digital, the ecosystem of online software technologies, can be seen as this era’s new oil, driving progress in today’s economy. The analogy is not far-fetched, if we compare the role of oil in the economy of the 20th century versus the one of software in the 21st century. Standard Oil or the Worst Case Scenario for the Westcoast digital giants. Standard Oil, an American oil company established by John D. Rockefeller in 1870, came to dominate the oil products market. In 1904, Standard controlled 91 percent of production and 85 percent of final sales of refined oil flows in the US. In 1911, Standard Oil had to split, amon others into Exxon and Mobil, under the Sherman Antitrust Act. Oil drove growth in trade and industry after World War I when it became a cheap and abundant commodity. Since the early beginnings of the 20th century, rotary drilling and fractional distillation became state of the art. Oil and gas, and their derived petrochemicals, fueled economic and societal progress until the crisis of the 1970s. Oil related companies, first Standard Oil, later Exxon, GE, Shell and Dupont, dominated the stock market. The cheap, abundant and versatile nature of oil and its derivatives revolutionized industries: human transport with combustion engines for cars and jet engines for airplanes, logistics with diesel engines for cargo transport, agriculture with petrochemical fertilizers, product design and packaging with plastics, and construction with composite materials and gas heating.

The Y-axis ranks the profit (generated by Fortune 500 companies) contribution among sectors. The three critical commodities of the modern economy zig-zag towards the lead. In grey Financials, first developed as a commodity in the 17th century, in black Energy, with carbon fuels which emerged around 1900, and in blue (digital) Technology with its rise in the 1990s. From 2014, the traditional stock market champions à la GE and Exxon (adepts of the carbon fuel and financials commodity) are being overrun by the Amazons and Googles. Only a commodity can transform substantial parts of an economy. If the resources is expensive, exclusive, scarce or difficult to master, then it will only have a limited impact on the world beyond its original borders. Nuclear, for instance, never delivered its promise from

the 1950s as the main source of energy; it was too unwieldy to be commoditized. Digital disruption and digital transformation can be seen as the renewal of the world economy, the nth one on a list fueled by economy-critical commodities, starting with the salt trade in the Iron Age. The cheap digital resource is nest to cheap carbon energy and capital the main catalyst of this era’s economy. Digital’s role will further expand in the coming decades, probably at the expense both. This phenomenon has geopolitical impacts. Every commodity shaped its time and the power of who mastered it best: the London capital market fueled the heyday of the British empire, oil shaped the American century. Digital will turn the 21st century into the X era – with X potentially the American West Coast, or China. Time will tell which. Economic wealth, diplomatic power and cultural influence are closely linked with the ability of a nation to apply a new commodity to transform industries. Clearly, the US has taken the initial lead for the digital commodity. Once upon a time The business relevance of digital is good news for integrators which see opportunities in renewing a specific industry, but less so for artisanal manufacturers that produce the raw material, the software code. In analogy to steel or oil production, coding software became a price business characterized by oligopolies and competition from abroad. The suppliers of code feel the commoditization through the price they can demand for their work and the small margin left for them. Software development has become a tough business: it has a customer base spoiled by good and almost free applications. Software contractors & co LTD est. 1984 Not very long ago, in the late 1990s and early 2000s, the independent company, Software Contractors & Co., succeeded in building custom-made software solutions for local SMEs. Its team was able to build and deliver on time, within budget and with quality complex IT solutions tailored to the need of a specific customers’ business processes. Focusing on the SME niche gave them a sharp edge, allowing for a decent margin. The company steadily grew to a size of 30 people. After 2007, selling large IT projects became harder and harder. Increased competition led to low prices and thin or no margins. The company had to let go its last hired employees and looked for new business opportunities, outside software development. They moved to an Open-source and Cloud-hosted IT consultancy. Nowadays more than two-third of its revenues comes from consultancy and subscription reselling. One third of the turnover is still related to software projects. Most of these projects are existing customers’ integration projects. It remains a question if this activity will continue over time or just will fade out. All cases mentioned in the Once Upon a Time part throughout the book are based on coaching trajectories at Sirris clients. We anonymized the companies to respect confidentiality. The case of Software Contractors & C° is based on a Belgian SME, whom we have a longstanding relationship with.

Pricing is under pressure and will continue to be so Independent of a recurring subscription or one-time license model, we see a steady increase of the pressure on software prices over the last two decades. This is true for business solutions as in B2C. The average app price on the App store is $1.13; for games only $0.55. Good luck in keeping a medium-sized company afloat with this kind of pricing, minus VAT and a 30% distribution fee for the app-store owner. Profit margins at several major software companies have been under stress since the mid-1990s, as seen in the graph below detailing Microsoft.

In 2004, Michael Cusumano from the MIT Sloan School of Management had already identified in his book, The Business of Software, the pressure the software industry felt with product licenses versus service fees. Companies turned to services such as Maintenance and Support to counter the drop in license revenues.

What happened and how can this phenomenon be explained? The shift of the value-price-cost ratios in software business The price of a product or service sits somewhere between the cost to produce it by the supplier and the value for the customer. Below this cost, the supplier is no longer interested

to sell it. Above this value, the customer has no incentive to purchase it. The actual price settles in this range at a level dependent on many factors as explained in Porter’s Five forces model. Clean water is a critical product with a large value (our live depends on it), but we only pay a tiny part of this value to the water company, who has a tough job to deliver it to us in the right quality and quantity. In the desert we probably would be ready to pay a hundred times the price. Its value however did not change. But the willingness to pay a fair part of the customer value depends on the context of the customer and the supplier. At home it is a commodity, in the desert it isn’t. At home, we keep the value for us, in the desert we share it with the trader. Software used to be a lucrative business. Its value was perceived by the client as critical and difficult to realize. A large value part returned to the software supplier which resulted in a good price. Up until 2007, this provided a decent margin on top of costs. See Case A in figures.

Case A: profitability in the golden software age with margin (difference between customer value and supplier cost) shared equally between customer and supplier. Case B: price erosion due to commoditization; the margin between value and cost goes entirely to the customer. Today, the delivered value is still high, but the customer has no incentive to pay the price; the magic of software is lost due to commoditization (Case B). The entire margin between supplier cost and customer value is absorbed by the customer, leaving no margin for the supplier. The industry finally starts to adapt to low pricing, pushing down costs and surviving on thin margins. In essence, this is an issue of the supplier’s weak capture of both created and delivered value. Instead, the transferred value is almost completely captured by the customer.

The suppliers only captures a small part of value. Most of value is captured by the customer. If commoditization is a fact, with its downward push on prices and small slice of the value-cost margin earmarked for the supplier, what are the possible strategies for the supplier to rebuild his business margin? The two obvious ones are cutting costs and scaling in volume of customers: Total Business Margin = Number of Customers x (Deal Revenue -Deal Expenses) The deal revenue is fixed by the market and low, the two variables left in the formula above are number customers (volume) and deal expenses (cost). Going for scale and low cost, the strategy pioneered by low-budget airline carriers and retailers, is not an end-game solution for every digital company. Could we adopt a better strategy? Could the supplier capture a larger part of the value and regain profitability? The strategies that lead to better pricing, a higher value, and an improved cost structure are rooted in leverage digital game changers – not in traditional economies of scale or in better product design. The statement above touches on the essence of the digital economy. The traditional approach to build a successful business – producing a better product and/or distributing it with an economy of scale – are caught up by new kinds of drivers. The struggle of industry giants who dispatch top engineering teams and take advantage of scale in their fight with agile, small challengers is a visible sign of this evolution. The rest of the book will focus on building insight about this paradigm change.