Secrets of Software Success: Chapter 2007
January 16, 2007
Gareth Morgan, McKinsey & Co
Irish Software Association
Secrets of Software Success
• Quick overview of Global Software landscape
–Dimensions for key segments
• Macro-economic industry trends
• Traditional success factors in software industry
• Building blocks for successful software companies
in the future
• Open discussion
Although packaged software is the smallest revenue producer in
the high tech sector…
Share of revenue – all companies
$ Billions, percent CAGR
Percent
12/95-12/04
100% = $711bn 1,120 1,145 1,078 1,252 6%
Datacom and 22 17 17 2
26 23
Networking
17 18 11
13 13
Semiconductors 12
IT services* 12 19 22 24 22 14
Software 8
10 11 12 12 11
Hardware 42
35 32 30 31 3
12/1995 12/1999 12/2001 12/2003 12/2004
* Does not include internet software and services
Note: Adjusted for diversified companies, i.e., revenue for diversified companies has been allocated to different segments
Sources: Compustat; team analysis
…it has captured the largest share of market value
Share of high tech sector market cap (WW) – all companies
Market cap / CAGR
$ Billions, percent revenue Percent
12/2004 12/95-12/04
100% = $896bn 4,929 2,868 2,565 2,602 2.1 15
Datacom and 20 18 21 2.5 11
24
Networking 30
16 24 26 21 2.4 16
Semiconductors
18
IT services* 13 14
13 14 1.3 14
12
Software 26
28 28 5.0 14
26 27
Hardware 21 16 1.1 9
14 15 14
12/1995 12/1999 12/2001 12/2003 12/2004
* Does not include internet software and services
Note: IBM, HP & Compaq market capitalization distributed using aggregate sector multiples based on operating income
Sources: Compustat; team analysis
Focus of this
document
Defining the Software Industry landscape
Market size
$ Billion
Software North Functional Typical
category Worldwide America segments providers
Commercial $190bn* $47bn* • Enterprise SAP, Oracle
resale/packaged applications
software • Application tools Oracle, IBM
• System Microsoft, CA,
infrastructure Symantec
• Consumer Microsoft, Intuit
Internally NA $60bn** • Applications • Internal
developed • Embedded software
development
units
Custom (3rd NA $91bn** • Applications • IBM Global
party) developed • Application tools Services
• System • Accenture
infrastructure • EDS
• Infosys
* 2004 market size
** Based on North American estimates by U.S. Department of Commerce
Packaged software industry landscape by functionality WORLDWIDE
Market size in US$ Billions - 2004; 2004-09 CAGR in %
Applications ($91 bn, 6%)
Consumer Collaborative Content ERP and SCM CRM Engineering
Applications Applications applications operations applications applications applications
applications
$4 bn $4 bn $13 bn $46 bn $6 bn $8 bn $10 bn
(4%) 6% 7% 5% 6% 4% 6%
Tools ($44 bn, 7%)
Database Application Application life- Application Information Other
management development cycle deployment access and development
management delivery (BI/DW) tools
$8 bn
$20 bn $6 bn $2 bn $7 bn 8% $1 bn
7% 7% 9% 5% 3%
Infrastructure ($57 bn, 8%)
Systems and network Security software Storage software Networking software
management
$13 bn $9 bn $8 bn $2 bn
7% 12% 10% 2%
System software $25 bn 6%
Secrets of Software Success
• Quick overview of Global Software landscape
–Dimensions for key segments
• Macro-economic industry trends
• Traditional success factors in software industry
• Building blocks for successful software
companies in the future
• Open discussion
Macro-economic industry trends- observations
• Growth stabilizing; margins increasing
• Restructuring continues and investment
increases
• Both supply and demand continue
to globalize
Software industry is maturing with improved margins
and stabilizing sales growth
Percent
Revenue growth ** EBITA margins ***
3 year rolling average Aggregate
25 25
20 20
15 15
10 10
5 5
0 0
1995 1998 2001 2004 1995 1998 2001 2004
* CPC All SW Index : 274 companies in software industry with revenues > $0.1 Billion in at least one year during 92-05
** Revenue indices are adjusted for entry and exit
*** EBITA Margins are not adjusted for fair value of stock option expensing
Source: Corporate Performance Analysis Tool, McKinsey Corporate Performance Center analysis
Long term implied growth rates rank software near top of
industry sectors
Growth Expectations Next 10 years
Percent
Housing Construction $1 Billion in at least one year during 92-05 period
CPC Mid Software Index: 37 companies with revenues between $0.5 - $1 Billion in at least one year during 92-05
CPC Small Software Index: 188 companies with revenues between $0.1 - $0.5 Billion in at least one year during 92-05
** Revenue indices are adjusted for entry and exit
*** EBITA Margins are not adjusted for fair value of stock option expensing
Source: Corporate Performance Analysis Tool, McKinsey Corporate Performance Center analysis
Global software deal volume and values are growing steadily
M&A* Value of Deals Count of Deals
$ Billion Number
120 800
100 86
600
80
60 44 400
38 41
40 32
25 20 200
20 10 11 11
0 0
1997 1998 1999 2000 2001 2002 2003 2004 2005 2006*
PE & VC ** Value of Deals Count of Deals
$ Billion Number
30 800
600
20 17
400
10 8 7 7 8
6 200
4 3
1 2
0 0
1997 1998 1999 2000 2001 2002 2003 2004 2005 2006*
* Global Software Industry , ** United States and Europe , *** Through 11/1/2006
Source: Dealogic , Thomson Financial , Capital IQ
Software supply continues to globalize
2005 Distribution of Software Engineers 2005 Computer science graduates/year
Percent Thousand
India
19
50 51
Rest of
41 World
30
25
USA 21
19
Europe US India Japan China
Source: Ministry of Education in China; Ministry of Education in
Source: Evans Data Corporation, Bureau of Labor Statistics,
Japan; IDC, interviews; literature search; McKinsey
McKinsey estimate
analysis;
Software developer population expected to grow 46% CAGR to 17 million by 2009
Secrets of Software Success
• Quick overview of Global Software landscape
–Dimensions for key segments
• Macro-economic industry trends
• Traditional success factors in software industry
• Building blocks for successful software
companies in the future
• Open discussion
Traditional software premises and corresponding success
factors
Industry premises Success factors
• Revenue growth drives company • Build functional organizations to
valuation scale rapidly
• Product innovation enables • Focus R&D on new features,
growth functionality
• Time to market captures growth • Emphasize customer acquisition
over customer experience
Invest in people
• Select top people
Difference in productivity levels "It's better to wait for the productive programmer to
become available than to wait for the first available
Individual
programmer to become productive"
Steve McConnell
• Retain top people by any means (unusual measures
x 10 required: i.e., former Platinum CTO Popek allowed
star programmer to work from a mountain cabin and
even paid for the high-speed communication setup)
Average Top • Leverage top programmers through effective
Teams team setup (i.e., surgical team)
• Provide ergonomics and equipment
– Quiet offices (no cubicles!)
– 75% of the time: no interruptions
x5
x 10
– Fast workstations and network access
Average Top • Training programs
– 5 - 15 days per year internal training
– 1 - 4 paid external conferences
– Material for autodidactic training
Source: Steve McConnell: Rapid Development, Secrets of Software Success
Turnover management
Examples
• Large networking software company gives its
Retain key managers a system to track the “walk-away-value”
people selec- (i.e. the value of stock options an employee would
tively lose if he left now) for their employees on a daily
basis – if this value gets too low for key employees
managers can take counter measures
• At Compuware, CEO Peter Karmanos, introduced a
Successful “typical profile of a Compuware employee” based
Hire according
turnover on “Compuware values” to support recruiting –
to cultural fit
management since then turnover has decreased
"20% turnover
is not too bad
as it also has • CISCO introduced “fast start” a dedicated program
advantage of Bringing new to bring new hires up to speed including specialized
constant hires up to “facilities teams” for setting up the infrastructure
renewal" speed fast (e.g., fax, phone, mail) as well as sophisticated
systems of automated e-mails to managers to
remind them of their duties with new employees
Source: Secrets of Software Success
But the world has changed
• Growth constrained by macro- and
microeconomics
• Customers want improved experience, not just
innovation
• Global mobility of capital and talent straining
organizations
• Competition for software margins increasing,
both inside and outside industry
Tide is shifting from a story of “consolidation” to one of
“business model changes, innovation, and globalization”
What Software Topic Will Be Most In The News In The Next Year? 2005 survey
Percent of respondents 2006 survey
52
40
30
22
17
15
6 7 6
4
Consolidation Business model Innovation Globalization New devices
changes
Source: Sandhill’s Enterprise 2005, Enterprise 2006 Quicktally survey
Secrets of Software Success
• Quick overview of Global Software landscape
–Dimensions for key segments
• Macro-economic industry trends
• Traditional success factors in software industry
• Building blocks for successful software
companies in the future
• Open discussion
What will be the building blocks for successful software
companies?
Improve customer experience
1
Optimize software supply chain
2
Embrace new business model innovations
3
Adopt a productivity mindset
4
Manage ecosystem economics
5
1. Customer experience really does matter
Satisfaction with Software
Percent of respondents
Min Average Max
How to get started:
Satisfaction • Map total interaction
index*
22 29 43
• Isolate drivers of loyalty
Min Average Max
• Invest in customer
experience that delights
Recommendation
Index**
11 27 42
Based on surveys for 10 enterprise application providers
* Current implementers who definitely plan to re-implement
** Current implementers who recommend brand
Source: Yankee, 2004
Areas that must be worked to professionalize the Go To Market
approach
Consultative, value-based selling
Engaging in a continuous dialog about
creating and delivering value to customers
Channel and partner coverage
Increasing range of coverage models and
partnerships to reach more segments
Pricing architecture
Creating easy to use but robust pricing
models that capture value and drive use
Marketing effectiveness
Increasing brand awareness and relevance
across all important customer segments
Sales operations
Creating standard, efficient global processes to
support and monitor all sales activities
2. Optimize software supply chain
Software supply chain elements
Internal R&D
Software
Customer-developed components
supply chain
Global sourcing
Historically, R&D levels have not correlated well with growth
2000 revenue growth 2003 revenue growth
Percent Percent
200% 75%
150%
50%
100%
25%
R2 = 0.00
50% R2 = 0.03
0%
0%
-50% -25%
0% 10% 20% 30% 0% 10% 20% 30%
1998 R&D/revenue percent 2001 R&D/revenue percent
Incorporate customer-developed components into your
products
Software investment by type
Percent; $ billions
100% = $147 $191
Software developed internally by end-user
customers (e.g., Ford’s software unit)
31
42
Custom software developed by third-party
vendors (e.g., IBM, Infosys, etc.)
37
30
Prepackaged software purchased from software
vendors 32 28
1998 2003
New software players within emerging markets
PRC ONLY
Software Engineers
FTEs
Huawei 8,000
UFIDA
5,000
(ISV)
Kingdee 3,200
(ISV)
Changhong
Electric 1,000
Beijing
500
Founder
Guangzhou
150
Haige (ISV)
* Footnote
Source: Ministry of Information Industry (PRC)
Source: Source
3. New platforms will become more important growth drivers
Total value Total SW Growth rate
Software content (HW+SW) market %
Platform
% $ bn, 2003 $ bn
Servers 65-70
65 164 115 5-7
Traditional
PCs 1515-20 218 40 5-7
Storage 1515-20 37 6 10
Industrial
automation 15 15-20 58 10 7
Emerging/embedded
PDAs/ mobile
10 10 82 8 25
Automotive 1 1.0
0.05 0.10 0.15 0.20 0.25 0.30 0.35 0.40 0.45 0.50 0.55 0.60 0.65 0.70 0.75 0.80 0.85 0.90 0.95 1.00
Software and services Accenture
Labor productivity, 2004 PeopleSoft
Siebel
SAP
237
Oracle Microsoft
Adobe Electronic Arts
152
130
Number of 102
companies 52 48
29
14 12 10 2 2 8 2 1 4 3 0 1 1 10
$mn/FTE
0.00 - 0.05 - 0.10 - 0.15 - 0.20 - 0.25 - 0.30 - 0.35 - 0.40 - 0.45 - 0.50 - 0.55 - 0.60 - 0.65 - 0.70 - 0.75 - 0.80 - 0.85 - 0.90 - 0.95 - > 1.0
0.05 0.10 0.15 0.20 0.25 0.30 0.35 0.40 0.45 0.50 0.55 0.60 0.65 0.70 0.75 0.80 0.85 0.90 0.95 1.00
Sources: Compustat; Global Vantage; Hoovers; team analysis
Need to optimize collaboration grows as interactions increase
Increasing interaction volume Solution: structured networks
1998 2006
From To
2B per 20B per
day day
E-mail 10x
1M 100M
Messaging users 100x users
Measure your network
Almost half of managers are • Cohesion – 2.5
interrupted roughly every 10 minutes
• Density – 50%
• Centrality – 2.3
5. Ecosystems must be managed to capture maximum value
Estimated profits in desktop IT
80
30
Operating profit
Percent
20
10
0
0 100
Other components Personal Operating Peripherals
Microprocessors computers systems
Services
Share of industry revenue Application software
Percent
Source: McKinsey analysis
Future software company operating model?
Percent of revenue Assumption ILLUSTRATIVE
• Lower cost of delivery (more electronic)
COGS / • More self-diagnosis, automated monitoring lowers
OCOGS 29 27 cost of delivering support
• Faster, leaner development and testing cycles
R&D 11
12 carried out partially with outside communities
• Simplified SaaS pricing models and more
SG&A 34 use of distribution lowers selling costs across the
35 board
• High single digit growth predictions come true
28
• Price pressure remains limited in enterprise
EBITDA 24 segments
Today Future
Contact Information
Gareth Morgan
High Tech and Telecom Engagement Manager, McKinsey
Dublin
Direct 01- 405 2431
Gareth_Morgan@McKinsey.com