Are Small and Medium Businesses really demanding cheaper software?

Paan-wala represents a growing breed of entrepreneurs in India, who are run traditionally “low-tech” businesses, but want to jump to the hi-tech bandwagon to explore markets (Photo courtesy: Shamili, Wikipedia commons)

Over the weekend, the guy that runs my neighborhood paan-shop said to me – “Kya IBM mujhe mera paan internet pe bechne dega?” (Will IBM help me sell my paan over the internet?) Someone had just told him about www.muchhadpaan.com and knowing that I work at IBM, he believed I could help him test the internet for boosting his sales. He even offered to pay me 30% of his profits if we enabled him to sell his paan online. This paan-wala represents a growing breed of entrepreneurs in India, who are run traditionally “low-tech” businesses, but want to jump to the hi-tech bandwagon to explore markets that they have never explored and scale to levels that they have only dreamt of reaching. And they are willing to pay those that help them achieve their dreams.

This segment of entrepreneurs combined with 8 million small and medium businesses of which only about 400,000 have a website, makes for an attractive customer group. The opportunity exists in growing markets across the world and several software vendors are moving focus on maximizing their revenues from countries like Brazil, India, Russia, and China.

But selling software means understanding not only the technical needs of the customers in those regions, but also the environment in which those customers do business. Many of these countries have fairly pathetic track records of controlling software piracy. Language, infrastructure (for example, bandwidth and network latency) and the skills of a typical operator are all determining the viability of software in these new markets. Having said that, governments are now warming up to what one would call “reasonable” anti-piracy laws. And software engineers are finding creative solutions to making their software more resilient in harsher infrastructure and more usable to so lesser skilled operator.

There is also the challenge of ‘size’ that software companies are facing in these new markets. While enough has been said about the potential of emerging geographies, and estimated growth of their economies in the coming decades, the reality today is that most of the individual businesses in these countries are small to medium by revenue size. Only recently have they tasted significant economic success and have started dreaming of expanding their horizons in this increasingly flat world. However, their pockets are not necessarily very deep and they are traditionally averse to spending big on software and services. (Maybe they are just used to having easy access to pirated software?) This presents an interesting pricing problem for software vendors. And here’s why:

Software is, in most cases, priced on a cost based model. Product managers create business plans aimed at quickest return on the investment made to develop the software. This approach often leads to flat, tiered or user based models. While each of these models differs from each other, they are all tied to the cost of development and the vendor’s view of the value that the software provides. As a result, when the customer is willing to pay only a fraction of the price of the software, the vendor has to choose between offering heavy discounts or providing “less” software. While discounts as deep at 90% off the list price are not unheard of in this industry, this approach obviously eats into the vendor’s profit margins and hence is not a viable longer term strategy. So many vendors, such as Microsoft are introducing “Lite” versions of their software, with lesser features/ functions and at lower price points.

While “lesser software for lesser price” seems like a perfectly logical approach, one needs to consider what the customer is looking to achieve by using this software. The small and medium businesses that I talked about earlier are looking to leverage the latest in information technology to leapfrog their bigger, more established competitors across the world. For example, Alibaba has leveraged the latest online platforms to grow rapidly over the past few years and become China’s leading internet company. With the penetration of smartphones, social media and cloud based technologies; small family owned businesses are able to reach consumers in every part of the world. These businesses want to build on top of internet based platforms to provide the best product, service and client experience that they possibly can, for their customers. To do so, they need the latest and best software technologies and “lesser” is just not good enough.

Software vendors need to think about “outcome” based pricing that allows their customers to pay them a portion of the value realized from the software. In other words, the software is priced based on the value, as seen from the customer’s perspective. In this model, the vendor becomes a partner in their client’s success and potentially stands to gain much more than the flat price of software. IBM did this very successfully when it struck a strategic outcome based deal with what was then an upcoming telecom provider in India. In the 10 years since that deal, the customer has grown to become one the world’s largest telecom provider, and IBM has benefited significantly and directly from that growth.

So why aren't more vendors following the outcome based model? Well, some of the smaller, newer and bolder companies are indeed adopting it quite successfully. The more established vendors are not structured to embrace this model and are stumbling their way to meet the need of the markets. The traditional incentive structures for sales organizations are based on booking up-front revenue. In the outcome based model, the revenue is realized over a period of time, and is dependent on the success of the client’s business. Also, some CFO'S don’t like the uncertainty of the revenue associated with such pricing models. So, the cost based models that sales teams understand and the CFO can rely on, continue to be pushed, even if it means discounting the software by 90% to meet the price point that the client can afford, today.

In the end, markets define vendor behavior and those vendors that evolve their sales structures and with them, their pricing models, are likely to grow in these “growth market”, and the rest will see their profits impacted over the longer term.

By Vishal Kamat, Strategy Lead, India Software Lab, IBM India.

The thoughts and opinions shared here are of the author.