Don’t Fool Yourself – What Type of Software Company Are You Actually Running?

Fork In the Road Picture

A common question I receive from people I have recently met or friends that are stepping into software is how they should look at their business. Not too long ago, a close friend repeated this same question to me.

Many people think of software companies as the ones they read about in popular articles. The reality is that there are different elements to balance within software companies and how you operate them varies. My guidance usually starts with a return question – do you know what type of software company you are actually running? Here is a short version of my response to encourage my friend’s thinking:

Software Innovation Business

This is the one that many of your friends think you do all day – lots of bean bag chairs, foosball and Beer Keg Friday’s – all centered on the startup mentality of, “How are you putting a dent in the universe?”

Unfortunately, like many early business ventures, the vast majority never meet expectations and often fail. Most software business models are extremely heavy on Research and Development before a single dollar of revenue comes in.

If the founders have not figured out exactly what it takes to get to break even, much of their efforts are spent on just getting to the next funding raise and potentially taking a radical turn in their business focus in order to get there. Even after the software is “ready,” the organization must invest in a successful Sales & Marketing strategy.

If you are in an industry where sales cycles are short enough, you have hopefully settled into the right balance between tech and client benefits. If you are efficiently selling your products, while making sufficient money on the project delivery, you may make it through to the next round.

Execute this same process enough times and you will get better, eventually transitioning into funding rounds that are less about survival and more about pace and expansion.

How should you think about it: Think of this as an “Entrepreneur’s Game;” you spend the money on R&D and Sales and Marketing in hopes of attracting clients. Your license revenue is your main source of revenue and you are massively investing upfront. Hopefully, the product is a hit and you make tons of money.

How should you look at running this business: Like an experienced gambler. You need to know your odds of success and only bet heavy when you know you have a high chance of winning. If you’re unsure, bet safely, and immediately leave when you have a losing hand (this is where most companies lose their lunch money as they heavily bet when they have a losing hand).

Monitoring profitability: Most want 50% margins on the sale (license minus third party costs minus Sales & Marketing) to pay for the upfront R&D investment. I would personally spend more on Sales and Marketing if you are obtaining a responsible return. This model is all about iterating through a better product and even happier paying clients.

Service Business

This is typically known as a Software Systems Integrator; you need to be very technical, often employing many coders that must make other people’s software work well together. This model requires you to be the main advocate for the client when pulling the solution together, but often you won’t be in control of much.

How should you think about it: Like a waitress at a restaurant. You many not cook the food but your service is what most people remember. If the food is horrible you take the heat, but if things are great they will want to be back at your table next time. Implementation service is what you are initially focused on but this will eventually include future consulting, custom programming, ongoing training, and other services your clients are happy to pay you for.

How should you look at running this business: Like a retail logistics analyst. There are many moving parts and low margins that need to be carefully managed. These engagements are not a sales call, they are a knowledge transfer effort; you want to get in, get the job done with high satisfaction and get out. Get paid for as much of what you do, don’t do what you don’t get paid for. Try to balance your people’s pay with your billable service rates. Your service manager here is key; they will live through managing many people and every exception in their day is usually negative. Managers should achieve average utilization rates of their employees (including vacations and sick days) of 70% billable hours. That means no messing around. Don’t staff up too quickly and look into creating an incentive plan that has your staff in the field well-aligned with your company values.

Monitoring profitability: 2:1 ratio of net billable revenue minus all the costs to deliver. Every month. Custom programming can usually be done more efficiently. Hourly ad hoc training barely covers its costs. Services that require travel quickly burn out your staff. If you can, get paid for travel. You want full days of billings, so it is even better to do full weeks. You will find that staff utilization is key. Study when you must do non-billable work to fix something else – it will highlight where you have problems in your process.

Software Maintenance Business

This, in many ways, can be the ultimate business – but a business can quickly disappear if not nurtured and invested properly.

How should you think about it: Like you were gifted a rare painting that needs constant care. You can’t take it for granted or else it falls apart, but you want to maintain it in a manner that only those who want to enjoy it would appreciate. If you can limp through the other businesses without killing yourself, this can be your crown jewel. Hopefully, at this point, the reality is that you have a popular and widely used product. You should be able to scale better than your marketplace competitors. Only if you fall asleep at the wheel should you not be able to turn a sustainable profit while making your clients very happy.

How should you look at running this business: Like a husband whose in-laws didn’t think were good enough for their daughter. You need to prove yourself every year. You want to get closer to your client’s business more over time. Ideally, you know their business as well as them and have your product support them as they grow. Study the support process for all your client’s issues (support tickets), and generate new ideas for other products in your software business. You want to obsess over losing any client; all signs of client activity, good and bad, can be felt here.

Monitoring profitability: Ask yourself: How much am I spending to acquire the next client? How much am I spending to satisfy existing clients? Why would anyone stop using this product? Is it still as valuable to my clients as it was last year? What about next year? Those answers will take care of the profitability.

Know What You Really Are

You will rarely have exclusively one of these three styles. You will often have a combination of the above, although never in perfect balance. It will change annually and will be based on the maturity of your product, as well as the type of clients you have.

Know what type of software company you actually have and manage it in the most effective long-term strategy. Click To Tweet

The key is to know what type(s) of software company you actually have and learn to manage that style in the most effective long-term strategy.

Good luck,
Mike

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