Death and Taxes

In the past few entries, I've taken a look at various ways to distribute software; so far we've mentioned two. The first is retail sales, where software is burned onto a CD, put in a cardboard box, shrink-wrapped in cellophane and shipped to brick-and-mortar shops around the world so that users can walk in and buy their copy. The second is hardware bundling; software that comes with a computer, whether the computer is sold by the same company that made the software (as in the case of Apple) or by someone else who pays the software vendor in order to bundle the software (as in the case of Microsoft and most computer makers like Dell, Acer and Toshiba). Hardware bundling is usually called OEM sales (OEM stands for Original Equipment manufacturer, a fancy name for a company that makes computers).

Another way of selling and distributing software is selling directly to businesses. Business sales can be a very effective way of selling software, and businesses are one of the biggest consumers of software. Business sales have none of the disadvantages of retail sales, since you usually sell directly to your clients without messing around with a middleman.

The most important differentiator of business sales is that businesses have a better understanding of the value proposition of buying software. Most businesses have an IT department that deals with hardware as a commodity and purchases software in bulk to deploy to all its users.

Software that tends to be sold this way falls into three categories: Generic user software (some of it not at all specific to business), business-specific user software and server software.

Generic software sold to business is usually of the same kind that is bundled with hardware: Operating systems (e.g. Microsoft Windows), office suites (Microsoft Office), security software (e.g. Norton Anti-Virus). Although business sales of this software is usually unbundled from the hardware purchase, it is still essentially the same business model; business buy this software because it is considered essential for the use of the computers they buy. Even though businesses tend to pay for the software directly rather than having it bundled into the price of a hardware purchase, it's usually the same software that comes bundled with a computer sold to consumers.

The business model for these kinds of sales is similar, or at least complimentary, to hardware bundling. The same network effects we talked about last time are used to great effect to create market lock-in and protect incumbent monopolies. In Microsoft's case, this phenomenon is often dubbed "the Microsoft Tax", since if you want to go into business today, you have little practical choice but to pay some money to Microsoft for, at the very least, a Windows license and an Office license.

The network effects work slightly differently for business sales. Remember that network effects mean that the value of a product increases with the number of other people using it. Since business sales are by nature bulk sales, software vendors that try to challenge entrenched players have an advantage when selling to business, since they don't have to make that first, almost impossible, sale. For example, if I was selling a competitor to Microsoft Word, compatibility would be less of an issue for potential clients since all of their computers would switch to my software, and hence have no compatibility issues when exchanging documents between themselves.

So, if you're the new kid on the software block, selling to business is easier than selling to consumers; you don't have to bother with the logistics and questionable value proposition of retail sales, and you don't need the sales clout to strike a distribution deal with an OEM. Other network effects come into play here, however: My Word-competitor example above falls apart when you want to send a document to another company that still uses Word. The costs of dealing with such incompatibilities is potentially much bigger for businesses than it is for consumers, and then you have to deal with the fact that businesses, especially large ones, tend to go with safe, well-established options when they procure anything.

It is not surprising, then, that the same products and companies that dominate the OEM market also dominate the business market - these days that's mostly limited to Microsoft and Symantec (we will be dealing with the whole security software fiasco in an upcoming post). Microsoft's domination of the operating system and office suite markets is more complete in the business space than it is in the consumer space.

So, the dynamics and pricing structures may be slightly different in the business space, but in the end this market is the same as the OEM licensing (hardware bundling) game. In fact, especially in the case of Microsoft, a monopoly in the consumer space reinforces the monopoly in the business space and vice versa; you use Windows at home because you use it at work; companies use Windows at work because people are used to it from their home computers.

In the next couple of posts, I will be looking at business-specific software vendors, such as Adobe, and server-side vendors such as SAP and Oracle, and how their business models differ.

Next Post: Divide By Zero