Monday, June 19, 2006

The flaw in the Software Services Business Model

Robert X. Cringely writes:

"IBM is a disaster-in-the-making. Big Blue as a total enterprise is running primarily on customer inertia and clever advertising, which definitely isn't enough.

One aspect of IBM's malaise is the disconnect between the traditional public image of the company (basic research, advanced R&D, patents, patents, patents) and the fact that most of their revenue-generating businesses aren't about hardware or software products at all, but services. Why continue to spend all that money if you're mainly just a business/IT consulting company made up of IGS and Price Waterhouse? Why, indeed.Here's what's happening with IBM. The heart of a company culture can be discovered if you look at the compensation system. IBM's major incentives right now are for signing business and cutting costs. In many IT firms, IBM included, billable hours are important. This results in a system where little is done to improve service efficiency, because doing so would lead to fewer hours and less revenue. Efficiency kills, so at today's IBM it is generally avoided.

The result is that an increasing number of customers are unhappy with IBM, signings are harder, so there is less return business. To get that signing incentive, IBM's sales folks are now under-pricing deals. The people who do the actual work are still expected to show a profit though, even if one wasn't designed into the contract in the first place. So to still be profitable, they under-deliver on the contract, and this leads to an even lower quality of service. What I am describing is a death spiral that top IBM management either doesn't see or simply doesn't want to admit."

IMHO: Hit the nail right on the head there. But this the case with almost every Software Services firm. The flaw is in the business model, where the charge is by time, and not by the result of that time spent. More the time spent on doing the little bit allocated to you, more is the money you make. Of course it needs a certain bit of naivete in the customer community as well for this model to work, and whatever else they may be, enterprise customers are not naive. So, how come it is working? Because the costs are low, and the quality is higher than what one intuitively expects for that cost. At least in the offshoring scenario. I am talking about the direct, visible costs here. Because, my hypothesis is that opportunity cost of the time and effort of the client is seldom taken into account. Truth be told, I have a feeling, the cost would still be comparable to nearshoring.

While offshore vendors have invested in getting certifications galore, like CMMi and ISO and what not, the hazard still remains that quality/ efficiency/ productivity will always be second rung to billable time/ loading factor. The alternative is the Fixed Bid model, followed by pioneers like GE, in which the incentive shifts back to the vendor to deliver efficiently to derive greater returns. One surmises that the number of such engagements should increase over time. Time to beef up estimation expertise as well for offshore vendors who severly lack it, but that is a story for another day....

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