| Much of my consulting practice centers on working | | | | those companies which aren't direct-only, distribution is |
| with early stage software companies. But I have | | | | similar for hardware and software companies. |
| substantial hardware market experience in my | | | | Traditional distribution through third parties tends to be |
| background, and I do take on consulting assignments | | | | very similar, although higher inventory costs are still a |
| with hardware companies. | | | | burden that hardware companies need to manage |
| So what are the differences and similarities between | | | | more closely, both for in-house finished goods and |
| successful software and hardware businesses? | | | | those held by the channel. |
| CAPITAL REQUIREMENTS | | | | DEFENSIBLE STRATEGIC ADVANTAGE |
| One of the larger differences is that software | | | | This is an area in which software and hardware |
| companies generally require much lower capital to | | | | markets have both similarities and large differences. |
| reach profitability and continued growth. This is primarily | | | | Both hardware and software companies value |
| because of the lack of need to invest in expensive | | | | patents as a form of providing a sustainable |
| semiconductor development tools, semiconductor | | | | competitive advantage. But in my opinion, the inherent |
| masks, manufacturing plants/equipment, manufacturing | | | | malleability of software makes patent protection less |
| engineering personnel, unfinished goods inventory, | | | | useful in software than in hardware. It is easier to "find |
| higher cost of finished goods inventory, etc. So except | | | | another way" of accomplishing the same end result |
| for startups backed by substantial institutional capital, | | | | when you are dealing strictly in software code. It's also |
| it's much easier to startup software companies | | | | easier to segment in software markets, creating a |
| compared to their hardware counterparts. | | | | targeted, niche version of a software product for a |
| MARGINS | | | | specific segment, nipping at a market leader without |
| Another important area where software companies | | | | drawing their fire. It's much harder for a small hardware |
| have an advantage is in margins—both in the | | | | company to differentiate itself this way. On the other |
| area of typical gross margins, as well as the potential | | | | hand, the market leader that establishes itself and |
| for higher net margins. This is primarily due to the | | | | creates a large volume business, creates the important |
| negligible cost-of-goods-sold for most software | | | | competitive advantages—cost efficiencies and |
| companies.As a result, it easier for software | | | | brand recognition are the huge, defensible advantages. |
| companies to get to profitability, and if a large market | | | | So I believe this point comes down to scale—in |
| is found, sustain profitability. Remember, throughout this | | | | software markets, it's easier for a small competitor to |
| article I am talking "on average". There are hardware | | | | overcome the scale of larger competitors, and |
| businesses with excellent gross margins (dominant | | | | develop a niche strategic advantage. While in |
| semiconductor companies come to mind) as well. But | | | | hardware, the large competitors can use scale to |
| in general, this is an area where the advantage goes | | | | create the ultimate competitive advantage. |
| to software. | | | | LOCALIZATION REQUIREMENTS |
| PRICING | | | | This is an area in which hardware companies normally |
| The big difference here also is related to product cost. | | | | have an advantage. They usually have simpler user |
| The major difference comes down to product cost, | | | | interfaces, and sometimes utilize symbols extensively |
| which in the long run creates a floor for anyone who | | | | in their interfaces, greatly reducing translation |
| would actually like to make a profit. While optimal | | | | requirements into local languages. Hardware |
| pricing of hardware or software should be based upon | | | | companies do have to deal with some physical |
| a value-based approach—with market | | | | differences in standards, such as electrical—but |
| segmentation as the key However, I rarely find this to | | | | these have stabilized over time, and are often handled |
| be the case in my consulting practice—whether | | | | in the standard product. |
| the company markets a software or hardware | | | | Conversely, software user interfaces are usually |
| product. | | | | language intensive and more complex, with thicker |
| In the hardware business, you tend to see a lot of | | | | user manuals. This requires software companies to live |
| simple pricing models that are cost-based. For | | | | with higher localization costs and longer lead times to |
| software businesses, the negligible product cost can | | | | market worldwide. The exception to this is complex |
| be the other end of the proverbial double-edge sward | | | | software sold to highly technical users, where English is |
| when it comes to pricing. In a competitive market, you | | | | often used as the standard language. |
| may see competitors in software markets literally | | | | POTENTIAL FOR DOMINANCE |
| "give away" the initial product, and rely on the upgrade | | | | I'm going by mostly by empirical evidence here. It |
| stream to make a profit downstream. This can strain | | | | seems that there have been a lot more hardware |
| the profitability of the entire segment, and in severe | | | | companies who have dominated there respective |
| circumstances, can suck all the profit from the market. | | | | businesses, for a longer period of time than in |
| You see this scenario most often started by weaker | | | | software. For every Microsoft (and there's really only |
| competitors, or in markets where switching costs are | | | | one of those!) it seems there are many more |
| high. While hardware pricing can be even more | | | | examples like Intel, Cisco, IBM, HP, Dell, etc. Hardware |
| competitive generally, it is less likely for a weaker | | | | markets tend to commoditize more easily, but with |
| competitor in a hardware market to introduce a | | | | standardization on a couple of leading brands. It's hard |
| "zero-margin" program. This is because it is often | | | | to make money in the long run in hardware unless you |
| tougher to hang onto a customer in the second | | | | are one of the top two or three players. Large |
| generation (if the market has commoditized), and the | | | | hardware markets are also relatively larger in revenue |
| market leader often has a gross margin | | | | than large software markets, allowing market leaders |
| advantage—making it an ill advised maneuver | | | | to more fully utilize their profit and cost advantages |
| other than as an attention-getting, short-term | | | | over competitors, by spreading marketing costs over |
| promotion. | | | | large product volumes. So if you're looking to build a |
| DISTRIBUTION | | | | truly dominant company, the odds are greater in |
| The advent of the Internet has created a major | | | | hardware—although you probably are still better |
| difference in distribution between software and | | | | off heading to Las Vegas, and putting your life savings |
| hardware companies, where there was very little | | | | on roulette red! |
| difference in the past. It has made direct distribution | | | | There are many more ways to contrast and compare |
| much more practical for small software companies, in | | | | hardware and software companies, but I will end it |
| markets where a simple download is practical. For | | | | here. What other points would you add? |