Most of us in the technology business are used to jargon, and those of us with an MBA degree are trained to employ a lot of them as part of our daily vocabulary. So it is no surprise that technology professionals use the concept of competitive differentiation extensively, especially when describing how a company or product will sustain itself, and grow, in a competitive environment. But I have often wondered if there are a set of categories that describe different software businesses. My main motivation in doing so is to develop a better understanding of winning strategies in each category which will allow technology practitioners to better position their products for success by adapting these strategies to meet their unique needs and circumstances.
So I took a stab and came up with three categories that collectively span most software businesses I know of but it is possible I missed one or more categories. I welcome comments and feedback from readers to augment and refine my thinking. Also, like most things in life, there is usually more than one reason for the success of a company but my goal with this post was to identify and focus on the key factors only.
Competitive Differentiation Categories in Software Businesses:
1. Intellectual Property (IP): Almost all of us have experienced the power of IP when we view search results in Google and recognize the significant difference between search results presented by Google relative to competition. But what is the definition of IP? I define IP as software assets built upon fundamental research or significant improvements to existing research. Algorithms are perhaps the best example of IP. For instance Google's PageRank algorithm to improve search results or the PatchMatch algorithm employed in Adobe's Photoshop CS5 ContentAware Fill feature. Often times people interchangeably use the words IP and patents but, in my mind, there is a clear distinction between the two. Patents act as legal vehicles to protect IP but there are lots of patents that qualify more as business model or usability improvements. Such patents do not qualify in the IP category defined here. An example of this is Amazon's well-known one-click buying technique. Typically IP businesses disproportionately invest in R&D relative to other OPEX categories and employ researchers (those with advanced degrees such as PhD in particular disciplines) to maintain their product differentiation.
2. Go-to-market (GTM): Those who work in large enterprise software companies probably know quite well what I mean by GTM businesses. There are businesses that thrive because they have an army of field sales reps whose job is to 'cultivate and harvest' relationships with CXO-level buyers. The number of CXO-level buyers is finite and these buyers have a finite amount of time available which is extremely precious as a large number of companies are interested in it. Eventually, companies that have fostered strong relationships over a period of time have an upper-hand as they have direct access to the decision makers. While there is tremendous amount of effort put in by companies to develop innovative software that addresses customer pain points, product alone doesn't guarantee success. Winning formula in this category consists of sales competence. For example, let's take a look at Oracle's growth strategy over the past several years. Aggressive expansion into various enterprise software segments, and now hardware with Sun Microsystems acquisition, is built on a winning GTM model that pushes more products to pretty much the same set of CXO-level buyers. One of the big advantages of this model is economies of scale and scope in the sales organization as Oracle continuously improves sales force productivity (revenue per sales rep) by adding new products to the mix while marginally augmenting product expertise (sales engineers, specialists, etc.) in the sales organization. And doing all of this while continuing to target the same set of customers. Interestingly Oracle's advertising campaign provides some facts about its hold on large corporations across the world (here's an example of a campaign that claims 98% of global Fortune 500 companies use Oracle products). Typically GTM businesses disproportionately invest in sales relative to other OPEX categories and the sales organization tends to be very powerful in terms of its influence on the product and engineering organizations.
3. Usability: The past few years have witnessed an emergence of a new category. Companies in this category have literally reset customer expectations in terms of user experience. For these companies the biggest product feature, and biggest differentiator, is the simplicity of product design (i.e., easy-to-learn and easy-to-use). For these companies less number of features equates to more value to customers. Design is not an after-thought but the most important attribute. Any feature that has the potential of complicating the user experience is kept out until such time that it can be implemented in a simple and elegant way that would delight the customer. There are plenty of examples of companies in this category but to name a few, take for instance the hosted project management app from BaseCamp, hosted invoicing app from FreshBooks, hosted file backup and sync app from Dropbox, or the smart phone & tablet content and notes tracking and storage app from Evernote. The beauty - and challenge - of this category is that unlike other categories there is literally zero barriers to entry. You could literally start a company with a handful of developers and deliver a product in a few months that matches the feature set of the incumbent. However, delivering on the user experience is the real challenge (...unless of course if you decide to completely rip-off the design). In my observation, companies in this category are usually not inventing new products that create new software segments but instead are dramatically simplifying the user experience for a software product that already exists. The winning formula in this category consists of a disciplined approach to solving a narrower set of problem(s) which allows companies to really hone in on the use-case and design the best user experience around it.
But what about hybrid competitive differentiation strategies, i.e., companies that mix two or more categories in a way where they are good enough across multiple categories. My observation is that these companies never rise to become market leaders in their respective categories, which is a big issue in software business. This is because most software markets exhibit "winner-takes-most" or "winner-takes-all" phenomena where majority of the profits are captured by the market leader.
Do you have other examples to share for the aforementioned categories? Are there software products that don't fit any of these three categories and hence warrant an additional category? Clearly, I left out hardware-plus-software products but my goal, for now, was to focus on software products only. Separately, what tactics should new entrants employ to compete against incumbents in each of these categories? Maybe that is a great topic for my next post :)
