I consult, write, and speak on running better technology businesses (tech firms and IT captives) and the things that make it possible: good governance behaviors (activist investing in IT), what matters most (results, not effort), how we organize (restructure from the technologically abstract to the business concrete), how we execute and manage (replacing industrial with professional), how we plan (debunking the myth of control), and how we pay the bills (capital-intensive financing and budgeting in an agile world). I am increasingly interested in robustness over optimization.

Tuesday, June 30, 2015

Without the Right Capital Structure, There is no Software Company Within

Is every company destined to be a software company? From a production perspective, there's reason to believe so: relatively minor things that were once the domain of hardware (configuration set by switches on a circuit board), operations (merchandise re-ordering based on sales and quantities) or subscription (license fees paid for usage) have become things that are now the domain of software (configuration is set through a browser interacting with Java code running in a Linux variant deployed on a hardware device; algorithms that automatically re-order merchandise based on seasonal, demand & promotional variables; advertising-sponsored or use-metered interaction). Virtual data centers, real-time algorithmic pricing, and new media are simply larger versions of that same phenomenon.

Production isn't what it used to be. A century ago, production was king: demand outstripped supply in economies with emerging consumer classes, which gave power to producers. That has long since changed. Today, production has few sustainable advantages: it is over-built (e.g., automakers have far more capacity than demand), highly flexible (lower labor intensity and cheap capital means production can shift quickly in response to economic or political demands, but by extension means there is no intrinsic strength derived from a "highly skilled labor force"), and subject to constant innovation in inputs (look at the progress in materials science in the last two decades). Producers can only counteract deflationary forces at their core with ruthless cost control and brand allure. A producer does this with a combination of efficiency (squeeze every penny from raw materials sourcing to distribution) and by appealing to or outright fueling user vanity (engender customer identity in every facet of its business).

Software is the means through which both of these things are done: we can use software to gather data, analyze performance and adjust operations in near real-time; we can also use software to reinforce identity, influence attitudes and drive behavior of consumers. No software, no chance.

So producers have to become software companies. But what does that mean exactly?

To somebody running a business, it means realigning internal operations. We have to look at skills and capabilities: we're not going to be much of a software company if we don't employ any software engineers. There are process and cultural considerations, too: an "optimized" business might squeeze more performance out of operations through software, but is less likely to be capable of capitalizing on external data that allows it to "re-invent" its industry through software.

But skills, capabilities, processes and culture all wilt in the face of an overbearing capital structure. A company financed to produce long-term stable cash flows from operations isn't a company that is prepared to respond to threat of competitive innovation via software or anything else, let alone one that will be a source of competitive disruption. It might consume a lot of software. It might even create a lot of that software. But software intensity in what we do doesn't make us a software company, any differently than walking for miles every day makes us athletic. Operations and execution matter to the bottom line, but ultimately dance to the tune called by finance.

Next month, we'll look at the organizational pathologies created by different capital structures and how those make a firm that innovates and competes through software as opposed to a firm that ingests and consumes software.