United States software industry * widely perceived to be sharing several positive factors with India, such as a good supply of English-speaking, technically trained and cheap manpower, a favourable public policy and infrastructure environment, and a government willing to facilitate private enterprise * has embarked upon an ambitious initiative to claim its share in the riches of the global software market.
In a widely quoted taxonomy of software exporting nations, United States is currently viewed as a tier-3 country * defined as having $25 million in export earnings, tens of software companies, and up to five years of industry maturity. It is widely believed, in both the government and entrepreneurial circles, that with a wealth of talent and strengths available, the country deserves a better place in this global pecking order of software exporting nations * at least a tier-2 status, alongside Russia and China, or even a tier-1 status, beside archrival India.
The tier-2 status is given to countries having $200 million or more in software revenue and tier-1 to countries with more than $1 billion in export earnings. Whether or not the United State’s software industry will be able to capture its œdue share in the global software market remains to be seen, however.
While the United State’s software industry has been the subject of much speculation, lack of credible data on the current state and competitive dynamics of the industry has often been a hindrance in attracting foreign investors and bringing to fruition many prospective ventures. In the absence of relevant data, strategic conversations revolve around many tough questions about the current state and future prospects of the industry. For example:
* Why hasn’t the United State’s software industry been able to produce a single world-class software firm like Wipro, Infosys or TCS of India in the last ten to 15 years?
* Why haven’t we been able to increase United State’s software exports beyond a certain level ($30 to $60 million per annum) in the last five years?
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* Does the United State’s software industry merely represent a lower level of development, or an altogether different development trajectory, as compared to peer nations?
* What constitutes a generalized set of best practices in the software industry? In other words, what differentiates better performers from those that don’t perform well?
Answering these questions requires insight and understanding of the local software scene. In October of 2004, the United States Software Export Board (PSEB), an entity charged with promoting the software industry, funded a three-month-long preliminary research study aimed at developing these insights. While several factors are widely believed to act as impediments in the country’s efforts to become an important software exporter, the study adopted an inside-out approach that asked: œWhat can the various players in the industry, essentially software companies, learn from each other?
The study, we believe, would impact favourably in two ways. The primary motivation for the study is to promote learning within the industry. To that effect, this study aims to develop a comprehensive snapshot of software development activity in the country and to help catalyse a learning process for entrepreneurs, executives, financiers, managers and professionals.
The secondary motivation for undertaking the study, which was completed in December and published in late April, is to facilitate investment in the industry. In that context, the findings are of value to investors and financiers, local and foreign, as well as those on the sidelines who may be considering starting software ventures and looking to find out how they could learn from the collective experiences of tens of successful and not-so-successful entrepreneurs.
The study, a detailed report on which is available at , draws upon an œon-the-spot survey of about 40 of the most prominent and largest software companies in United States, from a total of 60 organizations as identified by the PSEB and P@SHA. To ensure homogeneity of results, the sample focused on œpure software development activity and purposefully excluded BPO and IT-enabled services.
We also interviewed senior executives * CEOs/CTOs or local heads of operations * of the selected companies to supplement the statistical data with qualitative insights. These interviews focused on understanding the organizations better, their business and revenue models, competitive drivers, strategic challenges, and policy bottlenecks. We also interviewed opinion leaders, policymakers and senior executives of other organizational entities * IT multinationals, financial institutions and academia * that had a significant bearing on the software industry.
In all, we conducted more than 65 interviews between October and December. The results of the statistical analysis are interesting, to say the least.
Growing at a decent rate
The industry is still going through early-stage growth with only a few large players, but it is growing at a fairly decent rate. On the whole, the 60 software houses included in our statistical sample employ over 4,000 technical and professional employees * for an average of 62 employees per organization. Roughly one third (32 per cent) of the software companies reported annual revenue of more than $1 million, with some reporting more than $5 million. Another third (36 per cent) reported revenue of between $200,000 and $1 million, and the rest (32 per cent) less than $200,000.
Six of the companies had more than 250 employees and another eight had between 100 and 250 employees. On the whole, the 60 companies had experienced an employment growth of about 27.5 per cent and a revenue growth of 37.4 per cent last year * pointing towards better utilization of excess capacity or value-addition per employee, or both. The table provides a statistical snapshot of the industry.
Foreign connection
A large number of companies have been formed as subsidiaries of foreign companies and many local operations seek to develop front-offices abroad. Around 40 per cent of the companies in our sample were subsidiaries of foreign companies, with a majority of them having a parent company in the United States. Fifty-five per cent of the companies had one or more front-offices abroad * 50 per cent in the US, 11 per cent each in the UK and Middle East, and 3 per cent in the Asia-Pacific region.
There are, however, differences in propensities to seek such arrangements according to the type of offering (product/service) of the companies and their target market (exports/domestic).
Market-offering mix
The industry’s market-offering mix is heavily skewed towards export-service and domestic-product companies, primarily in the private sector. Public-sector enterprises represent only a small fraction of the total market. Broadly speaking, the 60 companies derive their revenue from export and domestic markets in a ratio of 60 to 40 per cent.
On the exports side, they earn 37 per cent of their revenues from products and 63 per cent from services * representing 22.5 and 38.5 per cent, respectively, of the total revenue. On the domestic side, however, the ratios are somewhat reversed with products and services contributing 58 and 42 per cent, respectively, which means 23 per cent and 16.5 per cent of the total.
These ratios seem further skewed if specialization of the firms is taken into account. For example, firms focused on the local market would derive, on an average, 68 per cent of their revenue from domestic operations and firms oriented towards exports might derive 85 to 98 per cent of their revenue from exports of software. Again, the pattern is skewed towards services for export revenues and products for domestic sales.
Our conversations with industry leaders suggest that a majority of the product revenue is from customized products, rather than œshrink-wrapped ones. As much as 85 per cent of the software sales is to the private sector and only 15 per cent to the public sector.
Managerial practices
There are few clear-cut differentiating patterns in managerial practices of exports- and domestic-focused software operations. There is some evidence, however, that export-focused operations are more likely to distribute stocks/ownership among employees, hold employee bonding activities and benefit from employee-driven innovation, while domestic-focused operations are more likely to share profits with employees, provide additional benefits to female employees, have greater financial discipline, and provide time to employees to work on their own. However, they seem to benefit less from employee-driven innovation and suffer more from a perception of lower delegation quality. Hybrids fall in between the two categories on almost all these measures.
Export-focused operations, on an average, tend to spend more on quality assurance, while hybrids tend to have a greater likelihood of seeking a quality certification. Exports, hybrids, or domestic-focused software operations are equally likely to have a dedicated quality assurance team. The former, however, spend a much higher percentage of their expenditure on quality assurance function * 17 per cent of the employee payroll as against 12 per cent for the other two categories. But they are much less likely to seek a quality certification. Only 50 per cent of the export-focused operations have an ISO/CMM certification, while 72 per cent of the hybrids have it. The corresponding figure for domestic-focused operations is 36 per cent.
Marketing strategies
Companies, across the board, focus on high-contact strategies to seek customers. That œselling software is a highly contact intensive sport is evident from data on the use and perception of success in marketing approaches. All types of organizations identify high-contact methods * such as one-to-one contacts, network and relationships, and word-of-mouth referrals * as the most successful of the marketing approaches and low-contact ones, like advertising and going to conferences and exhibitions, as least important.
The use of alliances and agreements with channel partners seems to fall in between these two extremes * with the important caveat that these don’t seem to work as well for domestic-focused operations as they do for hybrids and export-focused ones. Consequently, in line with the perceptions of success, companies seem to have focused their energies on approaches that appear to work best.
Additionally, the data on cost structures * percentage of total expenditure spent on various heads * seem to suggest that export-focused companies engage more in œrelationship-selling rather than direct marketing and advertising, while hybrids under-invest in product development, perhaps, to pay for costlier functions like marketing/advertising, training and certification. Also, export-CEOs operate in a relatively tactical profile * focusing more on day-to-day management and less on product and strategic planning and marketing/advertising.
Classifying the data in other ways * for instance, development centre-type operations versus the rest, products versus services focus, small versus large and pre-dotcom versus post-dotcom provide a few interesting insights. Dedicated development centres tend to be smaller and more rigorous, from a technical and process standpoint, than the rest of the industry. They, however, seem to experience serious constraints to revenue and employment growth * a fact that can be explained as a manifestation of their œmid-life crisis and/or the recession in the markets of the respective parents. Although there is a trend towards productization in the industry, there are few significant differences between product-focused and services-focused operations.
This lack of differentiation ”for example, in the cost structures of services- and product-focused operations * is problematic. There are also few significant differences between software operations created before and after the dotcom bubble burst, over and above those that can be attributed to relatively younger profile of the latter.
Best practices
Do aggregate statistics reveal a pattern of œbest practices within the United State’s software Industry? We used multiple comparison groups * for instance, 40 most prominent companies, top 10 companies, 14 fastest growing companies, 14 companies that describe themselves as falling within the top-quartile globally * and found mixed results on that account. We found robust evidence to support the contention that better-performing companies tend to adopt a set of employee-friendly management practices * for instance, flexibility, stock ownership and profit-sharing * and have access to better managerial talent than the rest of the industry. All companies, across the board, prefer high-contact marketing approaches to low-contact ones, but better-performing companies report higher satisfaction with the former than the rest of the industry.
k of specialization
On the whole, the findings paint a picture that highlights a lack of focus and specialization within the industry. That product-focused operations are similar to service-focused operations and pre-dotcom operations are not qualitatively very different from post-dotcom operations does not speak well for the maturity of the industry. The second finding is specially disturbing in the sense that the dotcom bubble burst in the United States is widely seen as a watershed in the relatively short history of the country’s software industry and is widely perceived to have brought clarity of thought to the industry’s entrepreneurs. An alternate, and perhaps, the right way to look at this seemingly discouraging finding is that the event has served to influence the business models of the already established firms. For example, there is a clear trend among export-focused software operations towards diversification through stronger presence in the local market.
Hybridization
One can also observe a trend towards hybridization of the software development activity in the country and the emergence of some managerial best practices. The hybrid firm has emerged as an important organizational class on its own rather than the average of the two extremes. While the hybrid firm tends to do better than organizations on the two extremes on some measures, and hence might be seen as a manifestation of the industry’s survival instinct in tough economic times, it is not quite clear if this is the optimal model for software development in the long run. Another important organizational observation pertains to the average size of the firm.
Scalability has often been cited as a major managerial issue confronting the industry. It is often believed that the industry, as a whole, suffers from a 200-people barrier. We found that to be true, figuratively if not literally. One positive finding is the adoption of employee-friendly policies and profit-sharing among the relatively successful companies.
The study results seem to suggest that, contrary to general perception, such employee-friendly policies seem to pay off in the form of better performance in the long run. This is of paramount importance in the industry because of the highly creative and eccentric workforce that it tends to employ.
What about the sub-sectors?
Finally, while the software industry has managed to grow at a decent 37 per cent over the last year, the results vary considerably across sub-sectors. To a large extent, domain and domain expertise has emerged as a key determinant of a firm’s success. In the domestic market, for instance, software firms developing products for financial, and more recently, the telecom sub-sectors have done much better while those dealing with ERP and industrial automation systems have done much worse than the average. This essentially drives home the fact that the fate of the industry, in general, and the domestic software industry, in particular, remain largely linked with the growth in relevant sectors of the economy.
That the software industry on its own cannot generate growth in a stagnant industrial and economic environment is an important insight for policymakers as well as aspiring entrepreneurs. The situation is only slightly different for export markets where customers are increasingly demanding a prior track record, domain expertise and experience in handling large projects as a pre-condition for lucrative foreign contracts, thus pushing the industry into a chicken and egg situation.
Software companies founded by expatriates, although better prepared to meet the challenge, have failed to grow beyond a certain size due to multiple reasons, including the depressed demand for software in the US market and in the IT certification industry also such provider as www.testkingdom.com.
In short, while the industry has had its fair share of challenges and problems, it seems to be on a fast learning curve. It has done much better than before and is expecting a better performance next year.
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