National Software Strategy for Scotland : The Strategic Options
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National Software Strategy for Scotland : The Strategic Options |
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With the substantial growth in Scottish software witnessed in the last 5 years set to continue over the next 2 or 3 years, our review of the options must address the possibility of implementing no proactive strategy for software in Scotland and providing no additional support to the sector. Indeed, Scotland has several initiatives in place to support the industry; both directly or indirectly.
The Scottish Software Federation provides wide-ranging support to the industry through various programmes including an industry directory, member services, and promotion of specific issues such as Year 2000 awareness. Scottish Enterprise has created a set of SOFTNET Centres - acclaimed software company incubators based at corporate sites. Scottish Enterprise also supports an industry journal and a comprehensive array of indirect support mechanisms in areas such as business formation, export, and foreign direct investment.
However, Scotland needs a more proactive, deeper software-specific strategy to respond to important future changes in the industry. Our prediction that the sector will continue to grow in the short term is based on the ‘local for local’ nature of the indigenous industry. Indeed, the UK market is set to expand by about 10% a year for the next three years and national firms should be able to exploit this local market growth.
However, as we approach the medium term, two important trends will begin to have a significant effect on the national industry:
Downward trend drivers: services
Upward trend drivers: products
A “Do Nothing” approach will result in under-achievement of potential and represent a missed strategic opportunity for Scotland. Scotland needs to reposition towards products.
Table 3.1: An Illustration of Consolidation Among Service Providers - Market shares of the top 15 vendors illustrate this.
Source: IDC
The global services industry is consolidating due to intense competition. As a result, service providers are increasingly looking to leverage low-margin service offerings across wider markets. In addition, more and more service clients are looking for a fully comprehensive service. Consequently, local service firms are becoming targets for acquisition.
Figure 3.2: Distribution of Scottish Software firms that cite provision of products only, services only, or both products and services - 1996
Source E&Y/SSF database
This trend is particularly important for the Scottish industry in which only about 15% of firms are “products-only” outfits. For Scottish service firms, the options will, be to either confine business to highly niche markets-constraining growth - or play a support/delivery role for larger - mostly foreign owned - vendors. This second option will become even less profitable as standard solutions become more available and transportable, and require less value-added implementation.
Figure 3.3: An Illustration of the Increasing Importance of Packaged Software. The growth rate of packaged software in Europe of 10.3% over the 1996-2000 period far exceeds the expected 4.1% of custom software
Source: IDC
The world market for packaged software is expanding rapidly, at the expense of the market for custom software solutions. The growth rate of the world market for packaged software is expected to outperform the market for ICT by around 2% up to the year 2000. The comparative performances of custom and packaged software in Europe are shown in the chart above. The absolute size of the European market for packaged software, at $35 billion in 1996, is almost three times as large as that of custom software ($ 11 billion).
There is a substantial difference in the profitability expectations of service firms and product firms. Ernst & Young would expect product software firms to deliver profitability of 20% to 35%; “if they got it right”. However, we would expect bespoke software and service firms to make profits of less than 10% on sales; usually 5% to 6%. The same is true for smaller product software firms - say with turnover of £2 million - because of the higher relative importance of product development.
Figure 3.4: Profitability as Profits/Sales 1991/2 to 1996/7 for typical Scottish Software companies
Source: Ernst & Young
Therefore, if the Scottish software industry is to maintain its growth, it must maintain and increase its presence in software products especially packaged software. This is borne out by the fact that most of Scotland’s star firms with high growth are product firms (see Section 2). However, software product firms have a strong tendency to hedge risk by introducing services to their market offerings and then proliferate the level of these service lines. Our interviews with Scottish Software firms showed that product development costs are the main cause of this hesitance. Scottish firms also face a lack of local test sites for their products. We describe the barriers to productisation in more detail later in this report.
With high competitive pressure in software services and the likelihood of a lower relative, Scottish presence in software products - the higher profitability/growth side of the sector, Scottish software will be under significant pressure as it approaches the medium term. The net impact is likely to be a downgrading of the sector to lower value business.
However, the opportunity cost to Scotland of not taking strategic action would be:
Therefore, we conclude that the “do nothing” option is not attractive.
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