What factors contribute to the success or failure of software firms?

November 18, 2010

Throughout the 1990s and 2000s, news about 20-somethings becoming billionaires from the sale of their software companies flooded the media, giving the impression that a good idea was all it took to succeed in the software industry. Jennifer Shang, an associate professor of business management in the Joseph M. Katz Graduate School of Business, along with colleagues Shanling Li of McGill University and Sandra Slaughter of the Georgia Institute of Technology, investigated what caused software companies to succeed or fail. Their research study, titled "Why Do Software Firms Fail? Capabilities, Competitive Actions, and Firm Survival in the Software Industry From 1995 to 2007," has been published in the journal Information Systems Research.

Because of low entry and exit barriers and low marginal-production cost, new-product development takes place rapidly in the , says Shang. However, the industry's bankruptcy rate of 15.9 percent is much higher than the rates in other industries. For example, the rate in the pharmaceutical industry is 4.7 percent.

Shang and her colleagues examined software-company data collected between 1995 and 2007 from 870 firms. The collaborators looked at three aspects of internal business capabilities—marketing, operating, and research and development. They also examined two types of competitive actions: those that were innovation-related (product and marketing actions) and those that were resource-related (capacity and scale expansion, operations, service, mergers, and acquisition). They found that a higher operating capability has the greatest influence on a software firm's chance of survival. Firms with a greater emphasis on innovation-related competitive actions have a greater likelihood of survival, and this likelihood increases when the firms also have higher marketing and operating abilities.

The researchers divided the software industry into three subsections: sector one, which included desktop suites and other business-enabling software; sector two, which included video games and graphics software; and sector three, which included operating systems and security programs. Depending on their sectors, software businesses need a slightly different approach to investments, says Shang. Firms producing games, for example, must emphasize marketing, whereas companies making products with a long life cycle (such as operating systems) must focus on operating abilities and research and development. Traditional software companies, those producing desktop applications, should follow a strategy somewhere between these two approaches.

"Our research underscores the importance of operating capability in the software industry," says Shang. "Managers of knowledge-based firms often emphasize big ideas (innovation). Our study shows that operational efficiency is even more important for firm survival. Also, competitive strategies and dynamic actions will have more impact if they are supported by strong capabilities. In short, to improve performance and competitiveness, software companies should focus on synergies between firm capabilities and strategic actions."

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