Scaling of Different Software Business Models

by Abhishek

Now I do want to follow this to its logical extreme and so let’s say
that you’re working as an individual consultant and then you bring on a
couple other people and pretty soon you’ve got a team of your 20 guys.
Guys and girls.  Your 20 professional, technical, developer type people
and you’ve got some sales people and you’ve got a whole bunch of
clients lined up and you’re doing all these gigs for these clients and
then all of a sudden what you’re going to start to notice is that
you’re charging by the hour and you're paying people by the hour and
therefore the total maximum amount of profit that you can make in this
business is just a function of how many people you can hire, in other
words with 20 employees then you can imagine making two million dollars
a year in profit (although that’s kind of pushing it, but that’s like
based on sort of New York rates) and in order to have four million
dollars you have to get up to forty employees and now all of a sudden
it’s just a game to see how many employees you can get and at some
point you start kind of reducing the quality of the employees a little
bit and it just becomes this gigantic recruiting exercise where whoever
can recruit the best makes the most profit and in fact I hate to say
this but Fog Creek actually started out with this as our initial goal. 
As the first thing we were going to do as a part of boot-strapping was
to create this consulting firm and one of the reasons that we have such
great conditions for programmers is that we thought that would allow us
to win that recruiting war and be able to recruit the most people and
treat them the best have them stay with us the longest and therefore be
the most profitable in that kind of "body-shop" business or that
consulting business where you’re basically just providing people with
some where you’re providing your customers with a human being with
brains for a fixed number of hours.

But compare that
momentarily now, to the software business.  Because in the software
business, as soon as you've written some code, you can license it or
sell it again and again and again and again and again, without writing
it again and again and again.  Which is very different from a typical
IT consulting kind of arrangement.  That means (among other things)
that you can make a lot more profit, because the profit is no longer
constrained by the number of employees you can hire, it's just based on
how many sales you can make, which is a function of how good your code
is.  So if you write good code, you probably want to start getting into
basically the licensed or hosted software business, where there's some
kind of scale, there's this scaling that you can do that doesn't
require you to bring on more warm bodies.  And that's really the
long-term goal.

In the early days of Fog Creek when I was
trying to evangelize this idea to people, I would always draw two
charts.  One was showing a line going up linearly and saying "Your
profits are a function of the number of people and that's the
consulting business, but we also want to build a software business,"
and a software business you sort of superimpose a hockey stick on that
line, so it takes a while to start up, but when it does, it goes up a
lot faster than the number of people and pretty soon the core of the
business is in selling software licenses or in hosting software that
you provide for other people.  And it scales a lot better and you can
make a lot more money, faster.

And one thing, which really
surprises me, and this is the only way I’m gonna touch on the
offshoring question of people in Argentina and Eastern Europe and
India, that are doing this kind of offshoring.  Is they are all looking
at Hyderabad and Bangalore as their model.  Which is they wanna be,
they wanna do the drudge work for cheap for American companies that
don’t wanna this stuff instead of looking at Israel as their model. 
And the Israeli model is not offshoring, or outsourcing or taking the
drudge work, or taking the programming work and just dumping it in some
country where the wages are lower.  The Israeli model is: "we're gonna
make some companies and these companies are gonna do highly innovative
things and they gonna sell software, and they're gonna make big
profits," instead of just providing kinda warm bodies that are neatly
bundled for you to use in packs of ten with a program manager and two
testers.  So one thing that’s always a little depressing to me about
much of the offshoring world is that they're just not ambitious enough,
you know they’re not ambitious enough to make real software companies
and to make product companies.  They are still, they are still trying
to do this kind of low wage programming kinda thing.  Which to me is,
you know, a quick way to make a buck and to get started, but in the
long run you really wanna be selling something where what you’re
selling is intellectual property, because it can be sold again and
again and again and eventually becomes much much more profitable.

Atwood: Right. And I think that falls under the umbrella of “just try to be good at your job”.