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Friday, November 12, 2004
More Developer Economics
By Steve Teixeira (steve) @ 4:00 PM :: Editorial - Steve :: 15 Comments :: 279 Views

My CodeFez colleague, Nick Hodges, just posted an interesting editorial on the economics of developer tools, particularly with regard to Borland. Nick points out that businesses are justified in maximizing profits versus, say, maximizing revenue or expanding market share. While this may be true (and I don't claim to be any more of an economist than Nick), this business strategy brings with it a number of other market forces that cannot be ignored. Most notably, maximizing profits may significantly increase the volatility of the revenue stream. In addition, deliberately shrinking the market, particularly in developers tools, reduce the total market of the tool – and ultimately reduces demand.

Increased Revenue Volatility

Just for the sake of argument, let's say my company has 100 customers. Let's say it then turns out that my support costs are sky-high, so I decide to focus on maximizing profit by increasing the price of my product. In this way, I know fewer people will buy my product but I also know that revenue per unit will be higher and support costs will be lower. Again, just to work with round numbers, let's say this shrinks my customer base to 10 very profitable clients. The problem this presents is now my revenue stream is much more volatile. With my original base of 100 customers, losing 1 customer means the loss of only 1% of my business. However, with the smaller customer base of 10 the cost of losing each customer is much greater: 10% of my revenue. Of course, these numbers are totally contrived, but the concept behind them is solid: the fewer customers you have, the less you can afford to lose them.

Shrinking Demand

A smaller market might be fine for some kinds of products. Fine wines or luxury cars, for example, are markets designed for the high margin/great service/few customers business model. However, a small market is not a good thing for developer tools. In developer tools, market share is king. While a small portion of the developer tools market will stick to their favorite tool, popularity be damned, the vast majority of the tools market will tend to follow the trends, those tools and technologies that organizations feel have the best longevity and developers feel will keep them best employed. At the end of the day, this translates into continually decreasing demand for the smaller market tools – a sort of death spiral into sub-one-percent-market-share oblivion.

In short, I'm not as fond as my good friend, Nick, of the Borland Delphi pricing strategy. I enjoy Borland tools, but it's clear that the growth of products like MS Visual Studio.NET and Eclipse is occurring at the expense of the higher-priced Borland offerings. I would prefer to see a strategy that more effectively balances growth with profitability.

Comments
By Craig 'craigvn' van Nieuwkerk @ 11/13/2004 2:05 AM
I think both Nick and your articles are very good and help explain why there is so much debate about such things over in Delphi.Non-Tech. At the end of the day though, unless we are in the inner circle at Borland we can only speculate about the companies strategy's, and the people who do know probably wont talk!

By Bill 'wmogk' Mogk @ 11/13/2004 7:17 AM
I agree with your general statement that Borland pricing is too high. However, it think it applies less to Delphi than it does to JBuilder. I have noticed JBuilder pricing coming down signifigantly in recent versions, as Eclipse gains momentum. Now that's a pretty simple comparison - two similar, Java-type IDE's. Since Borland is competing with a free product, they must lower the price closer to free in order to avoid loosing (too many) sales.

Delphi, OTOH, is quite different.
1. It is competing against Microsoft, which has a built-in "Buy Microsoft Only" market.
2. Assuming Delphi is the "Object Pascal" language, and not C#, then Borland is competing against and an anit-pascal bias.

Forsaking profit (for the moment), would cutting the price of Delphi 2005 in half increase Delphi usage signifigantly? I am not sure it would because of the above two points I made.


By Nick 'Nick' Hodges @ 11/13/2004 12:19 PM
Steve --

Interesting point: But /all/ companies price to maximize profits, not revenues. Pricing decisions may take a /long/ term view (i.e. price low at first to get market share with "introductory pricing", etc). of profits, but profit is the main driving force of pricing. Maximizing revenues isn't what successful businesses due, because increased revenues always mean increased costs as well. Maximizing revenue and maximizing profits are very closely related, but not exactly the same.

All of Borland's customers want lower prices in order to increase sales. But Borland has to weigh that against making money. Lowering prices and increasing sales may or may not actually increase revenues. None of us is really that familiar with the elasticity of Delphi sales. (Elasticity is the effect of price changes on units sold.) But lowering prices might very well /decrease/ Borland's profits. An unprofitable Borland -- accompanied by the inevitable "struggling tool maker" articles -- are far more dangerous to Borland's future than are the possibility of a volatile customer base.

Borland's customer base is measured in the tens or hundreds of thousands, so your example /is/ contrived, in that it makes the issue seem worse than it really is.

In the end, Borland must price to stay profitable. Fortunately, as a software development company, their costs are mostly fixed (the incremental costs of producing another unit of what Borland sells is quite small -- Borland's margins are really high), so they have a pretty good idea how to price to make sure that they make money. It's an imprecise science, but the fact that they've been steadily profitable over the last three years or more is a testimony to their success.

Nick

By Nick 'Nick' Hodges @ 11/13/2004 12:21 PM
One other point:

Bill Mogk makes the point better: Would cutting Delphi's price really increase its marketshare? I'm guessing that price is a less important factor in the bigger picture of increasing marketshare in the developer tools market.

Nick

By Steve 'steve' Teixeira @ 11/15/2004 1:59 PM
I must disagree with the assertion that all companies price to maximize profits. I'm sure we can agree that pricing depends on a variety of factors, including market maturity (e.g. introduction, growth, maturity, decline), disposition of the product within that market, company financial situation, etc. I guess one could say that the end goal of all products is to achieve cash cow status (mature market / high market share / low investment / high return), but it's definitely not accurate to say it's all about profit all the time.

Of course, we can discuss theory till the stars fall from the sky, but the proof is in the pudding. Have Borland's tools performed optimally over the past several years from a financial standpoint? Well, shrinking market share and shrinking revenues in those parts of their business combined with an ever-increasing effort to move their revenue base to the "ALM" products tells me no, but I appreciate that others may have a different interpretation of the facts.

-steve

By Charlie 'charlie' Calvert @ 11/16/2004 11:13 AM
I agree with my friend Steve that maximizing profits are not the key goal of doing business. But I have a slightly different point of view on this matter that I feel might be worth stating. The purpose of running a business is not simply to make money. The purpose of making software and running a business is to be a useful and contributing member of society. A person has to eat food to stay alive and a business has to make money to stay in business, but the purpose of life is not to eat food and the purpose of a business is not to make money. If money were what it was all about then each of us would think not about doing something useful that interested or fulfilled us, but about what job we could get that would make us the most money. (Of course, some people are primarily fulfilled by making money, but that is a different subject altogether that involves only a small minority of people. Think for a moment about your family, your wife, your children, your parents, your grandparents and friends. How many of them think of fulfillment only in terms of making money?)

If one stops thinking about maximizing profits and starts thinking about how to be useful member of society, then it becomes clear that getting software into as many people's hands as possible is important. A company is useful to society to the degree that it is engaged with that society. To be as useful as possible, Borland needs to start by standardizing Object Pascal and getting a free compiler out there so that the language can become widely used. It is hard for anyone to adopt Delphi because the language itself is tied to the future of Borland. With a standard established, and the source to a free compiler available, then the whole idea of Delphi being tied to the future of one company would go away, and people could finally start adopting Delphi on a large scale. Of course, to get customers to come to Delphi in large numbers, the product has to be affordable. If Borland created an affordable product based on an open standard, then customers would buy more Borland tools, and Borland would make more money. We all give money freely to a company that does something useful for us. This would create wealth not only for Borland, but for all the companies that work with Borland. It is that network of companies, customers and profits that are important. Money alone is not particularly valuable, it is meaningless unless it is part of a greater equation. We must see more than just profits, we need to see the significance of that greater equation.

One of the problems with thinking that businesses are only about making money or maximizing profits is that one doesn't understand all the different types of transactions that occur between a business and its customers. Sure we give a company money when we buy its products. But we are doing more than that. We are investing something of ourselves, we are investing our time and our lives in that company and its products. That is particularly true of compiler users, who literally spend eight or more hours a day using a company's products. It is a literal investment of time and energy in a company. There is far more than money trading hands. There are also transactions involving time, and enthusiasm, and trust. Borland customers write about Borland on the web, create products that enhance Borland's products, sell Borland products into the company's that hire them, they answer each others questions, and in general work overtime promoting Borland's products. If a customer feels that the transaction is all one way, that we give money to a company, that we invest our time and enthusiasm in a company, and the company gives nothing back but a product maximized for the company's profits, then the deal starts to go sour. Borland needs not just to maximize their profits while they make a mad dash for the ALM market. They need to show the Delphi community that they are interested in investing in the future of Delphi. We invest our lives in Delphi, why can't Borland do the same? The first step is for Borland to standardize the language, and get a free, open source compiler out there so that the future of the language is assured. When Borland does all these things, then Borland will have made the kind of contribution to society that almost always results in increased profits.

Marriage as an institution could not survive without sex. People could not survive without eating. A company must make money. But a marriage is about more than sex, living is about more than eating, and a running a company is about more than maximizing profits. If a marriage becomes about nothing but sex, and life becomes about nothing but food, and running a company is about nothing but making profits, then the marriage, the life, and the company are all finished.

Borland is a great company which has helped to grow a dynamic community of useful people who contribute to their own lives and to the lives of many others. But the company will become useless to itself and to others if it makes its decisions based on calculations about how to maximize profits. That's not the goal of a company. The goal of a company is to be a useful and contributing member of society. If the company can think in those terms, then the future of Delphi is assured, and the company can begin to grow again. Earning a living and making money is a great a joyful part of life, but it is only a small part of a much bigger picture.

By Parmod 'PGandhi' Gandhi @ 11/16/2004 12:40 PM
Charlie, sooner of later I knew s e x part will come up in the site. I hope it helps to increase membership.

I second your emotions about making money. Your next job is make sure that Bill, Paul and Steve also get to read your point of view. Tell them to quit killing the competition, as competition is good for technology and mankind in general (or should I say humankind). Live and let live should be the moto.

By Charlie 'charlie' Calvert @ 11/17/2004 8:36 AM
Parmod. I assume you are talking about Bill Gates and Steve Jobs? In the eighties Jobs was in the right place at the right time, but he got very interested in huge margins and in maximizing profits. As a result, I think he missed a huge opportunity. But here I'm making Steve's point, not mine.

I'll keep trying the sex thing, but I have a feeling that I would be smarter when building a site like CodeFez just to say words like Delphi, C++ and Java a whole bunch. I think the audience we are interested in is more interested in Delphi, Java, C++ and also C#, don't you? We've considered pornography, but I think we decided that saying words like Delphi, Java, C++ and C# would bring in the audience we want. It's hard to say for sure if using words like Delphi, Java, C++ and C# will work or not. It might get a little repetitive just to keep saying the words Delphi, Java, C++ and C# over and -- ah the heck with it. I think it might be easier just to give up on the key word thing and write regular articles. :)

By Steve 'steve' Teixeira @ 11/17/2004 11:03 AM
Plus, you've seen us, right? Not exactly porn star material. LOL

By Lino 'Lino' Tadros @ 11/17/2004 11:15 AM
Steve, please talk about yourself only :)

By Parmod 'PGandhi' Gandhi @ 11/17/2004 1:51 PM
Sometimes I think Delphi is sexy but I always look around me to make sure that no one is listening to my thoughts. If my girlfriend ever heard me say Delphi is sexy, I will have to sleep in the barn for much longer than Arnold had to.

By the way I meant Bill Gates, Paul Allen and Steve Balmer. Steve Jobs is another story.

By Nick 'Nick' Hodges @ 11/18/2004 8:16 AM
Steve --

I think 99.9% of the economists in the world agree that companies price products in order to maximize profits. That's what for-profit business do -- and that is certainly what public companies do. Anything else is inviting a shareholder lawsuit, as well it should. So, sorry, your assertion that "it's not about profit all the time" isn't accurate. If it isn't about profit, then what is it about?

You assert that "The proof is in the pudding" --- well, yes, it is. Borland is profitable and has been profitable in a very tough market. That the market share of specific products may be going down doesn't mean that their pricing strategy is wrong. For that to be so, you have to show that a different pricing strategy would lead to both profit and increased market share. I'd say you'd be hard-pressed to make that case.

Charlie -- I appreciate your "finer things in life" argument. However, in the end, businesses exist to make profits. If they don't, they go out of business. That's just the way it is. Some businesses are better at it than others, and some businesses choose to take "profits" out of things like "doing good", but in the end, all businesses have to make a profit or they cease to exist. Businesses exist to succeed, not to fail.

in addition, I refute the notion that there is anything inherently wrong with making big profits. You outline a plan for Borland to increase the popularity of Delphi. But of course, the only reason that Borland would or should do that is to make money. And of course, making money, being an inherently good thing, will bring about what you want: being a profitable, growing company is probably the very best way for Borland to contribute to society. They certainly don't contribute much by going bankrupt.

Your points all sound good, Charlie, but in the end, Borland has to make a profit. They have to price their products in order to bring in revenue greater and their expenses. That's the stone cold reality of the situation. We don't know what the demand curve for Delphi is, but I /suspect/ that lowering prices won't necessarily "make it up in volume". I'll assert that Borland knows what the demand curve is a lot better than you or I do, and that their prices are set to maximize their profits. And of course, that is the only reason businesses exist. Falafel sets their hourly rate to maximize profits. -- or at least I assume they do. You guys would be nuts not to.

Companies exist to maximize profits. If they can do that by "becoming contributing members of society" then that is how they'll do it. But no company can survive without focusing on profits. Borland will only give away the Pascal compiler if they think there is profit in it down the road. If they think doing it will /lose/ them money, then they won't do it.

It's that simple: Companies do things to make money, and they don't do thing that lose money. We can talk about "contributing to society", but it always comes down to that. //And there is nothing wrong with that//.

For instance, take your comment about Jobs. You claim he got interested in "huge margins and maximizing profits". Well, every business is interested in huge margins and maximizing profits. Clearly Jobs went about it in the wrong way, eh? If he had been smarter, he would have done things differently and actually /made/ those profits. In other words, your objection isn't that he wanted huge profits, it's that he went about it in the wrong way and failed.




By Charlie 'charlie' Calvert @ 11/18/2004 6:49 PM
Nick, this has to be some kind of mis-understanding. One for which I am no doubt partly responsible. But I can't believe you are serious about the position you appear to take here, and I know I don't take the position you think I take.

When replying to my comment, you write, “Businesses exist to succeed, not to fail.” The implication of this statement is that I somehow believe that businesses exist in order to fail, which is of course, absurd. It seems at times that your argument rests on the idea that because I don't think the primary purpose of a business is to make money, that therefore I am proposing the opposite, namely that businesses shouldn't make money and should fail. But look back at what I wrote. You will note that I repeated several times that businesses need to make money. In particular, I wrote “a business has to make money to stay in business.” I added that the purpose of life is not just to eat, just as the purpose of a business is not just to make money.

You write things like this: “Charlie -- I appreciate your "finer things in life" argument. However, in the end, businesses exist to make profits. If they don't, they go out of business. That's just the way it is.” Let's look again at what I said: “a business has to make money to stay in business.” What you are doing is setting up a straw-man argument (http://www.nizkor.org/features/fallacies/straw-man.html) so that you can knock it down. I never make the argument you imply I make, and therefore much of your refutation of my argument widely misses the mark. Whole paragraphs of your reply are based on the supposition that I said something which I irrefutable did not say. Once again, I said: “a business has to make money to stay in business.”

I believe that this misunderstanding is the classic one of assuming that the person on the other side must be stupid, or they couldn't possibly disagree so completely with something you think is obvious. We are old friends, and I know you don't think I'm stupid, and of course I don't think you are stupid. Nevertheless, we perhaps both tend to default to this “the other guy must be stupid” view when our fundamental beliefs get questioned. I think your opinion about businesses and money is probably part of your core belief system, something you don't really need to defend logically to believe. I know that I feel that way about my opinions regarding business. It really is hard for me to believe that anyone could possibly take the position that something as central to life as work is really only about money.

So how can we get past this, “the other guy is just a fool,” thing, so that we can begin a real discussion, rather than setting up straw-men that catch fire all too easily? Why is it that we don't we agree? What is this about, anyway?

You write the following: “And of course, making money, being an inherently good thing, will bring about what you want." This sounds like fertile territory to me. You make the statement that making money is an inherently good thing, but you never make any attempt to back up this rather extraordinary statement. This is what one would expect to happen when someone is talking about one of their core beliefs. I'm not saying that you don't have good reasons for believing this, only that it is common for people not to defend core beliefs, just as it is common to assume that people who disagree with our core beliefs must be dumb.

For my part, I do not at all think making money is an “inherently good thing.” Some people make money distributing snuff films, is that an inherently good thing? Some people make money exploiting child labor, is that an inherently good thing? Some people make money robbing houses or selling hard drugs. Are these good things?

You ask Steve, “If it isn't about profit, then what is it about?” In my comment, I answered that question by saying: “The purpose of making software and running a business is to be a useful and contributing member of society.”

Now here we have two very different points of view. One person says business is about making money, the other says it is about supporting society. So what do I mean by saying that bit about being “contributing member of society?” I mean that business is not just about making money, but about creating jobs, homes, food, meaningful work, give meaning to lives, teaching people self-discipline, helping them to become self-reliant. It helps create money for defense, for health care, for education. Business is about a lot of things besides just maximizing profits. In fact, maximizing profits is not, in my opinion particular important or even interesting compared to tasks like creating meaningful work, aiding education, health care or national defense.

You say: “Companies do things to make money, and they don't do thing that lose money. We can talk about 'contributing to society', but it always comes down to that. And there is nothing wrong with that.” I don't agree at all. In the real world, it doesn't always come down to making money. In the real world, companies do recalls when they release bad products. If it was all just about making money, then society wouldn't insist that companies do recalls. In the real world, people get sued and go to jail when they mislead the public, as so many stock brokers and businessmen did after the recent stock market crash. If business was just about making money, that wouldn't happen. In the real world, monopolies get broken up, companies have to pay taxes, they have to obey laws about hiring children, women and minorities. Why do they have to do these things? Because business is not just about making money. Businesses engage in a social contract in which they contribute to society, and are rewarded if they play by the rules. If a business does not play by the rules, for instance, if they make money selling heroin in the street, then society says that this particular company is no longer a “useful and contributing member of society,” and they are put out of business. With a bullet.

As you can see, I think business is very complex, interesting, and rewarding endeavor. To me, it is about complex, and potentially enormously beneficial, aspect of life on earth. In short, I'm not just some guy who somehow didn't quite have enough marbles to figure out that businesses have to make a profit. I know that. I know that people have to eat. But life, and business, is about more than that.

I'm sure that your point of view on these matters is probably quite sophisticated. So I would like to hear back from you. Defend your core beliefs by explaining why “making money is an inherently good thing.” It seems to me that it was in that statement, that you came closest to actually defining why you are so interested in maximizing profits at the expense of all other factors in life.

I'll add some quotes to give you a sense of why the things I'm talking about are such deeply held parts of my core beliefs: “For we brought nothing into this world, and it is certain we can carry nothing out. And having food and raiment let us be therewith content. But they that will be rich fall into temptation and a snare, and into many foolish and hurtful lusts, which drown men in destruction and perdition. For the Love of money is the root of all evil: which while some coveted after, they have erred from the faith, and pierced themselves through with many sorrows.” First Timothy, 6:7-10. ''Charge them that are rich in this world, that they be not high-minded, nor trust in uncertain riches, but in the living God, who giveth us richly all things to enjoy. Tell them that they are to be good, and to be rich in good works, to be generous and willing to share – this is the way they can save up a good capital sum for the future if they want to make sure of the only life that is real.'' (1st Timothy 6:17-19) “No man can serve two masters: for either he will hate the one, and love the other; or else he will hold on to the one, and despise the other. Ye cannot serve God and mammon.'' (Matthew 6:24) “Lay not up for yourselves treasures upon earth, where moth and rust doth corrupt, and where thieves break through and steal: But lay up for yourselves treasures in heaven, where neither moth nor rust doth corrupt, and where thieves do not break through nor steal: For where your treasure is, there will your heart be also.'' (Matthew 6:19-21) “Sons have I; wealth have I”': Thus is the fool worried; Verily, he himself is not his own. Whence sons? Whence wealth? (Dhammapada) Do not follow a life of evil; do not live heedlessly; do not have false views; do not value worldly things. In this way one can get rid of suffering. The wise man rejoices in giving and thereby becomes happy thereafter. Better than absolute sovereignity over the earth, better than lordship over all the worlds is the Fruit of a Stream-Winner. (Dhammapada) The longing for jewels, ornaments, children, and wives is a far greater attachment. That bond is strong, say the wise. It hurls down, is supple, and is hard to loosen. This too the wise cut off, and leave the world, with no longing, renouncing sensual pleasures. (Dhammapada)

By Parmod 'PGandhi' Gandhi @ 11/18/2004 10:30 PM
Wow, that was heavy. For what it is worth, I agree with Charlie. I too think that life is about much more than money. On the other hand I don't believe Nick is all about money. Nick just does too much, for free, for fellow developers that he could not possibly be all about money. But Nick did come on too strong about the idea that it is all about money. I think it perhaps an off moment for Nick?

I believe that the business and many individuals are too heavily craving for money. Many are willing to kill for it. Killing does not happen by guns or knives alone, now a day’s it happens much more by even lawful means. I have heard of people committing suicide because they were run out business by unfair competition or lawsuits. Common people sacrifice good family life for what; fancier cars, bigger houses, and other toys. Is it true that a person who dies with most toys wins.

I am speaking from experience as one big giant try to crush me simply because I existed. I had developed a super duper label printing system called LabelPro over almost 5 years. I had legally registered the name LabelPro after fiddling with few names including LabelWare. I even had a certificate saying that it was my company’s trademark. Then this big giant comes along and uses the name without checking with registry first. When they found out that it was my property. They had two choices, pay the little guy couple hundred thousand dollars to buy the name or spend couple hundred thousand dollars and kill him. Guess which one they choose? No, they spent the money to put me out of business. They found out that another big giant had done a press release with this name 3 years before I had registered the name and bought the name for a dollar. So I lost everything I had including my marriage. I almost ended my life after that. I had a cyanide capsule sitting at my desk while a bottle of scotch on the table. Actually there were many bottles of Scotch over many days with capsule still on the table. The idea was that one day I will get drunk enough to swallow the capsule. I never was curious as to how it would taste. But the problem was I never could get that drunk.

As they say “God works in mysterious ways”. One day when I was hitting the bottle, out of the blue, I get a call from a client of mine who I had done a favour few years back. I had not even talked to this client for couple of years. Before I knew I was in Montreal for a week and which stretched to two years and half a million dollars. No, I did not get that contract because of my exceptional talent or I was better than anyone else. It was because I gave a client few hours of extra work to save his face with his boss and he remembered it when he needed more work.

OK time to wipe away your tears now. You got to admit it was an interesting story. But I will leave you to draw your own conclusions.

By Steve 'steve' Teixeira @ 11/19/2004 2:30 PM
Wow, almost anything I would write pales in comparison to previous posts, especially Parmod's. I just wanted to add that I have been friends with Nick for many years, and I know he isn't an "it's all about the profit" kind of guy in his personal life. It seemed to me he was really referring to the practices of public companies. Even then, I have to differ; public companies are generally driven by stock price, not profit. Often, stock price goes higher when profits are higher (especially for large companies in established markets). However, that certainly isn't always the case, particularly in less established markets. In those cases, the stock price is driven by whether investors think the company's strategy is sound and the chances that it will be a market leader in the near future (think early Amazon.com). To piggypack on Charlie's point, it's also worth discussing that even public companies are willing to take a stock price hit to do the right thing -- delaying a product until it's ready, voluntarily recalling a bad product, and going above and beyond government pollution standards could all be examples of this.

However, all of this great discussion is a tangent to the original point, which is pricing strategy for a *specific product*. While companies certainly would like to produce profits overall, that does not mean that the best pricing strategy for individual products is to maximize profits. Hell, Microsoft simply tries to break even with all of their development tools because the more tools they can sell, the more widely their platforms are used, and the platforms are where they make their money. When I was at Zone Labs, we actually invested a lot of resources into a FREE product because it established us as the market leader and seeded our paid products. These are both examples of a strategy for a specific product line that does not call for maximizing profits.

One other thing I might add is that I, like Charlie, actually spent many years working at Borland, so I feel pretty comfortable in my understanding of their internal strengths and shortcomings.

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