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Selling 'software in a box'

J. William Gurley CNET News

Published: 12 Feb 2003 15:23 GMT

Most executives in Silicon Valley take it for granted that selling software is a better business model than selling hardware.

In their mind, this goes without saying. The self-evident reasons relate to software's remarkably high gross margins. With near-zero variable costs, software businesses offer the ultimate in scalability. Software businesses are simultaneously less capital-intensive than hardware. This combination of low capital intensity and high gross margins, also leads to better valuations in the marketplace. What's not to like?

Despite these seemingly irrefutable advantages, many start-ups are "choosing" to sell hardware instead of software. "All things being equal," software may indeed be the better model, but therein lies the issue.

There is an old joke where a man is crawling beneath a streetlight looking for his lost keys. Despite that, he readily admits he lost them at a location further away in the dark. When asked why he's searching in that area, he naively replies, "The light's better." While the "light" may be better with a software business model, these models are becoming difficult to execute -- particularly for a start-up. With tactical execution and business models highly interdependent, having the "better" business model but an inability to succeed is a futile exercise.

There is a silver lining. The industry has changed in ways that improve the "business model" elements of selling hardware. The key driver is the standardisation and general availability of hardware components, particularly those used in generic Intel-based 1U servers. As a result, the hardware is not a proprietary design, but rather a type of packaging. (Think of it as an alternative to a cardboard box.) Combine this availability with the proliferation of Ethernet, TCP/IP, and licence-free operating systems such as Linux and BSD, and this allows a company whose primary competitive advantage is software to deliver that software in a box -- a hardware box.

One might ask why a company would choose a hardware model in such a scenario when 1U servers are available from many reputable vendors. The generally accepted practice of delivering software designed for open platforms to be installed by the customer may be up for review. When you examine the details of what it takes to sell, provision, manage and rely on a piece of software, the customer increasingly prefers closed-end hardware to open-platform software. On top of this, for a start-up, this "software in a box" path is actually more cost-effective and easier to execute.