Pakistan Inc. -- The IT Industry Edition

Tuesday, May 03, 2005

Software Development in Pakistan: Lessons From The Trenches

Software Development in Pakistan: Lessons From The Trenches
By: Athar Osama

In the first of this series of articles, we looked at a statistical snapshot of software development in Pakistan. While our sample is not representative of the entire software industry in this country, it nonetheless includes a vast majority of the more significant players on the Pakistani software scene. Hoping to develop a better understanding of the structure and dynamics of the Pakistani software scene, not only facilitate investment and entrepreneurial activities but also to better inform public policy debate, we reported a number of fairly interesting findings. For example, although last year has seen considerable growth in both revenues and employment, Pakistan’s software industry is still going through a period of early-stage development and shows lack of maturity in many respects—that is only recently beginning to change. The most significant evidence in support of the above, that the study was able to bring to light, was lack of differences between domestic and export-focused software operations, between product and services-focused operations, and between pre- and post-dotcom operations—differences that one would have expected in a relatively mature industry.

We also found the prevalence of several best “managerial” best practices that differentiates the relatively better performing software houses from the not-so-good performing ones. The study, however, failed to find significant differences in technical practices of the better performing software operations as compared to not-so-good performing ones thus calling into question the assertion whether quality of software development processes makes a difference in the successfulness of a software operation. Indian software firms have been renowned in their ability to continually improve their processes through wholesale adoption and implementation of western process management approaches, like Six Sigma type approaches of the General Electric and Texas Instruments fame. No wonder then that major portion—as many as 50-75%--of the global CMM-SEI level-5 certified software operations are based in India. Indeed, a recent study by Dr. Michael Cusumano of MIT—a keen observer and researcher of software development best practices around the world—highlighted the fact that Indian software development operations have been especially successful in melding together older software development process approaches with the relatively newer ones in a manner that have made distinct and competitive.

While our own lack of finding is certainly a shortcoming of the study it cannot be perceived as an indictment of the industry. Certainly “lessons from the trenches” belie the simplistic conclusion of the statistical on that particular point. More research is certainly needed to understand the role of process quality in the development and evolution of Pakistani software industry. In this second of the two pieces drawing upon the results of the study, we highlight some of the lessons learnt from over 65 interviews of the leaders—CEOs/CTOs/Directors—of at-least 50 of the industry’s major players.

Before we do so, however, we must lay out an organizing framework for this discussion. We attempted to organize software companies within a smaller number of distinct groups—based on their salient characteristics. The purpose for this classification was to allow us to draw generalizations across the experiences of a large number companies into a set of prescriptions for the industry as a whole. Drawing from the qualitative insights of interviews and statistical findings, we devised a four-part taxonomy of generic software business models. The four sub-classifications were named after their most prominent examples, including: Export-focused Local Firm (“Systems” or “Netsol” Model), Domestic Focused Local Firm (“TPS” or “LMKR” Model), Export Focused Foreign (Expatriate) Firm (“Techlogix” or “Etilize” Model), and Dedicated Development Center (“ITIM” or “Clickmarks” Model). These generic models are explained, through the help of a graphic, in Figure-I. It is also important to mention here that none of these categories are as black-and-white as they seem. There is considerable gray area in between and a company might show characteristics of more than one type of generic software business model at a given time.

We present a snapshot of each of these generic software business models and identify key strategic challenges for each—13 in all for the entire industry. While we discuss each of these strategic challenges in the context of the generic software business model to which it is most relevant—they may be common across several (or all) of the business models. Readers seeking to thoroughly understand the strategic challenges faced by Pakistani software industry are hence advised to read through all four descriptions and their respective strategic challenges (thirteen in all) to get a better feel of the landscape as each contains some elements overlapping with others.

Before we begin this discussion on the taxonomy of generic software business models, it is important to highlight its several qualities and characteristics—as well as its proper and improper uses—to allow the readers to put this taxonomy in its proper perspective.

Firstly, the taxonomy gives us a relatively easy and comprehensive way to classify a particular software operation into a broad enough category of organizations, giving us a reference point to compare ourselves against, and quickly begin looking for certain organizational features, managerial characteristics, strategic challenges, and critical success factors that might apply to our own experience. This act alone somewhat simplifies the complexity of the Pakistani software scene narrowing down the search for comparables to look at or seek advice from.

Secondly, it is important to understand the fact that none of these generic software business models are inherently good or bad—just that each has its own place in the overall scheme of things. It is somewhat meaningless to compare firms across business models. It takes a fairly different set of initial conditions and skills to start, and overcoming a different set of challenges to successfully execute upon each. Each of these models, however, have better-performing and not-so-good performing firms within them and what one can do, again to a degree only, is to compare the performance of a firm against another within the same category.

Thirdly, while transitions between the generic business models are possible—they are not automatic. Depending on what a firm intends to do (its unique idea-offering-destination mix), there is a right model to look at and adopt. Although it may seem natural for a specific firm to transition from a domestic-focused firm to an export-focused firm, it is not automatically logical for every firm and certainly not for the entire industry to make that transition. One can remain within a particular model and aspire to be best in class within that model. An entrepreneur-investor must, therefore, clearly understand model implications, scalability challenges, and transition possibilities, before starting a firm.

Finally, it is important for aspiring entrepreneurs and business leaders and managers of existing ventures to understand the strengths, weaknesses, pre-requisites, and structural limitations of each of the generic software business models. They must vet their ideas through the lens of these business models and ensure that they fully understand their various dimensions and then adopt one that bests fits the idea-offering-destination profile of their venture and their short and long-term aspirations from the same. Understanding the model limitations is critical to the long-term growth of firms and the industry as a whole. Depending upon the circumstances and the goals and aspirations of the founders, many firms—trapped in the structural limitations of a particular model—try to outgrow it by doing more of the same.

Following is a brief discussion on each of these four sub-categories of models.

1—The Export-focused Local Firm (“Systems” or “Netsol” Model) is one founded by a predominantly Pakistan-based entrepreneurial team (that may or may not have been aided/encouraged by a group of expatriates), but with an explicit purpose of exporting software products or services. Within our own sample, it accounts of about a third (32%) or 16 of the 47 firms in our sample. Majority of the firms established in pre-DotCom Bubble burst era with an expressed purpose of exporting services to North America and Western European countries fall in this category. Although there are some that have taken the products route, their numbers are relatively smaller than those focusing on export of services. Many such firms have been created post-DotCom Bubble burst as well. Some salient examples of this type of business model in action are: ThreesixtyDegreez, Post Amazers, Advanced Communications, Makabu, Netsol, and Autosoft Dynamics etc.

The most defining feature of this class of companies, namely, the local-presence of their founders and the export-orientation of their products/ services, brings a number of unique and important challenges to this type of a firm. The most important of these strategic challenges, or critical success factors, is the ability to establish a first contact and a long-lasting linkage with the foreign customer. Gaining a foothold in the foreign market, signing up a first customer, and then quickly diversifying ones’ customer base has been a major challenge as well as a differentiator between successful and not-so-successful companies. A somewhat related challenge has been the setting up of a front-office abroad, generally for the purpose of marketing but also customer support etc. The dominant strategy here has been to set up a marketing office—manned by Pakistani or foreign staff. Not only is the cost of setting up a marketing operation in a foreign market prohibitively high (in $0.5M a year range for the smallest of the operations), it also hasn’t always paid off as per the expectations. An industry good practice is to consider other, more cost-effective, approaches like marketing alliances and reseller agreements as possible alternatives to front-office-type arrangements. These are especially suitable for smaller startup type operations. The aspiring entrepreneurs must look for such partnering opportunities and use them to their advantage.

A third strategic challenge (or critical success factor is the ability to understand a foreign domain and context—a factor made complex in this context by the geographical and cultural difference between the customer and the seller. For majority of these challenges, a regular expatriate connection (through a foreign/expatriate co-founder) and/or face-to-face visits to foreign clients and their markets certainly help. But more importantly, even the realization that one faces a particular challenge (e.g. understanding a foreign domain or diversifying the customer base) that needs to addressed would go a long way in getting one to the path of seeking the right kind of help/partnerships/arrangements. Having definite, well-thought-out, strategies in place could determine the difference between success and failure of an export-focused local software operation.

2—The Domestic-focused Local Firm (“TPS” and “LMKR” Model), with an exception of a few companies, is really one because of circumstances rather than choice. 14 of 47 (or 30%) of our respondents fall into this category. More often than not, and logically so, the domestic-focused local firm plans to export its products or services abroad and is merely using the domestic market as a vehicle to gain a track record with real life customers. Whether a firm is in this category by choice (“I’ll do domestic first, export later”) or by circumstances (“Since the export market doesn’t seem very good right now, I’ll survive by selling at home”) the strategic challenges are quite similar. Among the companies being established in this category, we see a much greater domain focus than the earlier category (discussed above). The primary reasons for this is that, unlike the exports segment, there is little or no lure of pure software programming (or coding) “services” on the domestic front. Thus everyone must be in the business to solve a fairly well-defined problem or not be in the business at all. This has led to a much faster accumulation of domain knowledge, maturity and perhaps, to some degree, better and more focused business strategies to start with in the first place. Some salient examples of this type of business model in action are: 2B Technologies, ZRG, TPS, Lumensoft, Yevolve, SI3, Softech Systems, AppXS, and Genesis Solutions

That this type of firm enjoys some advantages vis-à-vis the export-focused firm does not, however, mean that they don’t face serious strategic challenges. The most serious challenge this firm faces has to do with operating in an under-developed domestic market. There are many manifestations of this problem, namely, a psychological price barrier, lack of buyer-user awareness, lack of business volume, dealing with the seth mentality, and little appreciation of the value of software etc. We allude to a number of critical success factors and industry good practices to counter this strategic challenge, namely, avoiding the herd mentality, focusing on better developed segments of the market (e.g. financials, telecom etc.), correctly estimating the difficulties of “creating” a demand, making a business case rather than selling a technology, using innovative pricing strategies, and operating on the innovative end of the product-services spectrum etc.

Another major challenge for this category of firms is getting access to venture, expansion, and working capital. For a variety of reasons having to do with lack of demand, perception of success, and inability of financial and software communities to understand each other’s perspectives, domestic-focused local firm suffers from serious shortage of capital. Consequently, a realistic estimate of capital required to execute a business idea and a realistic fundraising strategy, through external or internal sources, is a critical ingredient of successful operations. A third major challenge for a domestic-focused firm is having a clear domain focus and a solid businessplan—and adaptable but solid businessplan—to start with. Box # 1 clearly identifies some industry good practices used by relatively more successful companies to address these issues.

3--The Export-focused Foreign Firm (“Techlogix” or “Etilize” Model) is one founded abroad (or jointly, in Pakistan), by a predominantly foreign (usually, an expatriate) entrepreneurial team, with an explicit purpose of using the Pakistan-based offshore development facility to deliver a product or service demanded by the foreign market. 7 of the 47 (15%) companies in our sample fall in this category. This type of business model has been adopted by services and product-focused companies alike. Some salient examples of this type of business model in action are: Elixir Technologies, Etilize Inc., Ultimus, MixIT, TechLogix, Prosol, and Xavor etc.

While companies in this class of software business models enjoy several advantages over those in earlier discussed categories, namely, quality of due-diligence on the basic idea, foreign contacts/networks of founders, and better access to capital etc., there are significant challenges as well. The most important challenge facing this class of companies is to deal with the “image” problem. Simply speaking, foreign entities—for reasons having to do with negative perception of the country or geopolitical environment of the world/region—are reluctant to do business with a Pakistani entity. While there are a number of things that can and must be done at the public policy level to address or atleast counter some of these concerns, several good practices of companies trying to address these issues on their own also emerge from the study (see the study for detailed findings).

Another significant challenge is the geographical shifting of the “labor arbitrage” argument whereby as the outsourcing movement matures, newer (less problematic) regions with even cheaper labor come into the competition with the more established ones. The example of Dubai (for it accessibility and investment and HR-attractive policies) and China (for its cheap and abundant labor and large domestic market) are cases in point. Consequently, the Export-focused foreign firm must adopt active strategies to continually counter the threat of becoming non-competitive in the market of cheap labor. Several good practices emerge from our sample of respondent, including but not limited to, developing domain expertise to lock-in customers, relocating part of the production activity to cheaper havens (e.g. Beijing, Dubai, the Philippines), climbing up the value chain, and automating their own systems to remain cost-competitive.

A third key challenge that the export focused foreign firm shares with companies in other generic business models is that of scalability of Pakistan operations. There is a widely perceived and talked about psychological barrier of 200-people in Pakistani software industry. Although the exact number is immaterial, what matters here the fact that the 20,000+ employees of the top companies of our closest competitor—India—dwarf the size of our entire industry. The largest Pakistani company in our sample is not even 2.5% the size of the largest Indian company—putting a big question mark on our ability to deliver serious large-scale projects. Companies face formidable supply (HR availability, lack of middle/project managers) and demand (inability to predict demand and hence scale up) side challenges in this regard.

4—The Dedicated Offshore Development Center (“ITIM” or “Clickmarks” Model), as the name suggests, is a fairly limited offshore operation of a foreign company. 7 of the 47 (15%) of the companies in our sample fall within this category. The dedicated development center is different from the Export-Focused Foreign (Expatriate) Firm in the sense that it is often an “add-on” to an already existing company whose strategic and managerial processes and controls are quite well-established. Due to its unique nature (i.e. limited scope and say within the parent’s strategic processes) it faces a number of challenges that are distinct and different from the earlier-discussed category. The nature and extent of the challenges also differ between the various phases of the entities life-cycle. Some salient examples of this type of business model in action are: MetaApps, ITIM Associates, Clickmarks, Trivor Systems, and Strategic Systems International etc.

The initial set of challenges encountered by entrepreneurs trying to set up a dedicated development center generally have to do with the actual setting up of a Pakistan operation and doing it in a manner that minimizes the disruption to the foreign operations of the parent company, putting in place a quality software development team that understands the foreign domain, quickly learns the parent’s corporate culture, and is both capable and motivated to deliver a quality product or service to an unseen entity. These challenges, however, are not insurmountable and a number of companies are using fairly good and innovative practices to effectively respond to the above-cited challenges.

The most important of the strategic challenges facing a dedicated development center type operation, however, is that of effectively managing the parent-subsidiary relationship. This is essentially a challenge that, unlike those discussed above, presents itself in the later (more mature) stages of the subsidiary’s life-cycle. It can, however, be addressed somewhat painlessly by planning for it at the very inception of the parent-subsidiary relationship. What actually happens is that, owing to the rather limited scope of the development center operation, there can come a time in its life when its interests may diverge from that of the parent company resulting in organizational confusion, serious management tension, and a loss of employee morale.

We find a number of companies in our sample suffering from such a “midlife” crisis and struggling to remain “purposeful” in the overall scheme of things. Despite being the most technically sound operations, they also faced serious bottlenecks vis-à-vis revenue and employee growth. There are many industry good practices that one can adopt to effectively counter this serious challenge, namely, diligently working out a “written” parent-subsidiary agreement to avoid later confusion and heartburn, providing the subsidiary with a voice in the parent’s strategic processes, allowing the subsidiary the freedom to seek other business, having separate top-management for the parent and subsidiary etc. In addition to these model-specific challenges, this model shares several other challenges and critical success factors with the rest of the industry but more specifically with the export-focused foreign firm model.

By using the lens of this four-part taxonomy of generic software business models, we can greatly reduce the complexity of the relevant organizational landscape. Pakistan’s software industry comprises a handful of different types of firms that face a remarkably common set of strategic challenges. While some of these challenges may be unique to the particular idea-market mix that a particular firm is targeting others are common across firms within a generic business model and the industry as a whole. As Pakistan’s software industry attempts to hasten its move up the “learning curve”, its executives must pay attention to the shared experience of the successful and not-so-successful entrepreneurs among them. While many of these problems are substantial and hence may requires years of hardwork, planning, and execution, it is refreshing to know that a number of companies have found ways to get around these in one way or the other and are willing to share these insights with others. The study highlights the thirteen strategic challenges and twenty-five industry best practices that industry leaders would find worth their while to think about and implement.

Athar Osama, the author of the PSEB Study, is a Science and Technology Policy Analyst based in Santa Monica, California. He maybe contacted for comments and queries at Athar.Osama@gmail.com

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