Choosing Foreign Markets in the Software Industry

Choosing Foreign Markets in the Software Industry

Whitepaper from TBK Consult

AuthorHans Peter Bech, M.Sc. (econ)

© Hans Peter Bech 2014

First edition

Unless otherwise indicated, Hans Peter Bech copyrights all materials on these pages. All rights reserved. No part of these pages, either text or images may be used for any purpose other than personal use. Therefore, reproduction, modification, storage in a retrieval system or retransmission, in any form or by any means, electronic, mechanical or otherwise, for reasons other than personal use, is strictly prohibited without prior written permission.

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The copyright of other frameworks and information sources mentioned in this whitepaper belongs to the proprietor quoted.

All TBK Consult documents referred to in this publication are available from the TBK Publishing® website.

Published by TBK Publishing® (a division of TBK Consult Holding ApS)Denmark CVR: DK31935741www.tbkpublishing.com

TBK-WIPA-019ISBN: 978-87-93116-11-5

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Choosing Foreign Markets in the Software Industryw

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Targeted audience 4

Abstract 4

Author 4

Acknowledgements 4

In Which Sequence? 5

The Level of “Touch” 6

What is Different in Foreign Markets? 7

The Ideal Market Profile 7

Macro Criteria 8Bech’s 1st Law 9Bech’s 2st Law 9Culture 10The World Value Survey 11The Hofstede Centre 12Other Generic Information Sources 12

The Long List 15

Market Reports 15Market Potential 15Market Requirements 15The Competitive Situation 16

The Short List 16

Market Assessment 16

Market Selection 17

Industry Analyst Reports 17

Opportunities 17

A Final Note 18

About the author 19

Table of contents:

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The target audience for this whitepaper is the board of directors, the CEO, the business development and the sales and marketing executives of software driven companies1 with ambitions for achieving global market leadership. The whitepaper primarily addresses the challenges of B2B software companies with long value chains.

This whitepaper discusses how to choose foreign markets.

Entering a foreign market in the software industry is a very strategic decision. Finding, winning, making, keeping and growing customers in foreign countries requires establishing infrastructures, which can drive the marketing and sales processes as well as the implementation and support activities. Customers in foreign markets will be reluctant to do business with us unless we can demonstrate a solid commitment for the long haul. A competitive product is not enough.

A B2B software company with small market share in many countries will suffer from economy of scale disadvantages until they have grown these market shares past the 20% mark in each market. The lion’s share of the value generation of B2B software takes place inside the foreign markets and not where the programmers of the software core are located.

This whitepaper provides an introduction to the selection process and to those sources of information, which can help software companies make informed decisions for entering foreign markets and thus prevent very expensive and sometimes “deadly” failures.

Hans Peter Bech, M.Sc. (econ.)

Design and lay-out: Flier Disainistuudio, Tallinn, Estonia, www.flier.ee

Proof reading: Emma Crabtree, [email protected]

1 Independent Software Vendors (ISVs)

Targeted audience

Abstract

Acknowledgements

Author

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The software industry is by nature a global industry.

Just make an inventory of the software you use personally and in your business. You will see that it comes from all over the world. If you look closely you will realize that a lot of the software products you use are based on other software products, which have even many more countries of origin. Hidden in the small

print in the “about” note or the Software License Agreement (that none of us reads) we find the nationality of the people who actually wrote some or all of that software and the list of countries grows.

However, a Finnish software company using Estonian programmers or a piece of code written in New Zealand doesn’t make the Finnish company an international company.

Selling the software or the services that the software enable as an independent brand in foreign markets is what we consider “internationalization.”

In our whitepaper “Entering Foreign Markets in the Software Industry2” we explain why the software industry is global and why software companies in the long run cannot survive serving a local market only. Most software companies are fully aware of this fact and one of the first questions we get in our consulting work for software companies is:

“Which markets should I choose?”

This whitepaper will provide the framework for identifying and ranking those markets that most likely will provide the best profit/investment ratio in a 10-15 year perspective.

2 TBK-WIPA-018

In Which Sequence?

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What about the short term?

Entering foreign markets is not a strategy for short-term growth. Entering foreign markets to stimulate short-term growth is bound to fail. As we describe below any ambition behind a global expansion strategy must be based by achieving market leadership.

Be systematic and patient: Rome wasn’t build in a day.

The software industry makes it possible to run business models with no or very low “touch” customer relationships. No or low touch refers to the absence of individual and physical contact with the customer3. No or low touch software (and Internet) based business models may not be concerned with internationalization in the traditional sense until they have saturated their English

(or Chinese or Spanish) speaking markets. Having done so they have normally gained enough momentum and cash to take on other markets. This whitepaper is not about these business models that are representing only a small fraction of the software industry.

This whitepaper is about high and very high touch business models, where engaging with customers requires localized products, local marketing, sales and support infrastructure.

3 Please note that customers and users are not the same. Customers always pay for a service, while users may not pay. Facebook have 1.2B users not paying for the service they receive. Facebook’s customers are primarily advertisers and Facebook must have local offices servicing these advertisers.

The Level of “Touch”

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Such business models have long sales cycles (>6 months) and the “whole product4” is a typically a combination of our software, of other (software) products and of customer specific services. Such business models represent the vast majority of companies in the software industry.

In our whitepaper “Entering Foreign Markets in the Software Industry” we present a framework for identifying those characteristics that may change as we move into foreign markets. We introduced Alexander Osterwalder’s business model environment framework for identifying those issues that have an impact on our business model.

If we had 100% visibility into all markets then how would we rank them?

To answer the question “which markets should I choose?” we must first explore which market properties we should add to the equation.

Just as we define ideal customer profiles (and ideal partner profiles) we must also define ideal market profiles. We cannot find and prioritize markets unless we know what we are looking for and how we should value or rank the various characteristics.

4 A term invented by Regis McKenna: A whole product is a generic product (or core product) augmented by everything that is needed for the customer to have a compelling reason to buy. Source: http://en.wikipedia.org/wiki/Whole_product

The Ideal Market Profile

What is Different in Foreign Markets?

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TBK Consult has developed an approach5 that recommends identifying 10-20 key characteristics for measuring market attractiveness. Such characteristics can be anything including size of key market segments, available channels, competitive situation, market requirement characteristics, etc.

While these characteristics can be used in benchmarking potential markets against each other they do not answer the question of which markets to consider in the first place. Bringing the number of potential markets down from the theoretical 220 countries available to a more manageable list must be based on some high level considerations.

Gaining market insight is costly and time consuming, thus we need to qualify markets on a few readily available characteristics narrowing down the list to 5-10 countries where we can invest in Market Reports and Market Assessments before making the final investment decisions.

The process of reducing the options from the 220 countries available to the “best few” has six simple steps.

Our business model and our business model environment will provide us with some high level criteria which will help us in qualifying markets and will produce the long list of countries that could be potential markets.

I recommend starting the process by applying Bech’s 1st Law and Bech’s 2nd Law.

5 Please see the factsheet Ideal Market Profile TBK-PFFS-007

Macro Criteria

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Macro Criteria

Long List

Market Reports

Short List

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3 Market Assessment

Market Selection

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Having worked and sold software in most corners of the world I have come to realize what I now call Bech’s 1st Law6.

This phenomenon complies with the economic principles of social physics, which explains why most countries in the world have their immediate neighbours as their most important trading partners.

A software company located in Copenhagen can reach the Nordics and most of the Central European markets within 2 hours. There is a maximum 1-hour time difference in each direction making communication convenient.

23% of the global demand for software and software related services is represented within 2 hours flight from Copenhagen. However, it is spread across 24 countries with 22 different languages.

The advantage that software companies from smaller countries enjoy is their experience with operating in market environments substantially different from their own home turf. Combining this experience with business acumen can outsmart even the large investment budgets that software companies from bigger markets enjoy.

Social physics remains a good guideline for short-listing foreign markets in the early days of internationalization even when the neighbouring countries are small markets.

I admit that my perspective is biased by my experience. My operational experience has mainly been gained taking software companies from small domestic markets to bigger international markets.

That’s going global on a shoestring.

6 http://tbkconsultblog.com/2013/09/05/entering-a-foreign-market-the-recipe-for-sucess/

Bech’s 1st Law

The cost of sales increases exponentially

with the distance to the foreign market.

Bech’s 2st LawBigger markets are more difficult than smaller markets

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Getting 20% market share7 in Norway comes much faster than the 20% in Germany or France8 (not to speak of the USA).

With unlimited resources any software company would choose the bigger markets first and then move to new markets determined by market size.

If you are short on funds and resources you will prefer a small market with an immediate fit as opposed to a large market with a poor fit. You will dream of the large market with the perfect fit, but with limited funds big markets are always tougher to conquer irrespective of how good you believe the fit is.

Table 1 lists the 25 biggest markets for software and software related services in world9.

A strategy based on taking the markets according to their generic potential would direct all the software companies in the world to the USA first. The reason this is not happening is exactly due to Bech’s 1st and 2nd Laws.

The history of the software industry is full of horror tales of companies losing massive amounts of money attempting to capture the US market. One of the most prominent examples is Swedish Intentia’s attempt at the end of the last century. In spite of investing heavily for more than 5 years Intentia never managed to grow the share of revenue in the US to more than 4% of total

revenue before Lawson acquired it in 2005.

Big markets look tempting from the outside, but are very difficult to penetrate.

The top 25 markets are spread all over the world, represent at least 15 different languages and are located in very different cultures.

Measuring culture characteristics and assessing which challenges they will represent are obviously very difficult.

7 20% market share is considered the tipping point where market dynamics change in our favour and an increasing pull effect is created.8 Unless there is a dominating Norwegian competitor blocking the market!!9 Source: http://www.tbkconsult.com/services/bech-index-2012/

Culture

Table 1: The 25 biggest

software markets in the world

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Culture plays an important role in how we can undertake the tactical implementation of our business models. The further away from our cultural origin we come the more we will have to listen to and rely on local people or people who have specific cultural insight.

There are two sources for cultural insight that I will mention here.

The World Value Survey10 measures, monitors and analyzes: “Support for democracy, tolerance of foreigners and ethnic minorities, support for gender equality, the role of religion and changing levels of religiosity, the impact of globalization, attitudes toward the environment, work, family, politics, national identity, culture, diversity, insecurity, and subjective well-being11.”

The World Value Survey produces the map shown in Figure 1.

10 http://www.worldvaluessurvey.org 11 http://en.wikipedia.org/wiki/World_Value_Survey

Figure 1: World Value Survey

The World Value Survey

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The Hofstede Centre provides a very practical service comparing various cultures and countries with each other on the following dimensions:

Power distance xIndividualism xMasculinity xUncertainty avoidance xPragmatism xIndulgence x

An example of a Hofstede comparison is illustrated in Figure 2.

The differences between cultures are substantial and values can be directly reversed from one culture to another.

Although most business models will work in most cultures (business is business) the tactical implementation can be very different. Ignoring cultural differences in the tactical implementation can make business models that are successful in one country fail completely in another country.

There are several readily available sources of information for comparing the countries in the world. Most of these sources are available free of charge and can be very useful when preparing for strategic globalization decision-making.

The Hofstede Centre

Other Generic Information Sources

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8

38

80

49

12

65

14

50

34

59

70

PowerDistance

Individualism Masculinity UncertainlyAvoidance

Pragmatism Indulgence

Brazil

Denmark

Figure 2: Hofstede Cultural Comparison

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The CIA maintains and publishes an impressive almanac12 with detailed information on each country in the world.

The CIA World Fact Book is updated regularly and is an excellent source of information on even the smallest countries in the world.

The CIA database is also available as an app for smart phones and tablets.

Kudos to the CIA and the US government for making this service available to all of us.

The World Economic Forum is mostly known for its’ Davos summit meeting in January attracting top decision makers

from government, business and NGO’s all over the world. However, the organization also provides a rich repository of reports valuable for market entry considerations.

The Global Competitiveness Index is a relevant source of input for choosing foreign markets.

High touch and very high touch software is mostly focused on optimizing business processes or personal productivity. The incentive to invest in improved productivity is affected by the competitive pressure and the cost of labour. The demand for B2B software is therefore much higher in countries with a high cost of operation, especially high labour costs.

As you can see from the Global Competitiveness Index there is a very strong positive correlation between a nation’s competitiveness and the cost of operations in that country.

As a rule of thumb competitive countries are more attractive markets for high touch and very high touch B2B software. Companies operating in countries with high operating costs are constantly on the outlook for, and thus much more receptive to, productivity improvement investments than companies operating in low cost environments.

12 https://www.cia.gov/library/publications/the-world-factbook/

The CIA World Fact Book

The World Economic Forum

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Another benefit of high cost and high competitiveness countries is the prices we can charge for our products. While the focus of low cost and low competitiveness countries is on low absolute prices13, the focus in high cost and high competitiveness countries is on price/performance, stability and quality.

The Organization for Economic Co-operation and Development (OECD) is an international economic organization of 34 countries founded in 1961 to stimulate economic progress and world trade.

The OECD publishes a vast amount of reports and statistics, which can be very useful in market entry considerations. All titles and databases published since 1998 can be accessed via OECD iLibrary14.

The country reports, especially, provide detailed insight and forecast on all macro economic parameters including rich commentary on issues that may be important for assessing a foreign market.

Each nation in the world has a statistical bureau. They produce vast amounts of data. Some of it may be very relevant for our market entry decision-making. The statistics often include the number and size of companies in various industries according to NACE or SIC codes. Such data may give us a good indication of the market potential.

Most governments15 in the world allocate funding that supports export activities and attracting foreign investors. These organizations, which are typically organized under the Foreign Service Administration and The Ministries of Economy and Economic Development, also produce vast amounts of reports.

It is highly recommended to get in touch with the Investment Attraction Organization in the countries considered, as they

13 This is reflected in the Big Mac index published by ”The Economist” http://www.economist.com/content/big-mac-index 14 http://www.oecd-ilibrary.org 15 On the federal, national and even the local level

OECD

National Statistical Bureaus

Export Associations and Investment Attraction Organizations

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will normally be very motivated in helping fi nding relevant information about their region.

The long list should include no more than 10 countries. As soon as you have decided to enter a new market you can review the list and add more countries.

A Market Report is a fast desktop research survey aimed at identifying issues that may make market entry risky or attractive. We need to know more about the specifi c business model environment in the market especially the following issues:

Market potential xMarket requirements xThe competitive situation x

Estimating the market potential will help us answer three critical questions:

Is there a signifi cant market matching our key market x segments?

What market penetration investments are required to x make it to the 20% market share?

Entering foreign markets must have the objective of achieving market leadership. The fi rst milestone is the 20% market share also called the tipping point. Passing the tipping point will change market dynamics in our favour. The market will start pulling and our cost of sales will decrease, our margins will increase, economy of scale will kick in, profi tability will increase and our barriers against competition will improve.

Before entering the market we must invest in meeting threshold market requirements. Most markets have certain local requirements that we must meet to comply with the legislation and be considered by potential clients. These requirements can be based on language, locale16, local legislation, market traditions 16 Locale is a set of parameters that defi nes the user's language, country and any special variant preferences that the user wants to see in their user interface. Usually a locale identifi er consists of at least a language identifi er and a region identifi er. http://en.wikipedia.org/wiki/Locale

The Long List

Market Reports

Market Potential

Market Requirements

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or by the competitive alternatives available.

The Market Report should help us estimate the investments required to meet the thresholds.

The most determining opposition against market entry is the competitive situation.

In general the B2B software industry does not allow for brutal force market entry17. Market entry requires that we have significant competitive advantages justifying the switching cost for the customers. In addition our approach and behaviour must convince the customers that we are a better alternative in the long term and that the risk of engaging with us is low.

The Market Report must give us a first picture of the competitive situation allowing us to qualify the market for further analysis.

The Market Reports will help us reduce the long list to 3-5 markets.

Before we can make the final selection we need to perform a Market Assessment.

The Market Assessment is based on in-market interviews with potential customers and market stakeholders such as analysts and consultants.

The objective of the Market Assessment is to assess if we can define a position in the market where we can compete successfully. Particularly important are the interviews with a significant number of potential customers showing if there is sufficient movement in the market and if our value proposition is strong enough to compete against the incumbents as well as other potential insurgents.

17 “Brutal force” is the situation where market entry is made through massive investments in marketing and sales against competitors with products of equal value.

The Competitive Situation

The Short List

Market Assessment

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With 3-5 Market Assessments we should now be able to make the final priority, define the Go-to-Market strategy, develop the action plan, allocate the budget and start the work.

The path to success is not linear and we will have to adjust the course as we learn more about how the market embraces our value proposition.

You may have noticed that I haven’t mentioned Industry Analyst reports from companies such as IDC and the Gartner Group. Industry Reports may give us some indication of market trends, forecasts and market shares on a global or national scale, but they are mostly not detailed enough to serve us with data for entering foreign markets decision-making.

Any B2B software company should invest time and effort in being included in the analysts’ report. It is especially important to be included in Gartner’s Magic Quadrants. Customers look to the analyst’s reports and those software companies appearing in the reports use them against the competitors that are not included.

However, for making decisions on entering specific geographic markets, Industry Analyst reports are mostly of little value.

It occasionally happens that a market finds us and not vice-versa. We stumble upon an opportunity that seems to open a market for us with little investment required and a promise of a very short time to revenue. Such opportunities come to us when we attend exhibitions and conferences, show up as unsolicited inquiries on our web site, may come through our personal networks or may be initiated by a government sponsored incentive program.

How do we handle such opportunities?

From my own experience with more than 30 years in international software operations I will give opportunities a 10% success rate. 90% of the opportunities will turn out to take much more time than anticipated, requiring much more investment than anticipated and end up in a dead end.

The only way you can increase the success rate of opportunities is to disqualify most of them as early as possible.

Market Selection

Industry Analyst Reports

Opportunities

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My recommendation is to formulate a firm set of criteria against which you qualify all inbound and unsolicited opportunities. The best approach is to add the opportunities from such markets to your list of potential markets and take them through the exact same process as you perform on those markets you select yourself.

Remember that the biggest cost of opportunities turning sour is not the loss of the opportunity, but the suffering of those strategic alternatives that you consciously or unconsciously decided to deprioritize in the mean time.

Your country of origin obviously makes a very big difference. A software company in Estonia has a domestic market representing 0,03% of the global demand for software and software related services. A software company in the USA has a domestic market representing 35,41% of the global demand. Although the US market is spread over a much larger territory, moving from one town to the next or from one state to the next is much easier than moving from Estonia to Latvia, Finland or Poland.

The determining factor in this context is the resources a software company can invest in the internationalization effort. In general US software companies can gain substantial momentum domestically allowing them to invest at a much higher level than their competitors originating from the smaller countries. This whitepaper was written for SMB software companies18 with limited resources and who are thus much more vulnerable when making even small mistakes.

With smaller budgets you have to be smarter. You don’t have to be big to be smart.

18 The SMB definition of the European Union includes companies with up to 250 employees.

A Final Note

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About the authorHans Peter Bech has been engaged with international sales and marketing operations in the software industry for more than 30 years.

Hans Peter was instrumental in building the international business platforms for companies such as Dataco (now Intel), Mercante, Dansk Data Elektronik (now CSC), RE Technology (now Barco), and Damgaard/Navision (now Microsoft).

As a management consultant Hans Peter has been providing consulting on internationalization to companies such as Microsoft, Danfoss, Proekspert, Jeeves Information Systems, eMailSignature, SoftScan (now Symatec), Netop, EG A/S, CSC Scandihealth and Secunia.

Hans Peter is an advisor to IMMIB, the Turkish ICT Exporters Association. He also lectures in internationalization at the Sabanci University in Istanbul, Turkey.

Hans Peter is the author of several whitepapers on internationalization in the software industry and he frequently writes articles on the subject.

He started his career as a management consultant in 2003 and founded TBK Consult in 2007. Since then he has built the company to its present position with 25 senior consultants in 16 countries.

Hans Peter oversees the development of TBK Consult as well as performs management consulting assignments for selected clients.

Hans Peter holds a M.Sc. in macroeconomics and political science from the University of Copenhagen. He speaks Danish, English and German and is a certified ValuePerform, ValuePartner and Business Model Generation consultant.

More about Hans Peter Bech

TBK-WIPA-019

http://dk.linkedin.com/in/hanspeterbech

Choosing Foreign Markets in the Software Industry

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