IT: The Price Is Right?
Buying information technology (IT) has never been easy. The Internet, with its barrage of new business services and pricing formulas, has made it a whole lot more challenging.
Driving the pricing revolution is a big shift to services and away from IT products. Most manufacturers are baffled—if not downright leery—as regards how these services are priced. They must, nevertheless, come to grips with this new reality. Services are becoming the primary delivery mechanism for huge portions of IT.
Underlying the pricing confusion has been the subtle shift in what IT does. Traditionally, manufacturers bought systems and software for standalone applications, like payroll and shop-floor control. In the last two years, however, IT is starting to play a whole, new business role. It is interconnecting firms and thereby enabling new trading-partner practices. To function in this new role, IT vendors are starting to sell new business capabilities as a service.
Manufacturers have no or little experience buying IT in this manner. Instead of making the familiar one-time purchase, the manufacturer is asked to pay a monthly usage fee. Management is asking tough questions when presented with such purchase recommendations:
- What will we really own?
- How do we determine return on investment (ROI)?
- How much is it really worth?
- What are we paying for?
- How do we explain to our boss these recommendations?
Some of these new services, such as auctions, give a manufacturer instant access to an entire community of new trading partners. What is this worth? Will new business really materialize? What is a fair price to pay the service vendor for this new capability?
Many managers fiercely resist what they see as excessive pricing in some of these new service models. In particular, they do not want to share cost savings or new revenue generation in perpetuity with an outside vendor. They view such an arrangement as allowing another firm to install a toll booth on their core business processes and exact a tax on routine transactions. Bred by surviving on the thinnest of margins, many automotive managers find such arrangements as intrinsically repugnant, regardless of the payback.
A step back in history, however, shows sweeping changes in the IT industry, its pricing and the business context it serves. These changes have been in:
- The expected longevity of a system
- The connectivity to other systems and firms
- The infrastructure it operates on
- The number of interfaces it must connect to
- The stability of the auto industry itself.
In the 1970's and 1980's, software was expected to last almost forever. Indeed, Ford Motor Company has some core, business software still operating that is over 20 years old.
Until the last decade IT and the business processes it served changed relatively slowly. For instance, SAP's R/2 product had a 10-year run and SAP's follow-on product, R/3, is already over 10 years old. Hasso Plattner, SAP's co-founder, likened SAP's product life cycles to that of a Boeing 747.
Software pricing was far different in its early days as well. Most software until 1970 was included free of charge by the hardware maker (namely IBM) to consummate the hardware sale. In the 1970's the first independent software vendors started selling one-time licenses, typically for a single computer. The emergence of workstations and PCs led to multiple-seat licenses. Next on the scene were enterprise resource planning (ERP) systems. Many commanded a huge, up-front, purchase price with the belief the system would automate the enterprise for decades.
Those days are gone. No one believes these assumptions anymore. A far different reality greets today's IT user and buyer.
First, the pace of change in IT has gone up exponentially. Its product life cycles have dropped from decades to months in many cases. For instance, Scott McNealy, CEO of Sun Microsystems, said dotcom companies are throwing out all their assumptions every three weeks.
Another major change has been in connectivity. Past systems operated essentially on a standalone basis. There were minimal or no connections to other systems. In contrast today virtually every new IT capability must connect to the Internet.
Today, software must operate on the Internet infrastructure. This infrastructure can be likened to a "highway" that a software "vehicle" must operate on. Imagine the dilemma of selecting a vehicle when the highway itself is in a constant state of flux: next year the lane sizes are reduced, the year after that the pavement is embedded with a magnetic propulsion system, and so on. What do you buy?
The infrastructure of the Internet is this volatile and dynamic. It is an extraordinarily complex collection of protocols, routers, pipes, and service companies. No one expects the Internet in 10 years to look remotely like it does today. It will undoubtedly be different two years from now.
Lastly, the manufacturing industry itself is no longer particularly stable. The Internet is revolutionizing both the auto industry's business processes and its products. These include extremely fast order-to-delivery cycles and Internet-enabledvehicles. For instance, General Motors is spending $1.6-billion on e-commerce this year. Its chief executive, Rick Wagoner, has proclaimed leadership in e-commerce a top strategic goal.
Given these historically unprecedented conditions it should be obvious why the IT industry is experimenting heavily with new business models and pricing methods. The underlying software must be constantly enhanced to cope with a host of new demands including:
- Maintaining near-perfect service levels across a network with millions of nodes
- Upgrading interfaces
- Continually adding new business features
- Fending off security attacks.
Internet-based service companies vary widely in how they charge for their services. Some vendors charge a flat membership fee. Other vendors charge per transaction, per month, by the number of users, or a wide variety of business-unit measures. Of course, pricing can also be combinations of these. A simple example is the many trading exchanges that match buyers and sellers; some charge a commission based on the dollar value of the transaction. A trading exchange for chemicals, CheMatch, on the other hand, charges one-tenth of a cent per gallon for each trade. Others charge a flat fee per transaction. In another arrangement, SupplySolution of Santa Barbara, CA, charges in part based on the number of production-part types its customers manage across its Web-hosted service.
Furthermore, not one but multiple manufacturers must get on today's services for them to work. This complicates pricing even more. An example is a service that electronically connects manufacturers in a supply chain. Some service vendors charge only the parts seller; the buying firm gets a free ride in this case. Other vendors do the opposite, charging only the buyer. In yet another arrangement, both parties independently buy the same service. Even in this case, one side typically pays a disproportionate share to the service vendor.
All these pricing models can easily overwhelm manufacturers. This is especially true when they attempt to compare vendors. Despite the mayhem, manufacturers should expect to become major buyers of IT services; the auto industry is certainly moving in this direction. For instance Covisint, expects to garner $3 billion/year in transaction fees from the auto industry.
Procuring IT in the future is likely to become even more complicated. Imagine multiple trading exchanges and other e-commerce vendors that must all collaborate and charge so a single transaction can be completed.
One scenario could begin with a software agent scouring multiple, trading exchanges looking for a maintenance part. The agent also goes to a transportation exchange to get shipping costs, visits a financial-services site for credit approval and to arrange financing, etc. In this scenario, multiple service firms participate and must get compensated.
If such scenarios become reality, every manufacturer would be required to be at least mildly adept at working in such a services-intensive world. To do so will require a new mindset, especially for business managers. Only with a fresh perspective and willingness to understand how new-style services can be justified will a manufacturer be able to take advantage of the new offerings.
Furthermore, management must relinquish all notions that systems can be bought and operated indefinitely. Carly Fiorina, CEO of Hewlett-Packard, said, "The pure product era is coming to a close. Products wrapped in services are what will lead strategy." Perhaps in a decade the IT industry will return to sufficient stability to offer long-life products, but not today.
Manufacturers' best response is to develop long-term relationships with a few key IT vendors. These strategic partners should be the vendors best able to keep pace with the torrid rate of change. Expect these vendors to charge for services.
At the same time, manufacturers should develop a strong internal competency for understanding these offerings and making sound business decisions for employing or rejecting them. In this way both the auto and IT industry will prosper in to-morrow's strongly services-oriented world.