Subject: RE: "I've got more programmers than you"
From: "Larry Augustin" <lma@valinux.com>
Date: Fri, 5 Oct 2001 23:07:58 -0700

> From: Bernard Lang [mailto:Bernard.Lang@inria.fr]
> Sent: Friday, October 05, 2001 10:31 PM
> To: fsb@crynwr.com
> Subject: Re: "I've got more programmers than you"
> 
> I should know but I do not
> 
> Does anyone have quick definitions, or pointers, to get the exact
> meaning of various terms:
> 
> Revenue  :  (I guess it is all the money that comes in)

Yes.  It's how much you collect.  Total sales.

> Gross Margin:

How much is left after paying the cost (cost of goods sold, or COGS) for
the item you sold.  In the case of software, the cost is the cost to
reproduce the media, manuals, and support.  Usually it's about 10% of
the selling cost for software companies.  (90% is left over - that's the
gross margin.)  For hardware companies, it's the cost of the parts, plus
the assembly of the hardware, plus support and warranty costs.

> R&D  : research & development

Yes.

> S&M  :

Sales and Marketing costs.  This is where you pay sales and marketing
people, commissions, etc.

> G&A  :

General & Administration.  This is Finance, IT, facilities, etc.

R&D + S&M + G&A make up operating expenses.

> Operating Margin:

What's left over after paying for operating expenses.

> Net Income:  (is that before, or after paying taxes ?)

In this cases I reported net income after taxes.

> 
> MS :  that I know :-)
> 
> Thanks
> 
> Bernard
> 
> On Fri, Oct 05, 2001 at 05:10:55PM -0700, Larry Augustin wrote:
> > In order to understand free software business models, we first have
to
> > understand business models.  Let's look at the business models for
two
> > mature, successful companies in the services and software
businesses.
> > Here are the business models for EDS and Microsoft:
> >
> > 			 EDS		Microsoft
> > Revenue		100.0%	   100.0%
> > Gross Margin	 18.5%	    86.9%
> >
> > R&D			  0.0%	    16.4%
> > S&M			  4.6%	    18.0%
> > G&A			  4.5%           4.6%
> >
> > Operating Margin	  9.4%	    47.9%
> >
> > Net Income		  5.5%	    41.0%
> >
> > These are June 30, 2000 fiscal year end numbers.
> >
> > MS's gross margins are typical of a large, successful software
company.
> > 90% is a good rule of thumb.  MS is a little bit below 90% because
they
> > have some non-software businesses mixed in with that.  MS spends
16.4%
> > on R&D, and 18.0% on S&M.  Both numbers are a bit below what most
> > software companies spend.  MS can get away with that because they
are so
> > big and so dominant.  It wouldn't be unusual for those numbers to be
10%
> > higher (each) in a smaller software company (e.g. I think Autodesk
or
> > Oracle is about 10 points higher in each category).  MS has a 47.9%
> > operating margin, which is huge.  A 20% operating margin is
considered
> > good.  Most software companies would be lower in the 20% to 30%
range.
> >
> > EDS is a great example of a pure services play.  EDS does a lot of
IT
> > outsourcing, managed services, support, etc.  EDS is what I would
> > imagine a free software services business to look like.  Gross
margins
> > are 18.5%, low in general, but not unusual for an IT services
consulting
> > business.  EDS spends nothing on R&D (they don't have a product).
4.6%
> > goes to S&M, and EDS returns 9.4% in operating margin.
> >
> > One of the things to take away from this is that EDS has very thin
gross
> > and operating margins.  Further, if a free software business based
on
> > services wants to do some development and contribute back, that R&D
line
> > is going to have to go up to at least 1% or 2%.  That's going to
reduce
> > operating margins to 7.4%.  At 7.4%, investors are going to be tough
to
> > attract.  Remember, that's operating margin.  Net income is going to
be
> > 3% to 5%.  Double tax-free municipal bonds are 5%.  Why would an
> > investor put money into a company (where there is risk), when they
could
> > put that money into low-risk munis and get the same or better
return???
> > Further, why invest in a business like EDS at all when MS returns
41%
> > net income?  This is why MS is a much more valuable company.
> >
> > Dell, BTW, has a model similar to EDS except that R&D is 2% and G&A
is
> > less than 1%.  Dell can lower G&A costs because they don't have the
> > overhead of managing all those bodies that an EDS has.  The result
(for
> > Dell) is a low gross margin business that works with about 10%
operating
> > margins.  But if Dell were to invest more in R&D (for example, by
> > directly supporting Linux development), Dell would be less
profitable,
> > possibly to the point where investors would walk away.  This implies
> > that Dell is unlikely to invest in Linux development, since that
> > investment would lower their profitability to the point where
investors
> > would walk away.
> >
> > This makes for an interesting point.  Companies like Dell and EDS
that
> > are the most likely supporters of free software (because it does not
> > compete with them) are also the least likely to have money to invest
in
> > free software R&D.  Proprietary software companies like Microsoft
have
> > lots of margin to invest in R&D, but are unlikely to invest in free
> > software.  :-)
> >
> > Any discussion of free software businesses has to happen around the
> > business model.  What gross margin are people willing to pay?  What
are
> > the costs in R&D, S&M, and G&A associated with running that
business?
> > Is the bottom line return large enough that people will invest in
that
> > business?  Answer those questions about any proposed free software
> > business and we'll be a lot closer to understanding how to build
one.
> >
> > Larry
> >
> > Larry M. Augustin, CEO, VA Linux
> > Tel: +1.510.687.7029      Fax: +1.510.683.8680
> > Web: http://www.valinux.com
> >
> >
> >
> > > -----Original Message-----
> > > From: Karsten M. Self [mailto:kmself@ix.netcom.com]
> > > Sent: Friday, October 05, 2001 10:03 AM
> > > To: fsb@crynwr.com
> > > Subject: Re: "I've got more programmers than you"
> > >
> > > on Fri, Oct 05, 2001 at 07:07:47PM +0900, Stephen J. Turnbull
> > > (turnbull@sk.tsukuba.ac.jp) wrote:
> > >
> > > >     Zimran> software world could you gripe about a 20%
> > > >     Zimran> margin being slim. Most industries would kill for
> > > >     Zimran> margins that fat.
> > > >
> > > > Most industries also don't have to worry about a Finnish college
kid
> > > > with no financial backing at all kicking their whole raison
d'etre
> > out
> > > > from under them.  A 20% margin on products that make it to
market is
> > > > nowhere near good enough in software development, any more than
it
> > is
> > > > in drug development.  That margin has to pay for all the
failures
> > you
> > > > never admit even got started (not to mention the ones that got
> > > > announced and you blew a wad on marketing before they got
killed).
> > >
> > > ...which is fine if you're arguing his words, and well considered.
> > >
> > > The facts though are that Microsoft tends to get about a 30%
profit on
> > > all operations.  Margin on product is likely higher.
> > >
> > > Peace.
> > >
> > > --
> > > Karsten M. Self <kmself@ix.netcom.com>
> > > http://kmself.home.netcom.com/
> > >  What part of "Gestalt" don't you understand?              Home of
the
> > > brave
> > >   http://gestalt-system.sourceforge.net/                    Land
of
> > the
> > > free
> > >    Free Dmitry! Boycott Adobe! Repeal the DMCA!
> > > http://www.freesklyarov.org
> > > Geek for Hire
> > > http://kmself.home.netcom.com/resume.html
> 
> --
>          Non aux Brevets Logiciels  -  No to Software Patents
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> 
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