Vertical software industry evolution: The impact of software costs and limited customer base

Software systems are commonly used in a variety of industries as a means of automating organizational business processes. Initially, such software is often developed in-house by the vertical organizations possibly with the support of professional IT service providers; however, in many cases, internally developed software is eventually replaced with the software products provided by independent software vendors. These vendors often use license fees to recover their software development investments, as well as to gain some margin. However, if the vendor’s customer base for a specific type of software is limited, then either the license fees are too high and hence the customers may prefer to develop the software internally, or the margin has to be decreased. As a result, the market for software products of that type may not materialize. The paper introduces an analytical model that defines the minimum number of customers that the software vendor should have for its software to be less expensive as compared to the in-house software. Following a conceptual-analytical approach, a model is constructed wherein the minimum number of a vendor’s customers is represented as a function of other factors affecting software development costs. This model is verified by applying it to estimate the minimum customer base in the segment of telecommunications billing mediation software. Using the proposed analytical model, the minimum number of customers and the maximum number of software vendors in this segment are evaluated. The obtained results are found to be in line with the information available from a telecommunications software market database. Based on the model, a preliminary conclusion is made that in industries with high software development costs, heterogeneous legacy systems to integrate with, and a limited pool of potential customers, the number of software vendors is unlikely to be significant, and hence the in-house or custom-made software is unlikely to be superseded by the software products.