Vertical Integration due to Small Market Size and High Product Development and Integration Costs

Abstract

An independent software vendor (ISV) recovers the costs of software development and configuration through license fees. However, if the number of ISV's customers is limited, then either the license fees needed for recovering the software development investments may be too high (and hence the customer would prefer to develop the software internally), or the ISV's margin may have to be decreased. Given the costs of development and configuration, as well as the margins set by the ISVs, it is possible to estimate how many customers an ISV has to have in order to recover its costs. Furthermore, given a market of a specific size and the minimum number of ISV's customers, it is possible to assess the maximum number of ISVs that can profitably compete in the market. This number may impact the evolution of the software market – if the maximum number of ISVs is small, the market may not attract enough competition, and the expected evolution of the software market may halt without proceeding to the vertically disintegrated layered set of software products. Below, analytical expressions for such estimates are provided, and are then applied to the context of the OSS/BSS software market.