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Ever since the advent of the internet, sending software on CD’s has seemed like a dying art. According to the blogosphere, the 95% profit margins on the software sent on these CD’s have been dead for some time already.

If you like grim predictions for the future of software companies who still stick to this arcane approach, you just need to tune to Burnham’s Beat, a blog dedicated to software technology and investing.

In an post aptly named The Incredibly Shrinking Software Industry, the author starts with the facts for 2005. Despite NASDAQ’s growth by 1.4% (modest, I know), the combined capitalisation for software companies fell by close to 10%.

What factors contributed to this downfall? I’ll summarise some of them briefly:

1) Software stocks move from “growth” to “value” – In essence, what happens is that software stocks exit from growth portfolios and enter value portfolios. If there’s one thing certain about “value” managers, it’s that there’s no way in hell they are going to pay for stocks at 35 times earnings. The focus shifts from spanking new products to maintenance charges and service revenues.

2) Open Source and SaaS – We’ve been babbling about open source and its impact on software vendors. Instead of shipping CD’s at a healthy 95% margin, open source gives away the code for free and charges for support. Similarly, SaaS (Software as a Service) charges customers fees for the services offered. Both models are difficult to scale up easily as you need to scale recruitment, training, etc. (instead of just printing more CD’s to meet demand).

3) No platform transition – although web services (and web 2.0) are being touted as the next big thing, the shift hasn’t happened yet. Or rather, it moves at a pace that doesn’t compensate for the loss of revenue with the last platform change (N-tier architecture).  

There’s plenty more insight in the post itself, if you have 10 or so minutes to spare.  

Update: You need not look further than the PC Game industry to see the changes. Long time leader Blizzard has 6,000,000 subscribers for its World of Warcraft franchise. There are rumors that Diablo 3 will be a MMORPG as well. Fortunately, Starcraft 2 looks like a regular RTS judging from the trailer.