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Revving the Engine
We kick off this month’s newsletter with a bold statement -- Software is the Engine of Business
Say what!?!? This better get good fast or I’m outta here
Bear with us for a minute. We’ll be the first to admit that sounds whacky, but seriously! In 2021, software is the engine driving productivity, enabling remote work, and creating competitive differentiation. Whether or not you build or sell software, you need to be a software-driven company and the faster you reorient yourself and your team around that truism, the better. Building a business without software is like driving a car without an engine. Sure, you can push it down the driveway to get it rolling, but you’ll soon be left watching the other cars blow by you.
Our last two newsletters have been laying the foundation for reframing your business as a software business. By first developing your digital strategy, you are mapping the route for the company. Next, building a fundamental understanding of APIs is like learning how your car’s electrical system functions. Now, it’s time to explore how we put all the components together and we are off to the races!
In order to reframe your thinking as a software business, we first need to establish two key premises: 1) your business is a “system” and 2) systems should be driven by software.
Here we go again. What the hell are you talking about??
The Modern Business “System”
Let’s take a step back. In the Industrial era, the traditional way of thinking about a business was inputs (raw materials) and outputs (finished goods) and management was focused on optimizing production processes to scale. Classical economics of the “smokestack era” was therefore governed by the law of diminishing returns. Tangible assets have a natural limit to their return on production. A factory can only produce so many widgets.
In 1994(!), Stanford economist, Brian Arthur, published a book articulating the key distinction between the smokestack era of the past and the digital era of today. Over the last century, industry moved from processing resources to processing information and the “underlying mechanisms that determine economic behavior have shifted from ones of diminishing to ones of increasing returns.”1 More specifically, “increasing returns are the tendency for that which is ahead to get further ahead, for that which loses advantage to lose further advantage.” Software provides the capability for creating these powerful feedback loops or flywheels.
Let’s look at Amazon as an example to make this more tangible. Sure, Amazon buys and sells products as any good retailer would, but as a digital marketplace it does not have the same constraints as having physical stores. This allowed Amazon to implement a flywheel strategy whereby pushing on the levers of the flywheel increased its momentum and fueled its growth. BOOM! Increasing returns to scale!
Source: Turning The Flywheel, Jim Collins
A more recent tech-enabled business, Carvana, has demonstrated tremendous growth from its own flywheel. Its vertically integrated technology strategy unlocks the ability to provide a superior customer experience. Carvana’s first shareholder letter as a public company lays out this vision (emphasis added):
Our goal has been to offer customers what they want: lower prices, wider selection and simpler experiences, which we believe is enabled by reducing the variable costs associated with selling cars. To achieve our goal, we’ve made significant investments in technologies that reduce those variable costs and simplify the customer experience...Integrating those technology investments allows us to provide customers with the quality of experience that has driven our growth to date, and we expect will continue to drive it in the future. We believe that customer experience quality is the single most important focal-point for any management team with a long-term view.
Source: Carvana Analyst Day Presentation 2018
Carvana “is driven by data and technology at all stages of the process, from inventory purchasing, reconditioning, photography, and annotation through online merchandising, sales, financing, trade-ins, logistics, and delivery.”2 All components of driving the best customer experience and increasing returns to scale!
If you’ve ever bought or sold a car on Carvana you immediately recognize how seamless the experience is and how differentiated it is relative to the traditional car buying experience. Their performance shows the difference. Five years ago the company sold 18,000 cars in a year. During their most recent quarter the company sold 5x that amount and it currently sports a ~$25B market cap. Damn, that happened fast.
Honestly this all sounds like a bunch of MBA bull $hit
You’re not wrong, but the important takeaway here is software enables the creation of powerful feedback loops that when harnessed can generate increasing returns to scale. You can no longer think about your business as linear production of inputs to outputs. Your business is a system.
Software Drives the System
If you had to describe the evolution of the technology industry over the last 40 years in one word it would be accessibility.
The software industry started with purpose built systems for power users. HR, Finance, Sales / Marketing, and Operations each had their own system that served only their own function.
Purpose Built Software Systems
Following the progression of accessibility, software systems have become more available, more powerful, easier to use and most importantly to this discussion — more tightly integrated. The development of APIs provides the capability for businesses to move from siloed software applications to interconnected solutions which can drive the overall business system.
Integrated Software Systems
Today, modern software applications still serve their functional purpose but they can act as complements -- givers and receivers of data and instructions to other applications serving other functions. These software solutions are integrated with one another or can be integrated through APIs. This enriches each function of your business, empowering you to implement a more holistic system to drive business functions.
Let’s jump into a more specific example to show this works. If you wanted to add an e-commerce option to your business 15 years ago your path would be to hire a full-stack software development team to build the online shopping cart, email marketing tools, payment processing, customer support system, fraud detection tools, etc. Good luck with that! After spending millions of dollars and years of work, hopefully you have something semi-functional.
Today you can use your credit card to purchase all the components needed to run a modern e-commerce operation. Implementing Shopify, Hubspot, Stripe, Zendesk, and Signifyd will provide you a fully functional system across all online platforms within weeks. To top it off, those services can all be integrated with one another, right out of the box.
An email campaign (via Hubspot) can lead directly to an online purchase (Shopify & Stripe). That purchase triggers automatic fulfillment (via Shopify after fraud verification with Signifyd). In parallel, a customer profile is created (ZenDesk, Shopify, Hubspot), which can be accessed when a support ticket (ZenDesk) is opened if the customer calls to inquire about the order. This all happens automatically without a single human touching any part of that process! It’s hard to overstate just how truly powerful it is to be able to buy all that capability off-the-shelf.
That’s great, but I don’t sell things online
The beauty of the APIs is that they are just building blocks. There are no limitations on how you use them within your business. Maybe you own a trucking company. Wouldn’t it be great to send notifications automatically to your customer when your driver is approaching the warehouse or get an email notification when a truck goes off route? Twilio’s communication network can send GPS data back to you and your customers via SMS or email ensuring real-time insight into location and expected time of arrival. This capability comes out of the box. All you have to do is plug in Twilio’s APIs.
Sounds interesting, but so what?
Congratulations, you now run a software company! The tools and the capabilities are there for you to redefine your operations and your customer experience. No engineers required! You are only bound by the limits of your creativity and your willingness to affect change. Your business is a system and software drives the system. With that insight you can upgrade your 4 cylinder to a V8. Don't be afraid to rev the engine!
Increasing Returns and the New World of Business by W. Brian Arthur via Harvard Business Review
Brian Arthur was ahead of his time in recognizing how the attributes of the digital era would change economics and business strategy. This article explains his key insights.
Turning the Flywheel by Jim Collins
A fantastic complement to Brian Arthur’s article. Pairing these two reads will help you identify the flywheel of your business and how software can help build momentum.
Invest Like The Best Podcast with Ben Thompson
Ben Thompson is one of the leading thinkers tying together technology and business strategy. Ben covers a lot of ground on this podcast and while he doesn’t use the term explicitly, “increasing returns to scale” drives a lot of his thinking
“Increasing Returns and the New World of Business” by W. Brian Arthur
Carvana 10-K Filed on February 25, 2021