This Week I Learned...
The fallacy of "closed" software systems
Historically speaking the vast majority of software products were created as closed, “walled gardens,” particularly mission critical systems such as ERP or EMR systems. Essentially these systems were architected such that users were forced to operate solely within the system – the features and functionality of the software is based exclusively on what has been built into the system itself. The developers of these systems often do so in the name of security, privacy, and usability and therefore this is the “right'“ way to do it. The assumption is that as experts of the system (since they built it) they know exactly what users need and they will be effective at training customers how to use their system. Over time, product managers continue to add features based on what they believe users need.
The reality is that oftentimes these product managers make decisions that lead to more bloat, more confusion, and reduce usability for everyone accept a small number of power users. The even more cynical point of view is that product decisions are made in order to force lock-in and reduce customer churn. The thinking goes like this — if we build mission critical systems, require customers to spend significant time and money implementing the system, and force customers to change their processes to fit the software then there will be enough friction and inertia to change such that companies end up stuck with the system. This is great news for the software company because they have locked in their customer base and can raise prices as they roll out new “features”. A recurring revenue business with high retention rates and pricing power means more profits and premium valuations. Investors will be salivating at the chance to own that business.
The problem is that if you actually measure NPS or customer satisfaction for these products the results would be horrifying. Businesses keep paying for these software systems because they feel like they no choice. The alternative of ripping and replacing a core system is far more painful. Most people would rather undergo a root canal then take on the thankless task of leading an ERP transition.
In our own business, we were reminded of the challenges of these closed systems recently with the Change Healthcare debacle which impacted the vast majority of healthcare service businesses. Our EMR relied on Change Healthcare for processing claims and it was built in to the walled garden. When the clearinghouse was shut down due to the ransomware attack all commercial insurance claims processing ground to a halt and we were stuck, beholden to the capability of our EMR. There were no APIs or web hooks with our system so our only choice was to download files to submit claims outside they system and hope that eventually Change would get turned back on. In an open architecture we would be able to seamlessly integrate another clearinghouse or 3rd party system to continue to digitally process claims feeding data in and out of the EMR.
So what does this all mean for buyers of software products? Well, I have good news and bad news for you…
The good news – this is no longer the modern approach for making software. A number of software companies have demonstrated that building open ecosystems is not only good for customers but it can also be extremely lucrative as a business. Two fantastic case studies for this are the Apple App Store and Shopify.
One of the more incredible product and marketing decisions Steve Jobs ever made was to open up app development for third parties. (yes, we can quibble about how “open” Apple really is, but for the purposes of the point I’m making, the argument still stands). It’s a better experience for users to make choices based on their own preferences. I can chose to use Spotify, Instagram, and Google Maps on my iPhone because I prefer them to the apps solely made and provided by Apple. This allows app developers to specialize in what they do well – create an experience for music, photos, and maps that customers value and leverage the distribution of Apple products to deliver this experience to end users.
Shopify is my absolute favorite case study for openness and what it means to build a true platform. Shopify itself provides the core engine for processing orders and payments for ecommerce, but it has architected its product to provide all the hooks for other 3rd parties to develop digital storefronts and custom cart and checkout flows the complement the core engine. This allows users benefit from having a large ecosystem of specialized widgets that provide the ability to customize and enhance the ecommerce experience they provide.
The power of this platform approach is demonstrated by fact Shopify is paying out hundreds of millions of dollars to the developers in this ecosystem. Shopify is spending its engineering resources to support this ecosysem with APIs, webhooks, SDKs, and tools to allow 3rd parties to build specialized products that work seamlessly with its ecommerce engine rather than try to build everything themselves.
Shopify’s competitive moat comes not from the walled garden, but rather the virtuous cycle that comes from facilitiating the creation of the best ecosystem where customers and 3rd parties mutually benefit from one another. Once you reach scale, it’s nearly impossible to recreate due to the network effects of the ecosystem.
Architecting your product in this more open approach allows customers to take more control in building a system that works for them. They can take advantage of functional specific applications to customize their experience and shape the software to the experience they want to optimize for.
Alas, there is still bad news…
Unfortunately, the vast majority of mature software products take the walled garden approach. Even if they have built APIs or out-of-the-box integrations they often charge more to access them. They say their system is open, but they don’t want to make it accessible. You can often tell from their product strategy how serious they are. Is this just a sales pitch or are they dedicating internal resources to build a best-in-class experience for third parties? Do they understand how to build and support an ecosystem or are they doing the bare minimum? The next wave of companies building true platforms is happening, but many are still early in early phases of development. But soon companies and consumers will be able to take back control of their data and systems.