One sometimes has to decide whether to accept a contract to
develop a piece of bespoke software
The Issue:
Do the revenues exceed the costs?
The "Go or No-Go " Decision (cont.)
An Example (You May Have Seen Before):
Using A Discount Rate of 4%:
The "Buy or Lease" Decision
The Situation:
One sometimes has the option of buying software or
leasing/renting software (in both cases, subject to
terms of a license) sometimes even from the same
provider
The Issue:
The alternatives have different cash flows hence one has to
consider the
time value of money
The "Buy or Lease" Decision (cont.)
The Cash Flow for a Purchase:
"Large" payment up front for the purchase of the original
product
The Cash Flow for a Lease:
"Smaller" periodic payments
The "Buy or Lease" Decision (cont.)
Comparing using the Present Value:
Choose an interest rate (a.k.a., discount rate)
Calculate the present value of the lease
Compare the present value of the lease with the cost
of the purchase
Comparing using the Internal Rate of Return:
Find the interest rate that makes the present value of
the lease the cost of the purchase
Compare that rate with the actual/anticipated market rate
The "Buy or Lease" Decision (cont.)
An Example:
I can buy the software for $4000 (in year 0)
I can lease the software annually for $1000 in years 0 and 1,
$1100 in year 2, and $1150 in year 3
Using the Present Values:
Using a discount rate of 5%
So, if you think that's the correct discount rate,
the lease is the better deal
Using the Internal Rate of Return:
The discount rate that equates the two is 4.02%
So, if you think the appropriate discount rate is that value or
higher, the lease is the better deal
The "Make or Buy" Decision
The Situation:
One sometimes has the option of either
"making" (i.e., developing either from scratch or by
modifying existing software) or "buying" (i.e., "acquiring"
which may be buying, leasing or renting) software
(whether it be a component or a system)
The Issues:
The alternatives have different cash flows
The alternatives have different probabilities of success
The "Make or Buy" Decision (cont.)
How to Proceed:
List all of the alternatives
Choose a discount rate
Calculate the present value of the cash flows for each
of the alternatives
Estimate the probabilities of success of each alternative
Calculate the expected present value of each of the alternatives
Organizing the Probabilities of Success:
A decision tree that contains the alternatives
(and sub-alternatives) and their
probabilities (and conditional probabilities)
can be helpful
The "Make or Buy" Decision (cont.)
An Example with Probabilities/Conditional Probabilities
The "Make or Buy" Decision (cont.)
Including the Estimated Costs (in Present Dollars)
The "Make or Buy" Decision (cont.)
With the Calculated Expected Values (in Present Dollars)
Outsourcing and Contracting
The Concept:
Hire an outside party to perform some or all of the
software development process
The Rationale (2014 SourcingLine Survey Results):
Reduce or control costs - 44%
Gain access to resources not available internally - 34%
Free-up internal resources - 31%
Improve business or customer focus - 28%
Accelerate reorganization - 22%
Accelerate project - 15%
Reduce time to market - 9%
Outsourcing and Contracting (cont.)
Harte Hanks Market Intelligence CI Technology Database:
1998: 18.6% of companies outsourced programming and design
2000: 30.1% of companies outsourced programming and design
Congressional Research Service:
2001-2002: 7.1% permanent job loss due to offshoring in IT
Some Recent Data:
The cost in India used to be 20% of the cost in the US but is
now about 70%
Salaries in China have been rising 30% per year
The Economics of Open Source Software
Definitions:
Freeware/Shareware - The "executable" software product has a
price of 0
Open Source - The source code for the software product is
available (but its use may be restricted)
Public Domain - The source code for the software product
can be used without restriction
History:
1960s-1970s: Software was often developed in academic settings
(and similar corporate research labs), source code was made
available, and property rights were not formalized
1980-1982: AT&T began claiming intellectual property rights
to UNIX
1983: Stallman started the Free Software Foundation
which introduced a General Public License (GPL) for the
GNU OS; Berkeley introduced the Berkeley Software Distribution
(BSD) license
1997: The Open Source Definition was introduced
The Economics of Open Source Software (cont.)
Who Works on Open Source Software:
Paid employees of "open source" companies
Paid employees of traditional companies
Volunteers
Relative Quality:
Raymond (1999) argues that open source software should be of
superior quality ("to many eyes, all bugs are shallow")
Kuan (2001) shows that in 2 out of 3 product pairs she
investigated bugs were fixed faster in the open source project
The Economics of Open Source Software (cont.)
Theories of Volunteer Motivation:
Raymond (1999) - It is a form of gift culture based on altruistic
motives (arising from abundance)
Shapiro and Varian (1999) - Software is an information
good exhibiting positive network/scale economies
Bezroukov (1999) - It is a social phenomenon in which status
depends on both contributions and social activities
Lerner and Tirole (2002) - Skills may improve; Excitement
of working on interesting projects; Contacts
Empirical Results:
Hann et al. (2004) - People with high rank in the Apache project
earn 14%-29% higher salaries whether or not their work
is related
Haruvy et al. (2003) - The promise of higher future
earnings is an important driver
Lakhani and von Hippel (2003) - The overwhelming driver
is the need to solve their own programming needs
Boston Consulting Group (2003) - Intellectual curiosity
is the most important factor
The Economics of Open Source Software (cont.)
Motivations of Traditional Companies:
Acquire expertise in a segment of the market that is
complementary (e.g., IBM)
Learn about the strengths and weaknesses of the process
Learn about the strengths and weaknesses of the
(presumably competing) product
Generate good public relations
Motivations of Free Open Source Companies:
Sell advertising
Sell support
Give away the razor but sell the razor blade (e.g.,
software is free but charge for hosting to generate
recurring revenues)
"Freemium" (i.e., some features are free and charge
for others)