What do tobacco and software have in common?

Everything from algorithmic trading in investments to lean manufacturing has been invented to drive up corporate profits. Following Gordon Gecko’s mantra, “Greed is good,” one has to wonder, if enterprises have gone through such creative measures to optimize everything and eke out new marginal efficiency, what can a modern company do to boost the bottom line? Look to the top performing net margin industries, of course.

Looking at the Fortune 500, the average net margins across the Fortune 500 were 7.28 percent with a median of 6.75 percent; however, the top two performing industries by net margin in 2011 were tobacco and software, with 21.50 percent and 19.88 percent, respectively. Clearly, tobacco and software maintain a wide gap when compared to these normative measures, and these numbers persisted through 2012.

Can companies in other industries incorporate tobacco or software into their business to boost margins?

Okay, so maybe not tobacco since that industry operates under circumstances (i.e., harmful chemical addictive agents) that can’t be replicated elsewhere. Software, on the other hand, offers an interesting proposition to Fortune 1000 companies looking to disrupt the status quo.

Today, enterprise applications can be written to do or supplement anything. For example, I can write an application to simplify word processing or to control the temperature of my refrigerator. As a result, software has become much more than a feature or means of improving operational efficiency. In fact, software has become the backbone of many non-software businesses, including Diebold, Nike and Tesla to name only a few.

Diebold, the world’s leading ATM manufacturer, released a vision statement in its investor relations deck last year stating they wanted “to transform from a hardware-centric manufacturing company to a world-class product, software and services provider.” Diebold recently announced the first ATM that integrates with mobile devices via the cloud, allowing consumers to complete secure transactions without cards, completely overhauling the traditional ATM experience.

Nike embeds chips in fitness apparel, sells tracking bracelets and supplies mobile applications that help you track runs, number of steps and other fitness metrics. Essentially, Nike is using software to shift from being a fitness apparel company to a fitness solutions company.

And aggressive upstart Tesla has a software interface for its electric cars that allows owners to develop applications that control certain aspects of the vehicle. Want to honk the horn? You can use your iPhone from 400 feet away.

Tesla Model S screen
Diebold, Nike and Tesla are examples of a new type of business known as “software-defined enterprises” that illustrate the truly transformative nature of software beyond just driving operational efficiencies and improving customer experience. Let’s examine why these three companies and others have decided to make this shift:

  1. Increased net margins – With software companies at an average net margin of 19.88 percent, average net margins of 7.28 percent don’t look so great. Rather than viewing this as a problem, software-defined enterprises see the difference as a 12.6 percent opportunity gap. They are incorporating software aligned with their product and services portfolios in order to flank existing revenues with a profit-rich revenue source.

    In fact, pulling the annual report for healthcare wholesaler McKesson, we find that although its distribution business accounted for 97.3 percent of revenue, the company’s software arm contributed to 14.1 percent of the bottom line while only accounting for 2.7 percent of revenue in 2012! Looking at operating pre-tax profits as a percent of revenue, McKesson’s software business provides 6x leverage, dollar for dollar, over its distribution business. Companies like McKesson expand revenues with a high-net margin software business that enhances regular revenues with nimble software value.

  2. Better customer acquisition – The proliferation of mobile devices and cloud services have reshaped consumer psychology, and today, consumers expect everything to have an app interface or some cloud service attached to it. To remain competitive and win over new customers, corporations need to embed a “software guaranteed” mentality to any new goods and services.

    Phillips released the Hue, a personal wireless lighting system, to attract consumers with home lighting technology that can be controlled from a mobile device. Consumers can go as far as uploading a photo to the hue app and using it as a lighting palette. This is surely attractive to today’s tech savvy consumer and will win over new customers from competitors like GE.

  3. Nike Fuelband

  4. Better customer loyalty – If a company can’t find a good way to increase net profits through new software-based revenue sources, software can represent a new way to reduce the risk of losing existing revenue and profit streams. Nike is a great example of this. Consumers are no longer buying just apparel; they are buying holistic fitness solutions with the software quickly becoming the hub of the purchase.

    When looking to buy a pair of shoes, most consumers don’t only buy the shoes; they buy shoes, a Nike+ Fuelband and download the mobile app. This creates a new ecosystem. Much like Apple did with iTunes, Nike ensures its existing consumers will remain customers because the cost and effort required to change to Adidas is simply too high. The software services incorporated into the physical shoe are driving this change.

  5. Software-defined enterprises are the future, and, like Diebold, companies across the globe must reevaluate their own corporate visions to establish software as a key strategy for all service and product offerings. Enterprises that do this right will realize new profit margins and become industry leaders, while those that don’t will become obsolete. If Tesla’s recent stock surge is any indication of the business benefits that software-defined enterprises will enjoy, why wouldn’t you want to become one?

    Sinclair Schuller is the CEO of Apprenda.