Group Logic

What can a tiny software firm show us about the future of American exports?

Also in Slate: Martha C. White explores California’s domination of the international almond market, Boeing’s push to sell more aircraft overseas, how a small steel manufacturer thrives on the world stage, and how exports can save the American economy.

Exporting software has become extremely lucrative

Americans traveling abroad 25 years ago came back with tales of encounters in remote outposts with locals who knew nothing of the United States—other than Michael Jackson songs. Surprisingly little has changed since the Gloved One’s popularity reached from the Amazon basin to the Australian outback: America is still a leading exporter of intellectual property to both consumers and companies. The global public’s appetite for entertainment is increasing as a growing middle class enjoys more leisure time and has more money to indulge in movies, music, and the like. Global spending on film entertainment is expected to jump to $107.5 billion in 2014, up from $85.1 billion in 2009, driven by innovations like Blu-ray and 3-D, according to consulting firm PricewaterhouseCoopers. James Cameron’s Avatar has raked in $2.8 billion worldwide since its release, most of which came from overseas audiences. *

But it’s not just big Hollywood studios cranking out blockbusters. Software is another booming export industry. Ashish Arora, a professor at Duke University’s Fuqua School of Business, estimates that America exported around $52 billion in software and entertainment media in 2008. It can be tough to get a handle on just how much export business big software firms like Microsoft and Adobe conduct, since these companies set up offshore outposts to tailor their software to that market before selling it (a process called “localizing”). To lower their U.S. taxes, they book overseas revenue as if it had originated in the country where the localization takes place. Further complicating attempts to quantify the scope of U.S. software sales overseas, companies like IBM and Oracle sell software, but they also sell hardware and support services, so there’s no reliable way to estimate what portion of their revenues come strictly from software.

Take a look at a smaller software company, though, and it’s easier to see how foreign customers boost the bottom line. Group Logic makes programs that allow Macs to connect to Windows-based infrastructure, as well as file-sharing programs for professional customers such as magazine publishers and ad agencies. This year, the 22-year-old company expects to generate 32 percent of its projected revenue from exports, contributing to its expected $1.6 million to $1.8 million EBITDA (earnings before interest, taxes, depreciation, and amortization). By 2020, Group Logic President T. Reid Lewis says he expects the percentage of revenue from exports to grow to 40 percent. *

Group Logic, which employs 33 people at its headquarters in Arlington, Va., didn’t do any exporting until a decade ago, according to Lewis. The twin hurdles of localization and a fragmented distribution system overseas were enough to deter executives from pursuing foreign firms as clients. Localizing involves rendering a program accessible to a user whether they’re in Toronto or Taipei, says Michael Fauscette, group vice president of software business solutions at IT market research company IDC. Feet and inches have to be converted into meters and centimeters, procedures need to be translated into the local language, and in some places, Roman letters have to be replaced with the local written language. Manufacturers of architectural and design software have additional localization demands, since they have to include parameters like local building codes that vary tremendously from place to place.

In addition to the challenge of localization, business-to-business software distribution is very different outside the United States. Here, office workers often buy tech products directly from the manufacturer or through a retailer. In almost every other market, though, a complex and sometimes insular network of middlemen hold the keys to access. Lewis and his colleagues had to grow exports by networking with distributors and getting referrals at trade shows.

It seemed like a chicken-or-egg situation: Group Logic wouldn’t know if there was a market for its products unless it adapted the material and found distribution partners, but it didn’t want to make the investment without knowing if customers would bite.

Like many small businesses, Group Logic got into exporting via our northern neighbor. U.S. customers—magazine publishers, for instance—recommended Group Logic’s products to their Canadian affiliates; from these referrals, an export business was born. From there, it looked to Mexico and then Western Europe. Lewis says he and his partners traveled extensively in those early years to establish contacts and to network with potential distribution partners. The switch from physical disks to Internet-based distribution helped Group Logic accelerate its foreign sales. Mailing hard copies costs more because of the expense of producing the physical CDs, boxes, and user manuals, as well as shipping charges and administrative costs for the time spent filling out forms. Selling online streamlined the process; it also makes follow-up support and license renewal easier.

One of Group Logic’s core products is a program that allows Macs and PCs to communicate, while the file-sharing tool is used by companies that historically have been Mac users. In both cases, demand for the software is a good indication of Mac products’ popularity in a particular country or region. Western Europe and Japan, where Macs are more common, compose the bulk of the company’s export business today. It struggles to break into less-affluent markets, since Macs’ higher prices make PCs the norm by default.

Experts predict a huge surge in demand for packaged software from India, China, and Brazil as these economies grow. Currently, Group Logic is just starting to edge into these markets, on the heels of Mac demand. Lewis acknowledges the limitations of waiting for Apple to break into a market and pave the way, which is why he says the company is planning to develop software for mobile phones and tablet computers. It’s a good strategy; according to market research firm IDC, worldwide adoption of smartphones is on the rise. Nielsen stats show that Chinese smartphone penetration as a percentage of the mobile phone market in the first half of 2010 is 24 percent, slightly ahead of Germany and nearly on par with France. Brazil and India each have 9 percent penetration, and analysts expect that to rise.

What about piracy? This is a huge thorn in the side of companies that create and market intellectual property to consumers. Group Logic incorporates common piracy-thwarting measures like user-specific license keys, but it’s spared the brunt of the problem because of its audience. Since Group Logic sells to companies, it doesn’t have as much of a piracy problem as companies that sell movies, music, or consumer software. While a movie buff in Jaipur, India, or Jakarta, Indonesia, might not mind too much if their illegally copied American blockbuster has a grainy picture, there’s no real equivalent in the software universe. If software is poorly copied, it won’t work, or the user runs the risk that the program will corrupt other files.

When it comes to piracy, analysts like IDC’s Fauscette say it’s up to lawmakers to put pressure on countries that have a history of ignoring intellectual-property rights. China and Russia are two oft-mentioned offenders; according to the Business Software Alliance, 79 percent of all software used in China is pirated. Trade groups like the BSA and the Software and Information Industry Association push for more government involvement and lend a hand by shaping policy. The SIIA, for instance, has cybersleuths on staff to investigate suspected instances of piracy and sift through tips from individuals and companies. In cases where egregious piracy is being committed overseas, they pass on the information to the Department of Justice or alert the U.S. Trade Representative’s office so they can push for enforcement from the country in which the company or site is based. Earlier this year, Sen. Patrick Leahy, D-Vt., introduced a bill the SIIA helped craft that would allow the federal government to ban banks and credit card companies from handling transactions for sites that sell pirated software. 

An even bigger threat than piracy is the proliferation of open-source software, which emerging economies like because it’s cheaper and because it doesn’t make them reliant on Western technology. Group Logic is lucky in that its specialized niche means there isn’t a challenge from open-source developers, but the issue has bedeviled giants like Microsoft. In some cases, software companies have responded by lowering prices on their products, then locking users into buying more expensive updates when the initial version becomes obsolete. Think of it as high-tech version of the way shaving products are sold: The razor is sold at a steep discount, but the user is compelled to buy expensive blades on a regular basis after the first purchase.

Another reason Group Logic has been able to expand its reach—it now exports to more than 20 countries—is the guarantees provided by the Export-Import Bank (also called the Ex-Im Bank) for overseas transactions. Group Logic pays what is essentially a small insurance premium to the Ex-Im Bank in exchange for a guarantee of payment. In one instance, a foreign dealer went bankrupt after taking delivery of $100,000 worth of software; the Ex-Im Bank paid out 90 percent of the total invoice, shielding Group Logic from what would have been a catastrophic hit to its bottom line.

Lewis sees only growth potential overseas. “The key takeaway is that we should’ve done it sooner,” he says of exporting. Lewis says America has a huge opportunity to increase employment and its presence in the growing high-tech universe if it embraces the Internet’s growing role in commerce and the proliferation of the mobile marketplace. “You can’t help hearing about jobs going overseas, but the opportunities we have in technology have a big chance to make up for that.”

Correction, Nov. 16, 2010: This article originally cited a box office gross of $2.7 billion for Avatar. The best estimate is $2,777,488,612 or, rounded, $2.8 billion. ( Return to the corrected sentence.)

Correction, Nov. 19, 2010: This article originally suggested that exports would be responsible for 32 percent of Group Logic’s earnings in 2010. In fact, exports are expected to be responsible for 32 percent of 2010 revenues. (Return to the corrected sentence.)