Sep 17

Tim O'Reilly

Tim O'Reilly

Hedge Funds are Software Companies

I recently began speculating on analogies and connections between Web 2.0 and financial markets, and that led to the development of our Money:Tech conference. Paul Kedrosky, the program chair, just turned up one more connection:

As I'm working away preparing for the Money:Tech conference early next year (and feel free to keep sending all those great ideas), I've been thinking a lot about the nature of technology as it's used by Wall Street. Here is a factoid that jumped out at me yesterday, one having to do with the ratio of software developers to non-developers at a major quant fund versus a major software company:

    Oracle (56,000 empl.) -- 1:8 (one developer for every eight employees)
    Renaissance Technologies (178 empl.) -- 2:3 (two developers for every three employees)

It's not too much of a stretch to say that hedge funds are the new software companies. After all, they have more developers per capita than the latter, and they certainly generate more cash flow per capita.

Now obviously, it's a stretch to generalize from one hedge fund to all hedge funds, and Wall Street has always been a heavy user of technology. But keep in mind how the definition of a software company is changing. It used to be that a software company was a company that created software for sale. But somewhere along the way, a big part of the web 2.0 revolution was that software companies discovered a better business model: namely to use the software to deliver services that they would monetize in other ways. Renaissance has no intention of selling their software; they can make far more money using it themselves. But this is also true of Google, Amazon, EBay, Facebook, and every other giant of the Web 2.0 era.

That being said, these companies are very concerned about adoption and re-use of their software, even if they don't charge for it. Web service APIs of various kinds are the preferred means today. Renaissance and other technology-infused hedge funds have no interest in having their software adopted by others.

Increasingly, everything is software. (I wonder how many software engineers Ford or Boeing employs?) So perhaps the distinction between a "software" company, and one that merely uses software, should neither be the ration of developers to non-developers nor whether the software is for sale, but whether the company depends on external deployment and adoption of its software to increase its success.

tags: web 2.0  | comments: 10   | Sphere It

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Comments: 10

  Graham [09.17.07 09:10 AM]

Interesting argument but isn't it more about the relative size of the companies rather than the industry they are in? Smaller companies like Renaissance will always have the potential to have a higher ratio of any single type of team than a large organisation that will have a wider range of capabilities and roles within it.

From your numbers Oracle's 7,000 developers would still dwarf Renaissance's 120!

  F Nazeeri [09.17.07 09:49 AM]

Renaissance is an outlier. Quant shops are a small segment of the overall market and Renaissance is the biggest of that small segment. The vast majority of hedge funds have a developer ratio lower than the 1:8 of Oracle. That's not to say that Wall Street doesn't utilize technology as much if not more than other industries...they do. It's just not the best supporting argument.

  Deepak [09.17.07 10:18 AM]

I am not sure I buy the argument. One could argue that software is becoming a greater part of the fabric of a company, especially as the ability to deploy it to more people internally increases. My first job was at a company which, at the time, was 100% in silico, but we used the software internally and sold the information. I don't think we ever characterized ourselves as a software company, unless being dependent on software makes you one.

  Thomas Lord [09.17.07 12:11 PM]

I'm not sure how to say this with perfect precision but:

The test should hinge on the question of substitutes. Company X does "something" with software. That's a pure cost center if a vendor, with the right offer, could walk up to the loading dock and say "Hey, just stopping doing that in-house and buy it from me for half price!"

If you'd have to consider such an offer seriously then you aren't a software company. If that would gut your company of its core capacity to produce value, then you are a software company.


  Alex Tolley [09.17.07 01:37 PM]

By the arguments you make, these example companies are also "wordsmith" companies because so much of what they do, internally and externally, depends on textual information, or "people" companies if they depend on the brains of their personnel rather than automation.

Software in organizations should be as unremarkable as text documents that define policies, procedures, work flow etc.

Software companies should be defined by whether their primary profits are generated by software sales/services.

  MM [09.17.07 02:24 PM]

I agree they are an outlier in the complete hedge fund world. There are several others similar, but most hedge funds are more fundamental and have a much lower ratio. I do agree it’s an interesting argument, and they certainly could be called “software companies” if we’re just looking at developers, but I think it’s also good to remember Quants are not only developers. (Not that it’s a bad thing to only develop).

  Bob Warfield [09.17.07 03:10 PM]

I'm with you: these are software companies. This is the ultimate promise of software, if you can harness a business model that works around it. It doesn't have to involve selling the software itself, and as you've pointed out, it is often more advantageous to sell the service.

I'm captivated by the idea of platforms (see my recent post on Marc Adreesen's platform musings for example), and can't help but wonder about platforms in the investment arena.

Yes, for the most part they don't want to share the software, but must this always be the case? I think not. Here are a couple of small examples.

Barra does a lot of this kind of programming and offers their results to others to integrate into their own products.

Bridgespan was a company that dealt with syndicating mortgages out to outfits like Fanne Mae.

How about electronic exchanges like the Island?

Why can't similar things transpire along platform lines for Wall Street? Probably the biggest obstacle is trust, but if they can overcome that it will make for interesting progress.

  Alexander Sicular [09.17.07 10:52 PM]

I have a slightly different take. IMHO, all companies are becoming information clearinghouses. The software they buy or develop are tools to better understand the information of whichever industry they happen to play in.

To take that argument a step further, those organizations that employ in-house developers have an additional edge in that those employees have a fundamental understanding of the problems being solved more so than those that merely employ "off the shelf" software.

Organizations that have an edge in their conceptualization, understanding, accessibility, etc of information will, in turn, utilize that information to a better degree than their nearest competitor.

  Ray Conley [09.18.07 01:22 PM]

If you consider microsoft excel as the IDE, and financial modeling as writing code, then the ratio of "software engineers" at hedge funds is nearly 1:1.

  Sin Jin Lee [09.18.07 02:22 PM]

it seems that the point is that software developers are becoming this generations factory hands (or is it?). It seems that software developers are a dime a dozen these days. I can't put up a craigslist posting without having it be responded to by countless "freelance" developers.

It won't be too long before kids in elementary are taking rudimentary lessons in programming along side their physical science and english.

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