SOURCENEXT 4344
ソースネクスト
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2021-11-11
2021-11-02
2021-10-27
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Shiodome City Center 33F, 1-5-2 Higashi Shimbashi Minato-ku, Tokyo 105-7133
Summary
SOURCENEXT plans, develops, and sells PC software and smartphone apps. The company uses hardware sales to attract users to its e-commerce site, where they can buy software, its earnings mainstay. The company sets itself apart from its competitors with a “commodity strategy”—high sales volume at low unit prices—and the ZERO model—providing renewals to security software at no additional cost to the consumer.
Internet Software & ServicesSoftware
Key dates
2014-07-31
Coverage initiation
Executive summary
Market leader in OTC retail PC software. Looking to move into manufacturing with POCKETALK® W
SOURCENEXT Corporation plans, develops, and sells PC software, smartphone apps, and IoT products. Its main products are security software (where it has roughly a 17% market share), postcard creation software (roughly a 70% market share), smartphone apps, and language learning software, but it also offers many other titles as part of its full lineup strategy. As of end-FY03/19, SOURCENEXT’s product lineup included a total of 599 software titles for PCs (including upgrades) and 310 smartphone apps. To increase repeat purchases of PC software by registered users, which numbered more than 17mn as of end-May 2020, SOURCENEXT sells PC software as well as hardware online through its own website.
In December 2019, the company began sales of POCKETALK® S, a pocket-sized language interpreting device the company developed. POCKETALK® S is the third model in the series, following POCKETALK® and POCKETALK® W. With the launch of POCKETALK® S, the company is looking to diversify away from its traditional focus on software distribution and become a global manufacturer. As SOURCENEXT expands its sales territory overseas, it is also looking to lessen its dependence on sales to general consumer (i.e., B2C sales) by increasing sales to the corporate market (i.e., B2B sales). Shipments of the POCKETALK® series exceeded 300,000 units in February 2019, 400,000 in April, 500,000 in July, 600,000 in December, 700,000 in February 2020, and 800,000 in November. According to a survey conducted by BCN Inc., the company’s sales of POCKETALK® series accounted for 92.3% of language interpreting devices sold in Japan in June 2020 in terms of units sold and 97.7% in terms of monetary amounts, making it the top product in terms of sales units and value for a 43rd consecutive month. The company had its sights set on selling more than 1mn units by end-2020, but had yet to reach that goal by end-June 2021 with the negative impact of the COVID-19 pandemic.
The company sets itself apart from its competitors with a “commodity strategy”—high sales volume at low unit prices—and the ZERO model—providing renewals to security software at no additional cost to the consumer. In contrast to many companies that only handle a small lineup of in-house developed software, SOURCENEXT also handles other companies’ software. The company is an industry forerunner, often offering innovative new services. For example, in 2013 it launched an “All You Can Use Software” plan. SOURCENEXT is also active in M&A and intellectual property (IP) acquisition.
Under its medium/long-term strategy, SOURCENEXT is looking to strengthen its earnings structure by enhancing its new product lineup and expanding its business. More specifically, it is looking to make use of the 20-plus years of experience as a software developer it has acquired since its inception, its large user base numbering more than 17mn, and its strong distribution network including electronics mass retailers as it moves ahead with the following three initiatives: First, the company is planning to step up efforts to develop IoT products and other new products that have unique features; second, it aims to continue growing its user base by increasing advertising and promotional spending; and third, it is looking to acquire major brands through M&A and IP acquisitions.
Earnings performance
In FY03/21, the company reported consolidated sales of JPY12.9bn (-25.6% YoY), operating profit of JPY540mn (+13.8% YoY), recurring profit of JPY453mn (-15.8% YoY), and net income attributable to owners of the parent of JPY191mn (-15.0% YoY). Sales and operating profit fell just short of the company’s projections. However, recurring profit came in well below plan due to weak sales of IoT products at an equity-method affiliate in China in the face of the prolonged impact of the COVID-19 pandemic, resulting in an equity-method investment loss of JPY87mn. Net income attributable to owners of the parent was even further below plan, affected by JPY35mn in expenses for structural reform at a subsidiary.
Demand for the company’s POCKETALK® AI translation device declined sharply on lower in-store sales and lower sales to travelers overseas amid the pandemic. Meanwhile, sales of software and hardware used in teleworking were firm. The company also boosted its sales base by expanding its lineup of PC software for teleworkers, increasing the number of locations products are sold, and enhancing promotional efforts. The decline in sales of POCKETALK® was offset to some extent by product launches and expansion of existing product lines.
The gross profit margin declined 2.7pp YoY to 57.4%. Adjusted for product return provisions/reversals, GPM was up 0.2pp YoY to 59.1%. The SG&A expense ratio fell 1.3pp YoY to 54.9% as the company took effective measures to reduce SG&A expenses based on the scope and impact of its sales activities and significantly curtailed advertising and sales promotion expenses for POCKETALK®. As a result, OPM increased 1.5pp YoY to 4.2%. Since net income attributable to owners of the parent came in below plan, the company lowered the annual dividend from the initially planned JPY0.46 per share to JPY0.21 per share (versus JPY0.25 in FY03/20).
For FY03/22, the company’s forecast (revised on August 13, 2021) calls for consolidated sales of JPY15.1bn (+17.1% YoY), operating profit of JPY104mn (-80.8% YoY), recurring profit of JPY100mn (-77.9% YoY), and net income attributable to owners of the parent of JPY36mn (-81.2% YoY). The company expects to pay an annual dividend of JPY0.04 per share versus JPY0.21 in FY03/21. While the company expects new POCKETALK® features such as POCKETALK Subtitle and Group Translation, as well as new products such as the new KAIGIO brand series designed for telework and remote conferencing to contribute to sales and profits, it has lowered its full-year sales forecast upon reviewing full-year product sales estimate based on Q1 results. In addition, after reviewing SG&A expenses for the full year, the company determined that it would be difficult to offset the decline in profits resulting from lower sales, and decided to downwardly revise its profit forecasts.
The company has not released a medium-term plan, but over the medium-term it aims to reach a market cap of JPY100bn by growing in scale through handling more products.
Strengths and weaknesses
Shared Research judges SOURCENEXT’s strengths to be its differentiation strategy for security software and extensive product range, its high brand recognition among consumers and packaging strategy, and cost reductions brought about by its shortened distribution channel. We judge the company’s weaknesses to be its dependency on Chairman and CEO Matsuda, the proliferation of free applications, and securing able planning personnel (see Strengths and weaknesses).
Key financial data
Note: Figures may differ from company materials due to differences in rounding methods.
Note: The company began reporting consolidated earnings results in FY03/11. However, the difference between consolidated and parent level figures for sales and profits is less than 1%. YoY figures for FY03/11 have been calculated based on the difference with FY03/10 (parent level) results.
Recent updates
1H FY03/22 flash update
On November 10, 2021, SOURCENEXT Corporation announced earnings results for 1H FY03/22; see the results section for details.
Acquisition of treasury shares
SOURCENEXT Corporation has announced the decision to acquire treasury shares.
At a meeting held on October 27, 2021, the company's Board of Directors reached the decision to acquire treasury shares according to the following conditions.
Details of acquisition
In response to changes in its business environment, the company has decided to acquire treasury shares as a means of improving capital efficiency and establishing a flexible capital policy.
Succeeded a business through simplified absorption-type split
SOURCENEXT Corporation announced a company split (simplified absorption-type split).
At a Board of Directors meeting held on September 29, 2021, the company resolved to conclude an absorption-type split agreement in which the company would succeed the foreign language education business operated by Tokyo SIM Language Institute ("Tokyo SIM") in a simplified absorption-type split. The agreement was signed on September 29, 2021, and the split is slated to take effect on November 2, 2021.
The company will succeed Tokyo SIM's foreign language education business as part of efforts to expand its business domain and aim for a further increase in enterprise value. The company already acquired copyrights for six of Tokyo SIM's products in total, including the English language learning material Super ELMer, in May 2020, and has since been selling Super ELMer series of products. Following the company split, the company will utilize Tokyo SIM's assets to step up its efforts to develop English language learning apps with the aim of expanding its business.
The company split is a simplified absorption-type split in which Tokyo SIM will be the splitting company and SOURCENEXT the succeeding company. The split will not result in any change in the company's capital.
The company plans to pay Tokyo SIM JPY9mn in cash in exchange for the foreign language education business.
The company expects this development to have only a minor impact on its earnings performance.
Trends and outlook
Quarterly trends and results
Note: Figures may differ from company materials due to differences in rounding methods.
Note: Figures may differ from company materials due to differences in rounding methods.
1H FY03/22 results (out November 10, 2021)
Summary
In 1H FY03/22, SOURCENEXT reported consolidated sales of JPY5.0bn (-13.7% YoY), an operating loss of JPY569mn (operating profit of JPY284mn in 1H FY03/21), a recurring loss of JPY513mn (recurring profit of JPY243mn), and a net loss attributable to owners of the parent of JPY414mn (net income of JPY125mn).
Progress versus the 1H FY03/22 company forecast put sales at 93.2%. The company recorded losses at the various profit lines as anticipated in its forecast (the losses in 1H were essentially in line with the forecast). Progress versus the full-year FY03/22 forecast put sales at 33.2% (1H progress of 45.0% versus full-year FY03/21 results). Progress could not be calculated for profit items as the company reported losses from the operating level and below in 1H FY03/22, but 1H FY03/21 operating profit reached 52.6% of the full-year FY03/21 result, recurring profit 53.6%, and net income 65.4%. The company made no further changes to its full-year forecast as revised on August 13, 2021.
Sales down 13.7% YoY: POCKETALK® generated higher sales YoY overseas, but overall sales declined due to three factors: absence of recovery in demand from overseas tourists visiting Japan and business operators that cater to inbound tourists, reluctance of companies to purchase Meeting Owl Pro (with a 360° web camera) due to prolonged emergency declarations in Japan, and a fallback after extraordinary teleworking-related demand in 1H FY03/21.
Operating loss of JPY569mn: The gross profit margin declined 5.6pp YoY to 54.2%. SG&A expenses declined YoY due to efforts to rein in advertising and promotion expenses based on the scope and impact of sales activities, despite system replacement expenses and increases in recruitment and personnel expenses to support business expansion. However, the SG&A expense ratio rose 6.6pp YoY to 65.6%.
External environment
The October 2021 report from the Japan Electronics and Information Technology Industries Association showed PC shipments down 27.7% YoY in the April–September 2021 period.
With ongoing restrictions on international travel for tourism, there were just 124,794 foreign visitors to Japan in the April–September 2021 period (+275.1% YoY; -99.2% compared to pre-COVID April–September 2019 data). The number of Japanese residents traveling overseas was 258,327 (+136.7% YoY; -97.5% compared to pre-COVID April–September 2019 data). (All tourism data prepared by SOURCENEXT based on October 2021 research by Japan National Tourism Organization.)
Results by sales channel
Starting in Q1 FY03/22, the company changed its sales channel classifications. Corporate sales, which were previously classified as Other, have been reallocated to the Smartphones and telecommunications carriers business, which has been renamed Corporate sales. YoY comparisons use figures for the new classifications. Results by sales channel were as follows.
E-commerce (SOURCENEXT online store)
Sales were JPY2.0bn (-23.7% YoY). The company operates the SOURCENEXT eSHOP as part of its own website. The eSHOP sells POCKETALK®, software, and IoT hardware.
With a substantial drop in demand for POCKETALK® for inbound and overseas travelers amid the global COVID-19 pandemic and the Tokyo Olympics and Paralympics being held without spectators, the company focused on selling POCKETALK® via campaigns and on selling teleworking products. It also worked to increase sales by enhancing the lineup of products it procures. Furthermore, it released the latest versions of its three brands of New Year greeting card creation software, and sales of upgrades from old versions were robust as well.
Although greeting card software salesincreased YoY, sales at the company's online shop declined overall, as extraordinary demand related to teleworking ran its course in 1H, and there was a decline in demand due to the prolonged emergency declarations triggered by the pandemic.
Electronics mass retailers
Sales were JPY1.5bn (-14.0% YoY). This sales channel consists primarily of major nationwide electronics retailer chains that sell IoT products, PC software, and other products to individual users.
In-store sales came in lower than expected owing to restrictions on going out brought on by the intermittent declarations of emergency. The ongoing decline in inbound and overseas travelers and a fallback from the extraordinary teleworking-related demand seen in 1H FY03/21 also led to lower sales.
Corporate sales
Sales were JPY1.2bn (-1.7% YoY).
In this channel, the company provides sales and rental of POCKETALK® for companies as well as all-you-can-use computer software and smartphone app services.
Although existing contracts are ongoing, sales of POCKETALK® to corporate clients fell due to lower-than-expected orders from new corporate clients as the number of overseas travelers declined.
The company provides content which it sells for use in major telecommunications carriers' fixed-rate, all-you-can-use app subscription services. The positive impact of advertising measures at some carriers helped sales grow.
However, sales through this channel declined slightly overall, affected by the decrease in POCKETALK® sales.
Other channels
Sales were JPY214mn (+103.3% YoY). Sales through other channels include POCKETALK® sales overseas.
Sales of POCKETALK® have been growing overseas, primarily via Amazon in the US and Europe. The global spread of COVID-19 caused sales of POCKETALK® to decline, but orders and sales are gradually recovering, especially in the US. At US-based Sourcenext Inc., sales via Amazon were at a record high, and there was an increase in orders from and sales to corporate clients, mainly educational, medical, and public institutions, boosting 1H sales YoY and generating the highest sales since POCKETALK® launched in October 2018.
For details on previous quarterly and annual results, please refer to the Historical performance section.
Full-year company forecast
Note: Figures may differ from company materials due to differences in rounding methods.
FY03/22 company forecast
Summary
For FY03/22, the company’s forecast (revised on August 13, 2021) calls for consolidated sales of JPY15.1bn (+17.1% YoY), operating profit of JPY104mn (-80.8% YoY), recurring profit of JPY100mn (-77.9% YoY), and net income attributable to owners of the parent of JPY36mn (-81.2% YoY). The company expects to pay an annual dividend of JPY0.04 per share versus JPY0.21 in FY03/21.
The following information was prepared prior to the announcement of the revised forecasts. Shared Research will provide an update following interviews with the company.
Reasons forecast is weighted toward 2H
SOURCENEXT projects consolidated sales of JPY6.9bn (+18.3% YoY) in 1H and JPY10.0bn (+41.1% YoY) in 2H, along with operating profit of JPY46mn (-83.8% YoY) in 1H and JPY532mn (+107.8% YoY) in 2H.
The company provides the following two reasons the forecast is weighted toward 2H.
POCKETALK® sold reasonably well in 1H FY03/21. In April 2020, the company shipped POCKETALK® orders received through March 2020.
In addition, right after the government declared a state of emergency in April 2020, there was extraordinary demand for security products, PDF creation software, and other software accompanying increased PC demand. The company expects this special demand to diminish to a degree in 1H FY03/22.
SOURCENEXT assumes that domestic demand for POCKETALK® will steadily recover from January 2022 onward. It thinks overseas demand will recover even earlier, but is still basing its forecast on the assumption that overseas and domestic demand will have a similar recovery trajectory from January 2022 onward, so its figures are not exaggeratedly optimistic. However, recent trends indicate that active seniors who enjoy overseas travel, a key customer base for POCKETALK®, are getting vaccinated. The company considers that if they are able to resume travel toward the end of 2021, the recovery in POCKETALK® demand may begin even before 2022 arrives (since there are many active seniors who want to travel while they still can).
POCKETALK® demand in the US
SOURCENEXT says POCKETALK® demand has been recovering in the US earlier than in other areas. Sales volume in the US in April 2021 was up nearly 30x YoY and up 24% versus March as more and more people are getting vaccinated and the scope of travel is expanding. The overseas sales ratio for POCKETALK® rose to about 40% in April 2021, and the company expects it will stay above 30% through FY03/22. In the US, sales via Amazon are growing, and the company hopes to increase sales in Europe through similar means.
Initiatives
The decline in POCKETALK® sales continues due to the drop in inbound demand triggered by the pandemic. However, in addition to new products in the IoT lineup, including the mimi series and AutoMemo™, the company will strengthen its proposals of high-value-added PC software and, in light of the Japanese government’s recommendation that companies use teleworking wherever possible, will continue to introduce telework-related products such as Meeting Owl. It will also endeavor to expand its sales channels, especially the e-commerce (SOURCENEXT online store) and B2B channels.
In the software business, in anticipation that teleworking demand will continue for some time, the company plans to expand sales by searching out new products to supplement its lineup of existing mainstay products.
SOURCENEXT aims to continue effectively reducing SG&A expenses by looking carefully at the scope and impact of its sales activities.
The company is pushing for product diversification by providing telework-related software and hardware services in a timely manner, making telework-related products an earnings pillar alongside software and POCKETALK®. This will allow the company to build a solid management base that can withstand drastic changes in the operating environment.
Partner strategy
Acquisition of shares in SORACOM
On June 18, 2021, SOURCENEXT acquired some shares (320,800 shares; equivalent to a 2.5% equity stake) in SORACOM, INC., from KDDI Corporation (TSE1: 9433). SORACOM is a platformer that provides IoT wireless communications services globally. Many IoT products, including SOURCENEXT’s own POCKETALK® series, use eSIM from SORACOM.
Acquisition of additional shares in AGENDA
On April 1, 2021, the company acquired additional shares in AGENDA Co., Ltd., which develops Android apps, PC software, and IoT-related products as a SOURCENEXT partner. The aims of the additional acquisition were to strengthen the development system by securing excellent human resources, to improve earning capacity by increasing product development efficiency, and to further hone the competitive edge of SOURCENEXT’s products. The acquisition included 100 new shares gained through a third-party allotment and 38 existing shares already held by individual AGENDA stockholders, for a total of 138 additional shares, raising SOURCENEXT’s share of voting rights in AGENDA to about 14.7%.
In principle, SOURCENEXT does not have any in-house full-time programmers. Instead, it develops software and hardware by partnering with excellent development companies both inside and outside Japan for individual projects. In particular, the company has a strong relationship with UMEOX, the company it hired to develop its core product, POCKETALK®. SOURCENEXT’s policy is to build strong relationships through capital alliances with key development companies such as AGENDA, BJIT in Bangladesh, and UMEOX in China (where President Kojima is a board member).
Introduction of shareholder benefit plan
In FY03/22, the company introduced a shareholder benefit plan (applying to shareholders holding 100 or more shares of the company’s stock listed or recorded in the company’s shareholder registry as of end-March 2021). Depending on the number of shares held, shareholders will be granted e-points (bonus points) that can be used at the company’s online store (1 point = JPY1).
Shareholder benefit based on shares held (end-March): 1,000 points for 100–499 shares, 2,000 points for 500–999 shares, 4,000 points for 1,000–9,999 shares, and 10,000 points for 10,000 or more shares
Shareholder benefit based on shares held (end-September): 1,500 points for 100–499 shares, 2,000 points for 500–999 shares, 4,000 points for 1,000–9,999 shares, and 10,000 points for 10,000 or more shares
Shareholder benefit based on holding period (continuous holding of one year or more; 100 shares or more): 1,000 points at end-March and 500 points at the end of each month
SOURCENEXT has more than 50,000 shareholders (as of end-March 2021), but only a small number of them are registered users, so the company introduced this shareholder benefit plan, hoping to promote sales.
Long-term outlook
Numerical targets
SOURCENEXT does not disclose its medium-term plan. However, the company has indicated that it is aiming for a market capitalization of JPY100bn over the medium term, to be achieved by expanding product range and growing the business.
As of June 12, 2017, the company’s stock market capitalization was roughly JPY20bn, or only about one-fifth of its target of JPY100bn. Its stock market capitalization briefly topped JPY100bn between October 22 and October 24, 2018, but as of July 5, 2021 was back down to about JPY44bn (about 40% of its target).
As detailed below, the company is in the process of transforming itself from a local distributor into a global manufacturer.
With in-house developed next-generation POCKETALK®, company aims to transform itself from local distributor to global manufacturer
Under its medium/long-term strategy, SOURCENEXT is looking to strengthen its earnings structure by enhancing its new product lineup and growing its business.
More specifically, the company is looking to make use of the 20-plus years of experience as a software developer it has acquired since its inception*1, its large user base numbering more than 17mn, and its strong distribution network including electronics mass retailers as it moves ahead with the following three initiatives:
Step up its efforts to develop IoT products and other new products that have unique features
Further expand user base by increasing advertising and promotion
Acquire major brands through M&A and intellectual property (IP) acquisition*2
POCKETALK® S
On December 6, 2019, the company launched POCKETALK® S, a pocket-sized AI-based language interpreting device covering 74 languages that it developed internally (75 languages as of June 2020, see below) and, in July 2020, POCKETALK® S Plus, which has a larger screen than POCKETALK® S, making it easier to read. POCKETALK® S is the third model in the POCKETALK® series following POCKETALK® W, which the company began selling in September 2018.
POCKETALK® S is priced at JPY32,780 (including tax) when including two years of global communication (utilizing eSIM from SORACOM, INC., a subsidiary of KDDI Corporation [TSE1: 9433]) and POCKETALK® S Plus is priced at JPY34,980 (including tax). This model is the third in the POCKETALK® series, following POCKETALK® (launched in December 2017) and POCKETALK® W (launched in September 2018). It comes equipped with new features, including the capacity to translate text photographed using the model’s camera (details below) and a conversational lesson feature (details below). Furthermore, POCKETALK® S is only about the size of a business card and weighs 25% less than POCKETALK® W at 75g, and is one third thinner with a thickness of 11.5mm. Despite these reductions, POCKETALK® S has a larger screen that is easier to see (30% larger than POCKETALK® W with 2.8-inch screen size monitor and a 70% improvement in image resolution). It also uses only one button, versus POCKETALK® W’s two, and features improvements in software functionality that enable translation instantly after pressing this button. POCKETALK® S covers 75 languages, providing both voice and text translation for 55 and text-only translation for 20. The POCKETALK® S model functions using an Android operating system.
According to the company, competitors offering compact translation devices tend to fruitlessly rush to raise product specifications. SOURCENEXT, in contrast, asserts that one of its strengths lies in its efforts to improve the usability of its devices based on feedback from its larger base of users (more than 700,000 total POCKETALK® units shipped as of February 25, 2020), which include the addition of functions requested by these users. The company says that input from actual users is most informative when adding new functions. It receives feedback on a daily basis through surveys completed at the time of purchase and from users who registered their purchases. Both developers at the company and the company president read all of this feedback and apply selected requests to new models.
POCKETALK® W
On September 7, 2018, the company launched POCKETALK® W, a pocket-sized language interpreting device developed by SOURCENEXT that uses the IoT to provide instant voice translation of 74 languages. POCKETALK® W follows the original model POCKETALK®, launched in December 2017.
According to a survey conducted by BCN Inc., combined sales of the AI-powered POCKETALK® series of portable interpreting devices (the original POCKETALK® and POCKETALK® W) accounted for 94.4% of sales of “voice translation devices” in June 2019, making it the number-one selling product in this category. POCKETALK® has also received favorable reviews across a wide range of industries, being awarded the top-prize in the Nihon Keizai Shimbun’s best products and services awards for 2018 and also ranking among Nikkei Trendy’s top-30 hit products of 2018.
Shipments of the POCKETALK® series exceeded 300,000 units in February 2019, 400,000 in April, 500,000 in July, 600,000 in December, and 700,000 in February 2020. According to a survey conducted by BCN Inc., the company’s sales of POCKETALK® series accounted for 90.5% of language interpreting devices sold in Japan in May 2020 in terms of units sold and 95.9% in terms of monetary amounts, making it the top product in terms of sales units and value for a 30th consecutive month. The company has its sights set on selling more than 1mn units by end-2020.
The original model was developed by and procured from Travis (a Dutch company), but SOURCENEXT was not fully satisfied with the decision-making at Travis concerning increases in the production line and other issues. With POCKETALK® W, the company decided to take the lead in the development and production, thus taking on the role of manufacturer.
In related moves, SOURCENEXT acquired shares in the company that designed POCKETALK®, UMEOX Innovations Co., Ltd., making it an equity-method affiliate*3, and also signed an outsourcing contract with IT device developer and manufacturer JENESIS Holdings Ltd. to manufacture the new POCKETALK® W handsets. JENESIS Holdings is a subsidiary of Neos Corporation (TSE1: 3627).
This has helped speed up the development process and also enabled SOURCENEXT to make prompt decisions about production line increases and other key issues.
To help expand sales of POCKETALK® outside Japan, the company is making use of the resources of its Silicon Valley-based US subsidiary Sourcenext Inc. (established 2012) and in January 2019 established a new subsidiary, Sourcenext B.V., in the Netherlands.
In addition to improving profitability by reducing production costs and putting its POCKETALK® business on a more stable footing, the company plans to develop more IoT products with unique features with the aim of enhancing prospects for new products and new businesses over the medium to long term (see Business section for details).
Next generation of IoT devices following POCKETALK® and POCKETALK® W
Leveraging its experience in software development and sales as with POCKETALK® and POCKETALK® W, the company intends to continue planning and developing more IoT products for the consumer market. Its goal is to establish itself as a global manufacturer in the IoT product arena. Because in most cases the main value added in IoT products is in the software (the company’s forte), SOURCENEXT expects to be able to continue coming out with new IoT products that are not aimed at engineers but rather at meeting the needs of consumers.
Fund raising
To procure the funds needed to strengthen its earnings structure through introducing new products and expanding business under its medium/long-term business strategy, SOURCENEXT issued a ninth and tenth series stock warrants (with provisions to revise the exercise price and conditions for suspending the exercise) through a third-party allotment in June 2018. All of the warrants in the ninth series were exercised by July 6, 2018, and all of the warrants in the tenth series were exercised by October 1, 2018.
The discussion below outlines the company’s basic thinking regarding areas other than POCKETALK® W.
PC: potential user base of more than 25mn
According to the company, its business forecasts are based on the size of the market and past sales performance.
There are no precise figures for the number of PCs in use in Japan, but the company estimates that based on annual shipments of around 10mn units and an average usage lifetime of five or six years, there are about 50–60mn PCs in use domestically. If it is assumed that consumers (the company’s main target market) account for around half of this total, there is a potential user base of more than 25mn users.
SOURCENEXT is the market leader in retail sales of PC software, but sales were only about JPY5.7bn in FY03/14. According to the company, assuming average annual revenue per user (ARPU) is JPY3,000–5,000, it will be able to boost sales by JPY3.0–5.0bn by taking another million users from among the 25mn total market. Although the PC market is maturing, the company thinks PC software is still underutilized and there is significant potential for growth in the market.
Smartphones: potential user base of 60mn
The spread of smartphones presents new ways to use software. SOURCENEXT is taking advantage of this by focusing on products for smartphones. According to the company, annual domestic smartphone shipments are about 30mn units, and if the average usage life is two years, the active base is around 60mn units.
SOURCENEXT is focusing on expanding its range of smartphone apps, including products developed in-house and externally. As a result, many SOURCENEXT apps are among the top ranked apps on telecom carriers’ fixed fee services providing unlimited app usage. The company expects that the spread of smartphones will mean potential for growth.
One million new users out of 25mn could prompt sharp profit increase
The company’s core security software market is dominated by three companies. The company’s products are low priced, and it offers free security software renewals. In contrast, its two main competitors have higher unit prices and use a business model based on charging for renewals, and have yet to follow the company’s lead.
This is likely because if they were to implement this model, they would risk cutting into the revenue base provided by existing users—whereas as an up-and-coming participant in the market, SOURCENEXT had nothing to lose.
According to BCN rankings, FUDEMAME (which SOURCENEXT acquired in FY03/18) has been Japan’s best-selling New Year card and postcard creation software for 21 consecutive years going all the way back to the year 2000.
As the company has been able to successfully increase its market share by leveraging its price competitiveness, management believes this trend is likely to continue.
If the company can win a million new users as outlined above, Shared Research thinks that operating profit would reach around JPY3.5-5bn (some 3–5x the forecast for FY03/14).
M&A and PMI
In FY03/18, SOURCENEXT actively undertook acquisitions, acquiring Fudemame Co., Ltd. and Rosetta Stone Japan. The company expects that these acquisitions will generate higher sales through the added sales of products of these acquired companies. The company also intends to cross-sell existing products to the customers of the companies that SOURCENEXT acquired. The company has also successfully moved forward with post-merger integration (PMI)*. The company expects to use what it learns during the post-merger integration process in future M&A.
Business
Description
Largest retail over-the-counter (OTC) vendor of PC software in Japan. Strong in security software. Moving into manufacturing with the launch of POCKETALK® W
Company overview
SOURCENEXT plans, develops, and sells PC software, smartphone apps, and IoT products.
Its main products are security software, postcard creation software, smartphone apps, and language learning software. As of end-FY03/18, SOURCENEXT had a total of 648 software titles for PCs (including upgrades) and 310 smartphone app titles.
To increase repeat purchases of PC software by registered users, the company also sells PC software as well as hardware online through the company’s own website.
In December 2017, the company began selling the original model POCKETALK®, a pocket-sized language interpreting device. It followed up with a second internally developed model, POCKETALK® W, in September 2018, and launched the third model, POCKETALK® S (similarly developed in-house) with coverage for 74 languages (75 languages as June 2020) in December 2019. In this way, the company aims to become a global manufacturer (for further details, see discussion below).
The company had more than 17mn registered users as of end-May 2020.
Note: Sum of gross profit by channel or product does not include common expenses such as R&D expenses that cannot be directly attributed to a specific product or channel, and thus does not match the figure for gross profit on sales reported by the company.
Main product lines
The company’s main PC software products include the ZERO line of security software, popular for its lack of annual renewal fees, and postcard creation software, FUDEMAME, FUDEOH, and Atena Shokunin.
Its security and postcard creation software accounts for around 20–30% of group sales. The company’s strategy is to offer a complete software lineup, so it has a number of popular titles in addition to its ZERO line, such as IKINARI PDF and B’s Recorder.
SOURCENEXT boasts a 59.2%*1 sales share in the postcard creation software market. The company is one of three major suppliers in Japan of mainstream PC security software. On a unit volume basis*1, in 2020, it held a 14.8% market share for PC security software.
In addition to developing and selling its own products, SOURCENEXT distributes leading products from around the world and actively acquires products of other companies and companies through M&A
Commodity strategy to distinguish itself
SOURCENEXT was founded in 1996 to plan, develop, and sell computer software.
The company set itself apart from competitors with the launch of its “commodity strategy” (high sales volume at low unit prices) in 2003 and its “ZERO model” (providing renewals to security software at no additional cost to consumers) in 2006.
However, its product pricing is determined through a mathematical process (see the Price strategy section for details). In 2011, the company began developing and selling apps for Android smartphones.
Industry leader in distributing products from other companies and using a fixed-fee model
In contrast to many companies that only handle a small lineup of in-house developed software, SOURCENEXT also handles other companies’ software; this started in 2012, when the company began domestic distribution of overseas brands.
That same year SOURCENEXT also established an overseas subsidiary in Silicon Valley in the US. Also, in 2012, the company moved away from its old outright sales model and started using a fixed-fee model for apps sold through telecommunications carriers. The company is an industry forerunner, offering new and innovative services. For example, in 2013 it launched an “All You Can Use Software” plan.
Moving into overseas markets, actively pursuing M&A
In 2016 the company launched its Smart Rusuden app, a readable voicemail service, and the following year launched the overseas version of the same app under the name iGotcha™ in the US.
In 2017 SOURCENEXT acquired unlimited and exclusive domestic rights to market Rosetta Stone software (one of the world’s most popular language learning software) as well as the right to adapt Rosetta Stone’s downloadable software for the Japanese market. This was followed by the acquisition of all shares of Rosetta Stone Japan, Rosetta Stone’s Japanese subsidiary. That same year, SOURCENEXT also acquired Fudemame Co. Ltd., known for its popular FUDEMAME software (the best-selling New Year card and postcard creation software in Japan).
Moving from local distributor to global manufacturer
On December 6, 2019, SOURCENEXT launched POCKETALK® S, a pocket-sized AI-based language interpreting device developed by the company that covers 74 different languages, followed in July 2020 by POCKETALK® S Plus, which has a larger screen than POCKETALK® S, making it easier to read. Including the global communications SIM (good for two years), POCKETALK® S sells for JPY32,780 (including tax) and POCKETALK® S Plus for JPY34,980 (including tax). POCKETALK® S follows the original model, POCKETALK® (launched on December 14, 2017) and POCKETALK® W, the second model (launched on September 7, 2018).
The original model was developed by and procured from Travis (a Dutch company), but SOURCENEXT was not fully satisfied with the decision-making at Travis concerning increases in the production line and other issues. Hence, with POCKETALK® W, the company decided to take the lead in the development and production, thus taking on the role of manufacturer. POCKETALK® S was developed by SOURCENEXT.
In related moves, SOURCENEXT acquired shares in the company that designed POCKETALK®, UMEOX Innovations Co., Ltd., making it an equity-method affiliate*2, and also signed an outsourcing contract with IT device developer and manufacturer JENESIS Holdings Ltd. to manufacture the POCKETALK® W and POCKETALK® S models. JENESIS Holdings Ltd. is a subsidiary of Neos Corporation (TSE1: 3627).
This not only speeded up the development process, but also enabled SOURCENEXT® to make faster decisions about production line increases among other key issues.
Shipments of POCKETALK® and POCKETALK® W exceeded 300,000 units in February 2019, 400,000 in April, 500,000 in July, 600,000 in December, 700,000 in February 2020, and 800,000 in November. The company had its sights set on selling more than 1mn units by end-2020, but had yet to reach that goal by end-June 2021 with the negative impact of the COVID-19 pandemic.
In addition to improving profitability by reducing production costs and putting its POCKETALK® business on a more stable footing, the company plans to develop more IoT products with unique features with the aim of enhancing prospects for new products and new businesses over the medium to long term. More specifically, the company followed up POCKETALK® and POCKETALK® W with the launch of its next IoT product in September 2019. Dubbed FamilyDot, the new addition to the company’s IoT product line is a GPS tracking device that allows people to check on the whereabouts of family members.
・Covers 75 languages, including English, Chinese, Russian, and dialects of Portuguese. Provides both voice and text translation for 55 languages and text-only translation for 20.
・Using internet-based AI technology, POCKETALK® S can also translate long passages, such as news manuscripts. Due to its reliance on AI technology instead of its own internal machinery, its performance will improve over time, consistently providing the newest and most accurate translation possible.
・Users can choose languages into which they wish to translate simply by tapping an option on-screen that will bring up a list. They can also utilize voice translation by pressing the talk button when the microphone icon is displayed and speaking into the device.
・POCKETALK® S uses only one button, versus POCKETALK® W’s two, and features improvements in software functionality that enable translation instantly after pressing this button.
・POCKETALK® S is only about the size of a business card and weighs 25% less than POCKETALK® W at 75g, and is one third thinner with a thickness of 11.5mm. Despite these reductions, POCKETALK® S has a larger screen that is easier to see (30% larger than POCKETALK® W with a 2.8-inch screen size monitor and a 70% improvement in image resolution).
・There is no difference in the translating capability of POCKETALK® S and POCKETALK®S Plus. Only the screen size and battery capacity differ.
Translation example:
English: I don’t like spicy dishes, so could you tell me which dishes are not spicy.
Japanese: 私はスパイシーな料理が好きではないので, どの料理がスパイシーでないか教えて下さい。
Translation example:
Japanese: 今日のオススメはマグロの刺身と鯛の煮付けです。
English: Today’s recommendation is tuna sashimi and boiled sea bream.
・Despite its small size, POCKETALK® W is able to handle two-way communication between language pairs selected by the user from 74 different languages, including English, Japanese, Chinese, Russian, French, Thai, and Vietnamese.
・The voice translation function is not contained in the device but instead housed in a cloud-based translation engine. That means the device will always be able to handle even the latest terms and expressions. (The processing speed also surpasses the capacity of existing online translation engines).
・The global SIM within the device allows it to be used in 105 different countries and regions (models without the SIM card must be set manually).
・Its 2.5-inch touchscreen with intuitive controls for language options, volume setting, and other options allows two-way communication using either voice or written characters
・Dimensions: 110x59.8x15.8mm
・Operating time: Will run for up to 10 days in a standby mode (in 4G LTE service areas), will run for roughly seven hours with active use (assuming repeated use for five minutes straight out of every ten minutes, with 50% setting for screen brightness and 50% setting for voice volume). Maximum usage time will vary depending on usage environment and settings.
Source: Shared Research based on company data and website
With experience gained through the planning, development, and sales of POCKETALK® W, the company will expand its focus on planning, developing, and selling software to include IoT devices and go beyond distribution to become a manufacturer.
In addition to expanding its sales territory to overseas markets*4, the launch of POCKETALK® W is also aimed at helping SOURCENEXT move from mainly a B2C business (selling mainly to general consumers) to B2C + B2B business as it starts expanding sales to the corporate market.
Core products
As of end-FY03/21, the company’s main product series were as follows.
*1 Based on sampling of postcards produced by PC software. Market share by sales volume by manufacturer, based of sales statistics from major electronics mass retailers compiled by GfK Japan.
Changes in business model
Commodity strategy enables SOURCENEXT to leap ahead
The company was established in 1996 for the purpose of planning, developing and selling computer software. Initially, the company released TOKU-UCHI (a computer typing practice software product) and other differentiated products. However, a turning point was the launch in February 2003 of its commodity strategy. Based on this strategy, the company reduced the price of its mainstay products from JPY5,000–10,000 to JPY1,980. This was the start of its high volume, low margin model. This strategy has proven a success, and the company has grown its market share and sales unit volume.
The momentum was further accelerated in July 2006 with the release of its ZERO security software product with no annual renewal fees. This basic commodity strategy adopted for ZERO further refined the company’s high volume, low margin model. Not only does it make renewal free (in contrast to its competitors who charge a fee for renewals), it also eliminates the need for troublesome renewals. Since the upfront cost to the consumer is also lower than for competing products, this product was popular and the company became a leader in the security software market. Furthermore, while products with no annual renewal fees pushed up unit sales, they also helped cut support costs on call centers to handle inquiries from customers at renewal times.
There has been a trend toward major PC software manufacturers heavily favoring their own in-house developed software, limiting the number of products that they could handle. However, SOURCENEXT is strong in marketing. The company aims to bring products that meet users’ demands to markets as soon as possible, regardless of whether they were developed in-house or externally. This has also been a factor in its strong unit volume growth.
The company has mainly grown market share by selling products through retailers. However, the global financial crisis that began in 2008 led to problems of excess inventory, and earnings performance took a large, if temporary, hit. In response, the company overhauled its inventory standards and retail channels. This set performance back on a positive track. According to research company GfK, in 2017 in-store sales for major electronics mass retailers across Japan, SOURCENEXT ranked number one in eight categories: OCR/translation software, mobile phone software, keyboard software, language learning/testing software, postcard creation software, video editing/DVD-related software, PC/software training software, and PDF software.
Overview of free renewal (ZERO) business model (as of March 2021)
This PC security software product offers annual free renewals. As long as the operating system (OS) software that the product is compatible with is supported, there is no expiry and the product is automatically upgraded to the latest version. Even when the OS is upgraded to a new version, the product renewal for ZERO is free to the user. Within the operating systems covered by the product, users can change to a different OS as long as they delete the entry for their old PC*.
Users pay once for either a single license or one that covers up to three devices. Virus Security ZERO is available in a Windows version (standard price of JPY1,980 for one device, JPY3,980 for three devices; both excluding tax) and multi-OS support version** (standard price of JPY3,900 for one device, JPY5,900 for three devices; both excluding tax), resulting in a total of four options.
Note: The company’s anti-virus software does not require renewal as long as Microsoft Corporation continues to provide security updates. Furthermore, the same software may be transferred to a different OS. However, the software will not support OS that are unreleased at the time of purchase.
*Microsoft’s offer of perpetual support for its Windows 10 operating system only applies to those devices that came with Windows 10 installed as their original operating system.
Initial cost plus renewal fees pricing structure
The costs associated with developing new security software and upgrades are fixed, and do not vary depending on the number of units sold. According to the company, even if the company charged a fee for renewals from the second year onward, the actual renewal rate is only around 50–60% of users. Additional fees and the effort of renewing mean that around 40–50% of users abandon renewals each year, the amount of renewal fees collected is not as great as expected.
Furthermore, eliminating renewals also lowers costs on call center support for inquiries from users when renewing. Based on this analysis, the company decided to factor the cost of renewals into the initial product price, and make renewals free. The company went a step further by lowering the upfront price, and switching to a commodity strategy whereby unit volume was the key earnings driver. This led it to offer products at an upfront price of less than JPY4,000. In July 2006, the company also introduced its ZERO renewal fee model.
At the time, the average upfront purchase price for competitors’ security software was around JPY7,000, and the annual upgrade fee for the second year onward was about 60–70% of the initial price, making it around JPY4,000–5,000. Seen in this light, the company’s new pricing strategy was a departure for the market. By introducing the low-cost pricing model, the company’s ZERO security software product greatly expanded its user base and the number of stores distributing the product, making it a hit product.
Expected revenue/user at 30% of competitors, volume pushes market share up
Microsoft Corporation’s basic product support life cycle for its Windows OS line is to offer mainstream support for five years after the product is sold or two years after sales of the next-generation operating system begin, whichever is longer. Plus, Microsoft Corporation offers extended support services for five years after the mainstream support services have ended or two years after two new generations of operating systems have come out, whichever is longer (with a minimum of ten years). Assuming that the average length of time customers will use a particular OS for is five years, the average expected revenue per user is shown in the table below.
Note: Figures are based on the assumption that initial cost is JPY7,000, annual renewal fee is JPY4,500, and 45% of all customers will cease to renew each year.
Thus, competitors’ expected revenue per user is about three times that of the company, at about JPY12,000 (less than JPY4,000 for the company). On the other hand, this means that—assuming security software development costs are the same for the company as its competitors—SOURCENEXT would be able to ensure the same amount of revenue overall were it to secure three times as many users as the other companies. The actual figure is probably less than three times the number of users, because competitors will likely have to pay marketing costs to encourage users to renew.
As of March 2014, the current price of the company’s most generic edition of its security software is JPY1,980—half of its former price. Competitors have not made significant attempts to lower the price of their software, which means the company will need to acquire an even greater number of users if it is to get the same revenue. Yet SOURCENEXT’s market share (value basis) and number of contracts is increasing at a notable rate along with its reasonable pricing policy.
ZERO renewal fee model unique in industry (as of June 2020)
The company cut the price of its ZERO security software to JPY1,980—half of its former price—in August 2010, and reduced the price further to JPY1,800 in November 2019. This marked an attempt by the company to broaden the appeal of this product line. The following table shows the different security software products. As of June 2020, the company’s two main competitors in this market offer fee packages that include two- or three-years’ worth of upgrades but they have not gone to a free-upgrade model. These packages appear to be aimed at appeasing those competitors’ existing user bases.
*Each company’s download price, divided by 1.10 where price included tax.
In the past, SOURCENEXT placed a limit on the number of years it would provide support for its security software, but when users bought a new PC or other device, they could transfer the software to their new device. Following the introduction of the new Windows 10 operating system in 2015, SOURCENEXT has done away with limits on the number of years it will provide support for its Windows 10-compatible security software, but will only offer support for the device on which the software was originally installed.
According to the company, in the past, many users bought new security software when buying a new device. After taking into consideration the average device replacement cycle, the company does not expect much difference between the actual number of years the average user will make use of a single version of its security software compared with past years. But by eliminating limits on the number of years it will provide support, SOURCENEXT believes it is now easier to attract customers in contrast to competitors, who are still charging renewal fees. Aided by this favorable tailwind, in October 2015, SOURCENEXT saw its share of monthly sales of PC security software jump from the No. 3 spot to the No. 2 spot for the first time in 74 months. There have been some fluctuations since then, but SOURCENEXT has gotten back to the No. 2 spot in the monthly rankings in January, April, and in May 2016.
Around 20% share of the new PC market, and 9.87mn customers (cumulative basis)
Until 2003 SOURCENEXT bought security software from McAfee Inc. (US; a subsidiary of Intel Corporation). After 2003, the company switched its most popular security title to software developed in-house, subcontracting development to K7 Computing Pvt Ltd of India. In the security software category, the company offers three product types, starting from the low-end version and working up to the advanced version, which uses the software engine developed by Bitdefender (developed by the Romanian SOFTWIN Group) and has won the number one ranking for overall performance on the AV-TEST for two years running. Hence, the company’s products cater to a range of user needs.
According to the company, it holds around 20% of the security software market. As of end-March 2018, the user base for the company’s Virus Security products was 9.87mn customers (cumulative basis).
New model: unlimited use of SOURCENEXT’s software
Tie-up with telecoms companies to offer unlimited use of PC software from 2013
SOURCENEXT has lowered prices in the PC software market. As the next step in this strategy, in 2013 it launched a new way of using PC software that allowed users unlimited use of its software. Telecoms carriers and internet service providers (ISPs) sell the service. SOURCENEXT provides PC software related to these services to the companies, who then sell it as part of their various services. Fees vary by company, but are JPY500–600 monthly, for services that provide unlimited use of PC software. SOURCENEXT was offering over 50 carefully selected PC software titles for such services (including security software and postcard creation software) as initial setup, and is expanding its title lineup along with the expansion of the unlimited-use services.
SOURCENEXT first offered software for such a service with Nippon Telegraph and Telephone East Corporation (NTT East). In May 2013, NTT East launched a service that allowed users to take advantage of SOURCENEXT’s entire software catalogue (about 50 titles) called “All-You-Can-Use PC Software on FLET’S.” In June of the same year UQ Communications Inc. and Kyushu Telecommunication Network Co Inc. adopted the service. The number of companies offering the service gradually increased, with Forval Telecom, Inc. (TSE Mothers: 9445) joining in November 2013, Oita Cable Telecom Co., Ltd. (unlisted) in December, Benefit Japan Co., Ltd. (unlisted) in April 2014, and Ehime CATV, Inc. (unlisted) in May 2014.
SOURCENEXT begins CHOU HOUDAI unlimited PC software service in June 2014
SOURCENEXT also offers unlimited PC software usage under its own CHOU HOUDAI brand. It began selling the download version of CHOU HOUDAI on June 10, 2014. On July 18, 2014, the company began selling a packaged version of CHOU HOUDAI at electronics retail stores nationwide. The CHOU HOUDAI service allows users access to the latest versions of over 120 software titles for a fixed annual fee. The price is the same for the packaged and download versions, at JPY500 for one month or JPY4,980 for a one-year version or JPY12,800 for a three-year version (excluding tax).
The popular CHOU HOUDAI offers greater bargaining power with electronics retailers
The CHOU HOUDAI services offer users added value, with access to many software titles for a fixed fee. It appears it also provides an opportunity for SOURCENEXT to increase the utilization rate of its software and the average price per software package.
Consumers purchase SOURCENEXT products in the PC section of electronic retail stores, when purchasing PCs, and also in the PC software section as single items. In 2017, the company held 16.9% of the OTC retail market in security software products by sales volume, ranking it third in the industry (source: GfK Japan). However, according to the company, its products accounted for over 40% of sales when purchased as single items (not alongside PCs). This would position SOURCENEXT as the clear market leader in this area. It appears this is because consumers are swayed by sales staff recommendations when making software purchases at the same time as PC hardware; sales staff tend to recommend competitors’ high-price products in order to take more commission.
SOURCENEXT is a late entrant compared with its two major competitors, and the above point places it at a disadvantage due to its commodity strategy of offering consumers good value. CHOU HOUDAI offers consumers good value while also allowing it to raise the average package price. As a result, it appears likely to increase the company’s bargaining power with electronics retailers.
In October 2014, the company launched sales of its proprietary service APPLI CHOU HOUDAI, a fixed-fee, all-you-can-use app service for Android smartphones. This service is offered in partnership with low-price smartphone and SIM providers, such as Aeon Retail Co., Ltd. and Biglobe Inc., and targeted at general consumers. The company expects demand to increase for this service, which offers a simple way for users to access a select lineup of over 100 quality apps ranging from security to popular games. The subscription fees are JPY360 per month or JPY3,600 per year (excluding tax).
A new initiative to cut inventory risk
The CHOU HOUDAI package version contains a prepaid card that uses POSA technology (see note below). POSA technology activates the product when it passes the point of sale at the retailer’s checkout counter, and generates a procurement order. This system thus cuts inventory risk for retailers and the company. It also eliminates the risk of loss or theft for the retailers. SOURCENEXT is considering introducing POSA technology for a wider product range, in addition to CHOU HOUDAI.
Transforming into a global manufacturer
Following the September 7, 2018 launch of POCKETALK® W (a pocket-sized language interpreting device developed by the company that uses the IoT to provide instant voice translation of 74 different languages), the company plans to launch still more IoT products, thereby establishing itself as a manufacturer that sells products worldwide (for details, see previous discussion).
Diversified product lineup to flatten sales peaks and troughs of particular categories
Sales breakdown in major categories
In tandem with its pricing strategy, SOURCENEXT also rolled out a key strategy of diversifying its product lineup. Since the company operates in a single business segment, its sales results are broken down by product category. It launched the original POCKETALK® in December 2017, followed by a second model, POCKETALK® W, in September 2018. Until FY03/18, security products and postcard creation software accounted for a high ratio of sales, but the ratio of sales from POCKETALK® grew rapidly, to 46.6% in FY03/19 and 52.1% in FY03/20. However, the pandemic caused the ratio of sales from POCKETALK® to shrink to 17.8% in FY03/21. On the other hand, sales of software products meeting demand from increased teleworking have been robust, with security software accounting for 9.2% of sales (5.6% in FY03/20), postcard creation software for 13.7% (10.4% in FY03/20), Hardware and Others for 20.0% (6.2% in FY03/20), and other software for 39.4% (25.7% in FY03/20).
Under its plan to become a global manufacturer, the company is looking to follow up the launch of POCKETALK® and POCKETALK® W with the launch of still more IoT products and further increase the proportion of sales coming from other products.
Note: Sum of gross profit by product category does not include common expenses such as R&D that cannot be directly attributed to specific products, and thus does not match the figure for gross profit on sales reported by the company.
With its move to broaden the range of products handled, the company will be able to avoid the risk of becoming overly dependent on a single product. PC software sales are subject to large peaks and troughs driven by the release of new products by the company and other software vendors. To mitigate the risks associated with dependence on a small number of software products and maximize demand, the company pursues an active policy of handling software developed by other companies that it sees as having good potential.
SOURCENEXT aims to offer popular products with good margins, regardless of whether they are developed in-house or externally. The company prioritizes getting products to market that meet market demands. First, it investigates whether there are products that meet certain demands on the market. Then—if the licensing conditions are right—it will license the products from other companies. If the licensing conditions are poor, or if there are no products that meet certain demands, it will develop products in-house. For products developed by other companies, it initially acquires marketing rights. Where it sees good growth potential it sometimes moves to acquire software copyright and trademark rights. For products with high potential, it sometimes pursues a high level of involvement from the outset.
The royalties paid on other companies’ products range from several percent of sales up to around 50%, depending on the product. Where an investment is considered, the baseline for a decision is whether or not the investment can be recouped in around one year after placing the product into the company’s channels. For in-house-developed software, the company typically spends several tens of million yen, and if a large-scale marketing campaign is undertaken, JPY100mn is sometimes invested.
Examples of success: FUDEOH and Blue Light SAKUGEN
One example of a successful application of the strategy of acquiring other companies’ products is the mainstay FUDEOH series. It acquired the copyright and trademark rights from i4 Corporation (now e-frontier Inc.) for JPY800mn in March 2007, but recovered more than JPY1.0bn in the first year. IKINARI PDF was initially a licensed product, but the company developed it in-house after seeing significant potential for low-price PDF software. The product is now one of the company’s most popular products. Examples of in-house-developed software to meet market needs include CHOU Blue Light SAKUGEN and KOKORO NI HIBIKU Wedding Photo Movie.
Acquisition, dissolution, and liquidation of Fudemame
In May 2017, SOURCENEXT acquired all outstanding shares of Fudemame Co., Ltd., a well-establish PC software maker and developer of FUDEMAME, the top-selling software program for postcard and address-label creations for the last 18 years. The shares were acquired at a cost of JPY813mn from Fudemame’s parent company, Softfront Holdings, making Fudemame a wholly owned subsidiary of SOURCENEXT. With this addition on top of its own brands—FUDEOH and Atena Shokunin (the top-seller for Mac computers)—SOURCENEXT has a virtual monopoly with greater than a 70% share of the market for postcard creation software. However, taking into account the business scale of Fudemame, SOURCENEXT decided to dissolve and liquidate it as of July 5, 2021, to improve the efficiency of the group as a whole.
Acquisition of domestic trademark rights and unlimited marketing rights for Rosetta Stone in Japan
In March 2017, SOURCENEXT entered into an agreement with Rosetta Stone Ltd. (NYSE: RST), the producer of one of the world’s most popular language learning software, that would give it the exclusive right to use the Rosetta Stone trademark and sell Rosetta Stone products in Japan for an unlimited period of time, as well as the right to modify downloadable products (including reproduction rights, the right to make changes, and the right to make secondary products). SOURCENEXT paid over USD19mn (JPY2.2bn at JPY115/USD) for the rights. This was followed in May by the acquisition of Rosetta Stone Japan, making Rosetta Stone Japan a wholly owned subsidiary of SOURCENEXT.
In addition to acquiring the exclusive and unlimited sales rights for all Rosetta Stone products in Japan, the agreement allows SOURCENEXT to do its own planning and development work to customize Rosetta Stone products to meet the needs of different users and even expand the Rosetta Stone product lineup. Moreover, SOURCENEXT has the right to sell the Rosetta Stone products that it has independently planned and developed not only in Japan but also overseas, provided the sales go through Rosetta Stone (US).
According to a 2016 survey by the Yano Research Institute, the language learning market in Japan generates sales of more than JPY820bn per annum, and with an increasing number of overseas tourists coming to Japan, the Tokyo Olympics coming in 2020, and English-language instruction becoming mandatory in Japanese elementary schools, the language learning market in Japan is expected to continue growing in the years ahead. With “taking down language barriers” as its mission statement, the company is looking to continue growing the Rosetta Stone brand in Japan to meet the expected growth in demand in Japan’s language learning market.
Collaborations with Silicon Valley companies via SOURCENEXT Inc.
In 2010, the company was an early mover in establishing an alliance with cloud service pioneer Evernote. This has included a wide range of collaboration, including packaged product sales and linkages with PC software functionality. In September 2012, the company established US subsidiary SOURCENEXT Inc. in Silicon Valley, in an attempt to acquire overseas developers and give it more power to discover new products. This has led to a rapid increase in alliances with leading Silicon Valley IT firms. The company has also been actively pursuing business alliances with a number of companies elsewhere in the world, including companies in Asia and Europe.
Online store strengthens cooperation with product development department and works as an antenna shop
The company plans to further utilize its online store as an opportunity to test sales of new products to expand its product lineup. Previously, each of the staff running the online store individually procured goods. Starting in FY03/16 the product development department began active involvement in product procurement. According to the company, participation by the department’s personnel, who are experts on the company’s products, has raised the likelihood that a product put on sale on the online store becomes popular. Formerly, gross profit at the shop was not so large though a large number of products were sold. After the beginning of the collaboration, the number of goods sold decreased but gross profit per good improved, leading to an overall rise in gross profit.
In line with profitability and market for its software products, the company handles three categories of products: Own production (products under full control of SOURCENEXT from development to sale), products sold on an OEM basis (products from its own brand but their copyrights held by other companies), and Others’ production (both brands and copyrights held by other companies). It gradually deepened its involvement with products in the Others’ production category that were likely to become popular by acquiring their brands and/or copyrights, with the aim of maximizing income.
In the three categories, the company’s product development department actively participated in product testing, manufacturing, marketing, sales, and support for each product, though there were differences in the level of involvement in terms of planning, development, and branding.
Products procured for the online store did not belong to any of the three categories. The shop handles around 100 titles annually, but they are sold in smaller lots than other products handled by the company. However, it now regards the products procured for the online store as targets for test marketing and plans to deepen its involvement with those that meet the market’s needs—just as it has done with other products—to maximize profit-earning opportunities.
Price strategy: sets prices through mathematical process
Sets prices using its e-commerce sites and registered users
SOURCENEXT operates an e-commerce website (eSHOP) and has a large number of registered users (17mn as of end-May 2020). Of these users, over 5mn have subscribed to receive a newsletter.
The company is utilizing its e-commerce site and registered users to set prices in order to maximize sales. In this process, the company chooses three potential prices (for example, JPY3,980, JPY1,980, and JPY980 for a product with a standard price of JPY7,000), and presents the product at a lower price (one of the three listed above) at random to a few select registered users. The company then uses statistical analysis to determine which price range resulted in the largest volume of sales, and determines the product price. In other words, the company does not set prices based on the simple logic that less expensive products will sell more.
The company set prices for both the ZERO renewal fee model and the discount on Rosetta Stone (limited to 300,000 copies) to JPY4,980 (standard price: JPY27,593) based on this mathematical process.
Marketing Strategy
The key to SOURCENEXT’s success has been innovative marketing, abandoning the prevailing conventional wisdom in its main market. The two main factors that set it apart from its competitors are the “commodity strategy” (introduced in 2003) and its ZERO model (introduced in 2006).
By cutting prices and increasing unit sales, the company has gained access to a new customer base. It enabled it to unlock new sales locations besides those traditionally associated with software sales. It can now sell its software in convenience stores and large supermarkets such as AEON (AEON Co., Ltd.; TSE1: 8267).If competitors follow suit in making products cheaper, however, it will become difficult for the company to maintain high volumes. It had to accept extraordinary losses when it introduced its commodity strategy because of returns and disposals of products that had their prices changed. These extraordinary losses would be larger for established corporations with high market shares, and they have not followed suit—meaning SOURCENEXT was ahead of the pack.
In order to maintain the advantage, the company pursues the following policies.
SOURCENEXT introduced new pricing methods for software.
One of the characteristics of the way the company markets its products is the slim packaging mentioned in the table above. It came up with this idea and introduced it in April 2003, shortly after starting its software “commodity” strategy in February 2003. Compared with regular cardboard packaging, slim packaging is much smaller, at about one fifth of the size. It allows retailers to save space, and thus played its part in helping SOURCENEXT expand into new sales channels, such as convenience stores and book stores. These products were initially sold alongside products in regular cardboard packaging, but sales of products in slim packaging began to take up a larger and larger share of sales. By 2005, the company had switched almost completely to slim packaging.
It is difficult to say how good a particular software product is without using it. Therefore, consumers tend to read the descriptions on the packaging. This presents an issue for slim packaging, as there is less space for explanations. In November 2004 SOURCENEXT introduced a new type of packaging with a flap on the cover. The flap opens to reveal an explanation of the product. Most software companies have adopted this type of packaging.
SOURCENEXT CEO, Noriyuki Matsuda, frequently visits stores, and the slim packaging and fold out flap were based on his observations of consumers and salespeople. Shared Research thinks that the way the company adapts its services lends it a competitive edge.
Sales channels: meeting user demands with store sales and e-commerce
The company’s main sales channels: retail stores and e-commerce. The company’s organizational structure closely follows its sales channels. It is often difficult for first-time buyers to grasp the details and advantages of a particular piece of software. Face-to-face sales at stores are good when users need explanation. On the other hand, e-commerce is convenient for existing users and other users that do not require an explanation. Further, sales of apps for smartphones via telecoms carriers are rapidly increasing.
As of end-FY03/21, SOURCENEXT generated 43.2% of sales from its own e-commerce sites, 32.9% from electronics mass retailers, 22.0% from corporate customers, and 1.8% from other sales channels.