Beyond Revenue: How to Avoid Getting Stuck as a Service Business
So you just launched a SaaS business that sells email tracking software, but you’re getting requests for custom features you haven’t budgeted for. No worries, you think. People seem to like the product, and just want it to do a little more. So you start creating customized features required to close deals. Revenue grows, you make more customizations. Revenue continues to grow, you keep making more customizations. And so on.
When you’re making money, you’re doing something right. At least, that’s what most people think. But while revenue is a honest metric, it can also be misleading. In the above scenario, you’re trading in a sustainable, scalable business model for a series of quick wins, which can eventually backfire.
Why? Because you’re stretching the product beyond its capabilities to fit varying customer requests, and while this strategy might sustain itself for a year or two, it just won’t last. See, you’re sidelining your original product for the constant demand of customized features — demand you helped cultivate. The business model has changed from a product model to a custom service model right under your nose.
So how do you keep this from happening?
Products vs. Services
A service business has a variable cost per project, which must be managed properly (hours spent vs. hours billed) or else you’ll start losing money. For example:
- A computer repair store has a variable cost per project. Depending on the severity of the problem and the length it will take to solve, the cost changes.
- A party planning company also has a variable cost per project, as it depends on factors like the size of the party, the venue it’s being held in, and the resources it requires
Products, on the other hand, have a fixed cost profile. Every time you sell a unit, the cost of production remains the same. For example:
- A Snickers bar has a fixed financial profile. Every bar costs the same, regardless of who’s buying and how many customers there are.
- A SaaS product also has a fixed financial profile (and a much better gross margin!).
The Wizard of Oz Trap
Lion was a coward, so he was given courage. Scarecrow was dumb, so he was given a brain. Tin Man was heartless (dude didn’t even cry at the end of Toy Story 3), so he was given a heart. In each case, each problem was matched with a specific solution.
The Wizard of Oz is a Lean Startup method for testing a specific solution to a problem hypothesis. Doing so helps startups determine if a customer will pay money for the product, before the startup incurs the cost of building out a full product.
The method makes perfect sense when figuring out a product-market fit, but if you’re not careful, businesses — especially venture-backed B2B SaaS products — can easily fall into The Wizard of Oz trap, where you’re delivering way too many customized solutions to keep revenue scaling up and to the right.
Here’s what happens:
- You achieve early revenue traction and raise your next round to scale.
- You’re now under pressure to grow revenue month over month, but the product, use-case, and customer-profile are not 100% solidified.
- Every deal in your pipeline has a slightly different set of requirements, which are just out of your product’s scope. In order to hit revenue targets, the business must deliver product customizations on a deal by deal basis to close sales.
- You hit your month over month revenue targets, and on the surface, everything looks great, but you’re accumulating customer and product debt. Everyone is grinding to sell and support these product customizations until, at the $1–2M annual recurring revenue (ARR) mark, everything begins to slowly implode.
How To Avoid The Wizard of Oz Trap
Track Customer Profitability
It’s also a constant reminder that you’re not selling a product yet.
As the business moves towards a finalized product that’s ready to scale, track and report on customer profitability.
It sounds like a pain (and it is), but it’s also a constant reminder that you’re not selling a product yet. First, you need to work through the transition from services to product revenue; from service-market fit toward product-market fit. If you’re truly selling a product, then this sort of cost tracking takes no time at all, because there’s nothing to track!
Align Road-map + Customer Profiles
The key here is getting sales in lockstep with product (i.e. selling the product you have today).
- Review your existing customer base and pull out all use-cases and customer profiles, as well as the approximate market size for each customer profile.
- Establish the minimum viable product (MVP) required to satisfy one of the use-cases with a meaningful market size (not necessarily the biggest). Stop all other development and only build a product for that use-case/market segment (and make it really good!).
- Get Marketing and Sales 100% focused on winning customers in that particular market segment.
- Base your product roadmap on other use-cases that boast decent market sizes and are a natural progression of the product. The key here is getting sales in lockstep with product (i.e. selling the product you have today).
While the business is transitioning from service to product revenue, take the focus off growth. Explain to your investors that you’re taking the necessary time to build a business which will scale to +50M ARR rather than rocket to 2M ARR and implode mid-flight.
Side Note: Professional Services
Most B2B products require at least some sort of integration or on-boarding process, which you should bill at market rates, or at least report internally as “Professional Services” (a separate item from “Product Revenue”).
The ‘Wizard of Oz’ trap creeps in when you start billing for product while bundling in a bunch of professional services for free in order to stretch the product to fit a use-case at the same price.
Every product company pretty much starts out as a services company and eventually finds product-market fit. I think the trick is to recognize where you are on the road to product-market fit and avoid scaling too early.