From Services to Products

Transition-company Options

A lot of tech companies begin life in creative or technical services, then attempt to transition into products but find it more difficult than expected. Some of the difficulty may stem from not examining all the options available.

Preface

Consider this article an introduction. It does not go deeply into supporting cases, as I intend to elaborate on the premise presented here in future articles, dropping in anecdotes from my experiences starting and growing companies, building products, and working in digital media. I’m sitting on a mountain of data and stories. If you see an unexplored statement, I hope you’ll leave a comment and I’ll do my best to cover it. Now…onward!

Why Transition?

Starting a services-based business is straightforward because it is based on time, a simple concept to bill for. Creative agencies are an example — they charge a set rate for hours spent on a project. Startup costs are often relatively low, require little R&D, and usually early revenue comes from the founder’s network. All this means lowered costs for advertising, and streamlined growth based on enhancing that network and growing reputation. But at some point this model starts to be problematic. What works well for a freelancer can be hard to sustain as an organization.

Service companies struggle with turnover in staff. It’s expensive to have people come and go all the time. They also typically do not own any stake in the services they have rendered, which means continuing revenue is impossible. Disruptions in operating capital can be disastrous for service-based companies, particularly if they contribute to losing people, causing essential skills to go out the door. Banks are not particularly keen on creative-service companies, and you almost never see VC’s fund them. Why? In short they are hard to scale and have no significant collateral.

The reliance on the founder’s network that accelerated growth originally begins to choke the further development of the company, limiting drive into new services since the current client list must be maintained.

All of this adds up to a situation where owners constantly struggle to please a network of clients, year after year, while never really “owning” anything. At this point they will often look to employ their technical skills in creating products. Let’s take a high-level look at the options.

The Incremental Route

A lot of companies in transition from services to products seek to ease the transition by generating revenue on a continued basis from the services business while breaking off a group to work on the new product. They plan to fund the new with the old, gradually shifting revenue generation over time while enjoying some safety from the existing familiar model.

On paper this makes sense, and it can certainly make people in the company feel more comfortable. But in practice this rarely works. No matter how strong the silos are, the models will fight each other.

Adding on product development does not magically ease the stresses from the services side of the business. Those still draw the attentions of the founders, who now have to add on the fledgeling product development effort to their list of concerns. Their attentions become divided, leading to frustrations among team members. The services team can start to feel like they are rowing the boat while the product team is playing shuffleboard on the deck.

The same comfort that provided reassurance becomes a stifling influence, often leading to a “zombie” company that keeps on going but never really succeeds to a great degree. Revenue continues to flow from the services, leading to the products never fully needing to establish themselves. In that scenario, the “product” becomes more of a marketing ploy, the purpose of which is to distinguish the service-company and provide a competitive advantage in services. It becomes a clever stunt rather than a legitimate enterprise, staying firmly within the comfort zone, where the challenges all remain the familiar ones.

During transition, service-based companies must seek new discomforts.

I have multiple examples of outstanding companies failing at this outright, others going into “zombie mode”, and none I can easily recall that have succeeded. Of those that have, it is questionable whether the services side of things ultimately contributed to success on the product side.

For companies that want to offer products and services, it is usually preferable to establish the product first, then tailor services to support that product. This automatically gives them a competitive advantage over others seeking to offer similar services.

The Startup Route

It may seem strange to think of a company that has existed and been profitable for years as a “startup”, which usually conjures up images of newly founded companies. But during a major transition from services to products the principle people in a company need to recognize that a lot of what they “know” has to be re-learned. There are whole areas of the new model they have never experienced before and do not understand.

Currently there is a lot of excitement in the startup world, with new companies seemingly popping out of the woodwork weekly, announced by sites like TechCrunch or ARS Technica. When startups receive funding rounds they are celebrated.

But this route is dangerous for transition-companies. It is all too easy to view funding as the profit model and focus on that rather than the product. Creative-services companies are particularly in danger of this — they have a large degree of skill in assembling pitch-decks and presentations. They know how to write exciting announcements. They can own a meeting. It is all too easy for creative companies to fall into a pattern of using what they know well to “build their brand” ending up with an incredible brand for a product that is impractical and has major holes in areas like revenue generation, supply chain, key partnerships, and customer service.

Reforming as a startup is a major undertaking and can come with heartbreak. For instance letting go of staff that don’t fit the new model can (and should be) extremely difficult. Abandoning a strong brand that has taken years to build may be a lot to ask. And most importantly going without revenue in the early stages may prove impossible.

For principles in companies looking to go this route the best thing they can do is accept that they know nothing, and do everything they possibly can to re-educate themselves. This means looking outward for any opportunity to learn from companies who are true product companies. But that can be difficult because many incubator programs and resources are set up for new companies rather than established ones. They may have to wipe the slate and start over.

Startup companies are expected to view the development of their new brand with a certain amount of detachment, an exit from it is to be desired and sought out. For many that is not a problem, but for others that viewpoint may be a poor fit. Hesitation in this area can lead to missed opportunities for funding or may slow progress to initial public offering or “going public”, the defining moment for many startups.

But there is a way to get real hands-on experience in products without abandoning a hard-won brand. It is a good route, but one that comes with significant risk.

The Revenue-Share Route

Transition companies moving from services to products should have one goal first and foremost, namely to re-learn their processes. There is no better way to do this than to be in close contact with companies outside of their world whose revenue comes from sales and support of an identifiable product, either digital or physical.

Service-companies in transition can position themselves as partners to such companies, offering their skills and expertise in exchange for a continuing share of revenue rather than on a fee-for-service basis. Essentially they are partnering up, but with each partner concentrating on their area of expertise for their mutual benefit. They won’t be a full owner of the product, but in turn get access to resources it may take them long to develop on their own.

The terror in this option should be fairly obvious — the company is now doing for free what they used to charge a pretty penny for. They must insist on not getting paid for services or they will be a contractor again and not transition. And they will not see revenue for some time in many cases. This route is a true “money where the mouth is” attempt, in which the company may find out just how useful those services they have been offering are in the real world, outside of the owner’s network. If their efforts do not result in increased revenue with the partner, they will lose their services investment. So why would anyone consider this option? Turns out there are many reasons.

By partnering up the company gets instant access to knowledge it may take them a long time to figure out on their own. Some examples may concern dealing with supply chains, handling customer service, research and development, and more. While some of this knowledge can be obtained from consultants and the like, nothing beats working within those areas of operation on a daily basis in the real world.

There are also benefits on the planning side. The partner already has a market established — something many startups never achieve. That alone should be attractive in terms of knowledge related to making a transition succeed.

This route allows the brand to be maintained and even derives benefit from the brand, unlike the iterative or startup options. If the company has invested significant time and resources into building a portfolio of impressive clients writing that off is not an option to be considered lightly — not if leveraging that brand could lead to obtaining the kind of partnerships that yield significant mutual benefits.

For Further Thought

These three routes have only been touched on in a very basic manner here, and they are not the only options available. Companies may find themselves borrowing from each of these directions before settling in to something that works.

In future articles I will pick apart each of these options in more detail, examining specific aspects of each with supporting material.