Two Paths for Tech-Enabled Services
Building a tech-enabled service? Make sure you know which path you’re on, before it’s too late.
Since writing my other blog posts (1, 2 — read these first) about tech-enabled services (TES), I’ve gotten a lot of requests for advice from other TES founders.
Usually they’re either at the idea stage or approaching an early funding round. In both cases, I’ve noticed a similar issue, but usually by the latter point it’s much harder to remedy. Hopefully you’re reading this early in your TES journey.
TES is still a foreign concept to many founders and investors. The default startup is either SaaS or hardware/physical goods. They both work well with big up-front investments in fixed costs, later producing something scalable for relatively little or no variable costs — the core insight of the venture-backed paradigm.
TES isn’t yet a distinct corner of thought, so it blends in with the SaaS and hardware startups. Unfortunately, the founders and investors who swim in the waters of the venture-backed paradigm unconsciously apply the same assumptions and heuristics to TES, which produces much weeping and gnashing of teeth.
Founders and investors must understand the two paths for TES: become a large TES, or pivot to SaaS.
Become a Large TES
This is the default path for a TES. After all, startups = growth.
Paradoxically, many founders and investors think this is a bad outcome! That’s because they’re in the venture-backed paradigm, which leads them to focus on metrics like margin or growth rate. On average, a TES is not going to achieve the same margin or growth rate founders and investors expect from a traditional startup.
The actual bad outcome on this path is “failing” into a normal service. At Castle, the tech-enabled property management company I cofounded, we could have let the Growth and Tech teams go and kept managing properties. Instead we chose to wind down. Startups are supposed to make and test a hypothesis, not survive at any cost.
I want to be clear: becoming a large TES is a fine and viable path. There are many large, successful, powerful service businesses. Ever heard of the Big Four? How about Bain, McKinsey, BCG? Heck, they probably consider themselves TES nowadays.
As a TES founder, if you choose this path, you have two jobs:
- Make sure you, your cofounders, and your employees know the journey you’re signing up for
- Find investors who are comfortable with the returns and timeline inherent in your model, or don’t take traditional VC
Pivot to SaaS
Anyone inculcated in the venture-backed paradigm but working in TES will think about pivoting to SaaS, to being a “real” startup.
You can see the appeal: fat margins, faster growth potential, far less operational complexity and overhead. It’s a nice trick if you can make it work.
Not everyone can, though. Your business has to suit this plan:
- Establish customer base and reputation in the service
- Build and sell a related product to a similar customer base
- Grow product revenue enough to allow service revenue to shrink while still increasing revenue overall
Steps two and three are big risks! It’s not normal with the venture-backed paradigm to be taking existential risks so long after earning revenue. To build a successful business, then take such risk, requires high confidence and an iron stomach from founders and investors alike.
While in theory any TES could build and sell a related product, most TES I’ve consulted with don’t have a strong thesis on why they will make the jump.
We did not attempt a pivot to SaaS at Castle. If we absolutely had to, we could have sold our internal tech as SaaS, but there’s plenty of good property management systems out there. We had no special insight or qualification — no unfair advantage — that would have made for a viable pivot.
In contrast, my current employer, Scale, has an excellent SaaS product. The thesis at Scale is that data labeling — our bread and butter — is only part of a wider ML lifecycle. Current customers want Scale solutions for other parts of the ML lifecycle. An all-Scale ML lifecycle will be greater than the sum of its parts, and better than an ML lifecycle composed of different third-party tools. (Scale is still mostly a service, but I think eventually SaaS will bring in the bulk of the revenue.)
Another example: a founder I consulted for had a TES for a small but lucrative market. This particular market has a high barrier to entry; many vendors want to serve this market, so only vendors who have earned the community’s trust receive any business. The founder’s thesis was that he could use the trust he had earned to launch a marketplace, where vendors he trusted would pay a lot in exchange for access to this market. (It’s too early to tell, but I think he’s right.)
If you pick the pivot path, there’s no going back. The expectations you set with the team and with investors won’t allow you to fall back into becoming a large TES. On the plus side, your team and investors likely expect implicitly that they’re already on the pivot path, because it fits with the venture-backed paradigm.
A Word for Investors
The piece above is primarily for founders, because my experience with TES is as a founder (and employee). While I believe more founders experimenting with TES need to know what they’re dealing with, investors need it even more; there is no venture-backed paradigm without the venture backers. I would like to see more angels and VCs who explicitly work with TES and have models, term sheets, networks etc that fit the needs of TES. Many founders I’ve consulted for have asked me if I know of any investors who really get it.
If you’re a founder or investor in TES, drop me a line at me@timdingman.com. There’s so much work yet to be done.
