29 July 2019
"Service companies are much easier to start than product companies because you very quickly find out if the customers want to buy what you are selling."
Terry Gold is Entrepreneur in Residence at the ICC.
A product company designs and develops things – the product could be engines for trucks or software for keeping track of fleets of trucks, but that thing is then resold many times over the life of the product.
A services company generally employs people to do something such as repairing the truck engine or dispatching the trucks. An IT services company makes money by employing people to handle their customer’s websites and computers. They may specialise around another company’s product, such as Microsoft or Apple, but they are clearly a services company and are not competing (usually) with the product companies.
Some companies do both products and services, but usually there is a focus on one or the other. The truck engine company may also sell repair services for their engines, but usually product companies only offer enough services to enable more sales of their products while allowing other companies to take on the majority of the services work.
I love services companies. They are much easier to start than product companies because you very quickly find out if the customers want to buy what you are selling, and you can often bring your personal skills into the business on day one and start doing business. Add some marketing and you might get your first customer in the first week, and start generating cash in the first month or so.
You can quickly change how you sell and what you sell with a service company as you learn the market. You may think your customers need network administration, but maybe what they really care about is cyber security support. Or maybe they like that you can do all of that plus anything else they think of, for a price. If the customer wants you to do things that you don’t want to do, you just raise the price on those services until you either learn to like them or the customer stops asking for them.
A product company on the other hand can take many months or years and lots of investment to even get to market with the first product, and if the customers don’t want the product, the company may die right there. Depending on the product, it may be years of time and millions of dollars in investment to get the first product sold. First time founders are going to find it more difficult to convince an investor to let them play with their millions to build a product that may not ever work, much less sell.
So why does anyone ever start a product company? POTENTIALLY, once you get the product designed and built you can sell it over and over again at a higher profit than you can sell a person’s hourly work. If the product is software, it’s even better because once you pay off your development costs, the ongoing sales can be nearly 100% profit assuming the product requires little or no ongoing support. Investors GENERALLY prefer product companies, because of the potential for outsized returns. Because most product founders need investment, the investors can get in early at a low valuation and then get a big return if the product is a hit.
I started my own company as a services company, because I didn’t have the capital to fund product development. I had a software skill though, and I could sell a little bit and I was able to identify the first customer before I even quit my job. Turns out I never closed that deal, but luckily I got another customer to sign up before I ran out of cash, and we were off and running.
With services companies you hire people as you need them, and you can let them go (it’s painful for everyone) if the demand goes away, so they are more resilient than a product company generally. But that’s also the problem - to grow a services company you need to be able to keep hiring more and more people, and it gets harder the bigger you get. Running my company with two employees was very different from running it with 130 employees!
If you don’t care about growth, and you just want to be independent and do what you want to do, a services business can provide that. No one says you have to get big. That’s not to say you can’t grow a services business, but it may just take a lot longer and it may never be as valuable as the product business doing a similar amount of revenue or turn-over.
So . . . I like product business and I like services businesses. I tried to be both at the same time with my own company and that’s perhaps even harder than picking one and focusing on it. As I’ve said lately, “a product business makes money by saying NO and a services business makes money by saying YES.” A product business that adds new features to the product for every customer, isn’t really a product business. A services business, assuming they can charge for it, pretty much does whatever the customer is willing to pay for. But a company trying to be both at the same time is always trying to find a balance between being focused and being willing to do anything to get the next customer, and that’s really hard.
Author Terry Gold has exeperience building both product and service companies.
"A product company can take many months or years and lots of investment to even get to market with the first product."
