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Drilling for Oil

Services vs Product Business ModelsWest Texas Pumpjack

It always struck me that there are very few companies that are equally as strong in products as they are in services. This is in sharp contrast to the number of companies that have moved from their core to embrace the other side.  Companies like Cap Gemini quickly abandoned the idea of becoming a product company and we see HP struggle with services by now trying to jump start it through the acquisition of EDS. IBM might be held as a contra-example with both products and services, but I would submit that they have switched from being a product company to the current service company that they are today (e.g., selling the laptop division to Lenovo and printer division to Lexmark)

First, I think I should define by what I mean by products vs services businesses.  I think about the definitions from a sales perspective.  For the purposes of this article, I define a product that is anything that has an up front investment requirement (R&D, factory infrastructure, etc.) and long term payback.  A service, by contrast, is something with a limited up-front investment and limited up-side margin over a longer term.  Placing a $0.99 application on iTunes is a product while providing expertise to connect a blackberry server to a Lotus notes server is a service.  Some may argue that “clarity of scope/features” is a better attribute of differentiation, I would agree for many situations, but ask that you consider the business cash-flow attribute as the key in this discussion and not get too troubled by the terminology of the words service or product.

Why is it that these two business models (products vs services) rarely coexist in the wild? My thesis is that the two business models need different corporate cultures and values. In effect, it is a similar story to “men are from Mars and women are from Venus”.  At its core, I see the organization’s approach to investment, risk and improvement as the key elements that make the business models mutually exclusive.

Selling a product (e.g., producer, as opposed to being a reseller or distributor) entails a limited number of product lines that you have invested in and that each of these products requires an ongoing investment to keep them current, supported and marketed. The costs are typically front end heavy and the profits are likely long term. This type of business is similar to drilling for oil. You can read all the geological reports, but at some moment you have to trust your feeling that “this is the spot” where oil will be found. At the point you start drilling you are fully committed to some unknown outcome at a future date. Companies that prove out a successful well (their product) then need the discipline to stop improving it and allow the money to flow.  Their charge now is to find new holes to drill (products to make). If that fails, they need to learn from their experience without loosing their confidence to drill again. The key attributes of product companies is the ability to resist all the possibilities except for a limited few and then to fully commit. Discipline in a product context is the ability to resist small changes and saving it for the big opportunities.

In contrast, a service company is a less glamorous, incremental margin work. Most efficiency improvements are small and incremental. Utilization is usually the key indicator of profits and any major change or investment usually has an immediate negative impact to this utilization. Consequently, the goal is to make small, continuous improvements and never stop improving. Likewise, investment will be viewed as a large number of small initiatives. Discipline in a service context means resisting big moves and converting opportunities into a series of steps that can be evaluated and adjusted at each stage.

There is one more twist to this concept that is not immediately intuitive. Just because you sell a product does not mean you are a product company. It is a similar question as Kiyosaki’s “what business am I in?” that is deceptively simple yet quite revealing. An online betting service seems like a service business, but when you look at its attributes, it behaves and needs management like a normal product company (especially in a start up phase). Likewise, Amdocs (one of dominant mobile operator billing system providers) looks like they sell a product, but in reality they make all their money in the customization services. As a result it behaves more like a service company.

So what is the take-away? You need to know what type of business your company is in before you can understand what business models will be appropriate and so that they will not “be attacked by the antibodies” of the organization.  If there are both products and services in the company portfolio, you need to find a way to protect these incompatible business areas from each other.  Also, if you are an internal entrepreneur, you need to understand why certain types of ideas will become victims to the system.

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