Product to Service…to Product? Go Long.

Product to Service…to Product? Go Long.

If a sports fan in 1980 could time travel to 2017, he or she would probably assume – and props here, since it would have been before Elon Musk made it fashionable – that today’s competitions were some sort of video game simulation of reality.

Take the three-point shot in basketball as a data point. The Los Angeles Lakers converted on 20 out of 100 three-point attempts throughout the 1980 season and won the NBA finals. In the 2017 season opener two weeks ago, Nick Young, who is probably the ninth most important player on the Golden State Warriors, hit six. His teammate, Steph Curry, famously made 13 in a game last year (the guy’s automatic).

Football has also transformed to a much higher commitment to passing the ball. Notice the stark contrast in quarterbacks who achieved the 4,000-passing yards milestone in the 1980s1 versus in the last decade:

You can also see the huge upswing in three-pointers, which continues to become a bigger part of basketball at all levels (thanks to a blend of very advanced stats work and common sense. Quick math: What yields a better expected value, making 35% of your three-point attempts or 50% of your two-point attempts?)

A little more history

When comparing national economies, being a “service-based” economy is generally favorable to being one that is dependent on industrials and manufacturing. It’s a natural, intuitive progression: Industrialization creates wealth, which drives a higher standard of living and more importantly, better education. This increases the supply of human capital, which is the primary input to services like medicine, banking, travel and hospitality, entertainment, education, etc. It becomes more expensive to manufacture physical goods in that economy, so manufacturing is pushed to less-developed countries.

Technology firms, a byproduct of this human capital infusion, come to represent a larger share of the overall economy. These firms leverage the internet and, in the case of software firms, close-to-zero-marginal-cost business models, to generate much higher margins than a typical widget-maker.

In a nutshell:

services (especially tech) > products

But this is too simplistic a view, too broad a definition. The line between “product” and “service” in the context of technology-based firms can become fuzzy: They create “products,” after all, which are meant to make things easier compared to having humans carry out services manually.

The household names of Big Tech are easy to plug into this framework:

  • Facebook allows businesses to launch narrowly-targeted ad campaigns without ever interacting with another human;
  • Amazon lets you start a company without any significant computing hardware investment.

Advertising brokerage and data center hosting, in these examples, are the points of friction that the technology “products” (Facebook ads and Amazon Web Services) have minimized.

So, let’s update our nutshell:

software products > services > traditional products

Not all technology businesses are equal

It’s easy to look at Facebook and Amazon and say, “let’s be more like them,” but nearly impossible to replicate in practice. There are thousands of technology businesses that never appear in the Wall Street Journal or TechCrunch:

  • The $50M revenue firm that makes billing software for the pest control industry;
  • The analytics company that scrapes the podcast universe for sellable data;
  • The company that integrates the software and hardware that run your point of sale terminals.

How can these niche technology firms innovate?

There’s a lot of nuance in the markets these firms serve, but one commonality exists among the successful players: automation. The podcast analytics company could create self-service reporting and data visualization. A business process outsourcing (BPO) provider may develop a data ingestion tool to reduce the amount of paper and manual entry. As obvious as it sounds, this is the point of software.

Automation is the next step of the product-service evolution – marking a paradigm shift in what it means to be competitive, like the three-point shot or pass-centric NFL offense.

What it all means

Technology businesses, despite the immensely (and mostly, rightfully so) hyped “everything as a service” (XaaS) movement, should NOT strive to be service businesses – they need to think of themselves as product businesses.

An obvious benefit of this approach is margin expansion: Marginal cost stays low as revenues increase. Even the monopolies of the old industrial world would be jealous of Facebook’s 86% gross margin in 2016.2 Meanwhile, service businesses have a margin ceiling. If that BPO firm never modernizes, it’ll always have the paper-pushers swallowing up precious OpEx dollars (if they’re even able to survive).

Paradigm shifts happen everywhere, and the teams, firms, and individuals that succeed are the ones that embrace these shifts. Fortunately, you don’t have to be the first mover within the paradigm shift to be successful.

From 2005 to 2012, the Orlando Magic and Phoenix Suns led the NBA in three-pointers made in seven of those eight seasons; both also failed to bring home a championship. And as much as it pains me to write, Dan Marino, the most prolific passer of the 1980s, never won a ring for the Miami Dolphins.

Likewise, winning firms aren’t rewarded for identifying the next technological frontier – they’re rewarded for executing. The playbook is Strategy 101: Secure appropriate R&D funds; talk to customers and objectively weigh market opportunities; make sure you have the right talent (and go get it if you don’t).

Don’t simply throw darts at the technology project board. Understand your market and capabilities, then embrace the shift.

Head coaches and CTOs, looking at you.

Footnotes:

1The 1982 and 1987 NFL seasons were not included in the analysis due to player strikes. In 1982, Mark Moseley, a placekicker, won MVP. When I think about how strange the world is in 2017, I remind myself that Mark Moseley, a placekicker, won MVP in 1982.

2 Source: Facebook Income Statement, Q2 2017

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