Business is changing. Everywhere you see product-driven organizations counteracting product commoditization through the addition of value-added services. Services-driven organizations are packaging their services into repeatable service offers and products to shorten time to value. The line of demarcation between products and services has become very blurry. Is software-as-a-service software or a service? Is Google selling software or a service? What about Linkedin and the host of e-commerce and social media applications are they products or services?
One thing is clear. Across all industries, firms are placing a premium on the total customer experience — lifetime value — not just the worth of the product sale. Aftermarket services are the cash cow of the automotive industry where product margins are thin, and competition is intense. This trend is good for customers because it means the days of selling and running are over.
Today, it’s about customer value creation. This means consumers expect usable products that actually help them do a job. They don’t want shelf-ware. This trend has also emerged in the professional services sector, as increased global competition has made it necessary for services-driven organizations to offer service packages and products, with tangible deliverables.
For the past five years, we at Service Performance Insight have tracked the percentage of total revenue generated by products in independent professional services organizations. Until recently, independent service providers reported about 5 percent of total revenue came from the sale of pass-through hardware and software. In the 2014 Professional Services Maturity™ Benchmark, this figure nearly tripled to 12 percent, and this is just for independents, such as IT and management consultancies. Figure 1 shows the percentage of service provider revenue coming from products.
Figure 1. Percentage of Revenue from Products in Independent Services Organizations
Not all of the revenue comes from proprietary packaged services, as many independent professional services providers also sell additional off-the-shelf hardware and software. However, an increasingly higher percentage of revenue comes from their own internally developed products such as dashboards, report packages, data loaders and integration tools.
Is this an anomaly? We doubt it. Just like product-driven organizations have moved to services as a source of differentiation, now services-driven organizations are doing the same.
The good news: Products help differentiate services
Given the commoditization of many types of professional services, a packaged solution including products can help professional services organizations distinguish themselves from the competition. When hiring a service provider, customers look for demonstrable outcomes. The product could be hardware and software combined with services to create a unique solution. These solutions offer a proven complement of hardware, software and services that together solve a complex business problem.
This is especially evident in the IT consulting sector, as systems integrators are increasingly developing their own proprietary software to better help their clients use the technologies they implement. As the market moves towards greater industry specialization — with unique business processes, data and analytics — this trend will become increasingly popular.
The bad news: Both Products and Services are complex
Many products, while providing a competitive advantage, are very complex to develop and manage over time. It brings a whole new host of factors into play as services-driven organizations begin to develop and sell products. Complex products require additional infrastructure for long-term development and support, something many professional services organizations are not accustomed to providing.
In the past, it was all about implementing a product with a defined, albeit time and materials, statement of work, without any long-term support or ongoing commitment. Now there are upgrades, staged roll-outs and re-implementations of the product in addition to managed services and hosting. This new scenario keeps the service provider engaged with the customer for the life of the solution, demanding long-term contracts and relationships.
Profit margin of products versus services
Products and services generate very different profit margins. For instance, traditional software vendors sell software with a 90 percent margin, whereas their consulting services might only produce a 10 to 20 percent margin as shown in Table 1.
Table 1. Services Provider Percent of Revenue and Margin from Products and Services
Obviously, executives prefer 90 percent product margins as opposed to 20 percent for services. Unfortunately, as products become more complex, the services component also becomes more complex and mandatory. Product executives must carefully consider the desired profit margin of services without degrading overall corporate profitability all while maintaining high levels of customer adoption and satisfaction.
An approach to consider
Products must be developed with specific services in mind and include the potential for additional service and support revenue over time. Executives need to agree on the specific goal of the product, as it might be a sales enabler for more services, and thus carry a minimal cost or margin. Or it could be intended to generate high levels of product profit with minimal service margin.
We have worked with organizations on both sides of this spectrum. The biggest issue is confusion regarding the realistic amount of services required to bring the product to life. Immature products or products that solve complex business problems may require loads of services. The question is: Can the required services be sold at a profit, or must they be discounted to garner the product sale?
When the goal of the product is to generate profit
In general, most technology products deliver high profit margins. However, as products become more complex, so do services. Failure to implement the correct services strategy could ultimately doom the success of the high-margin product if customer use and adoption are low due to poor implementation and training.
When the goal of the product is to generate additional services sales
Develop a services strategy that incorporates service importance at the time of sale. Most products require additional training. If this service is offered for free, then executives must closely monitor it, as it can eat into both product and service margins.
Conversely, services firms that have already begun to develop products need to watch their cost and the perceived value they deliver. Many firms that have had initial success developing a product get caught up in the “develop a product at all costs” mindset. Unfortunately, improperly managed products tend to eventually cost more than the value they deliver. Do not lose focus on the intended goal of the product.
Questions to consider
Before working on the development of a product to enhance overall revenue, all parties involved need to answer key questions and accept the answers.
1. What is the intended goal of the new product?
2. What are the projected margins for products and services?
3. Will the combination deliver the desired overall profit margins?
4. Is the services workforce required to sell, given the technical nature of the product?
5. What is the upgrade strategy, and how often will upgrades be delivered?
All firms care about bottom-line profitability. Whether it comes from products or services may not be the primary consideration. In many cases, products are more predictable than services, but without required services and enhancements, product revenue could quickly dry up.
What does it take to succeed in selling both products and services?
If men are from Mars and women are from Venus, then products are from Pluto and services are from Saturn. The development and sale of both is very complicated. Companies with strong skills in manufacturing products cannot easily begin selling services. And of course, the opposite is true.
A team must be developed with specific skill sets and a collaborative framework to ensure the synchronicity between products and services. The IT infrastructure is especially important, particularly the enterprise resource planning (ERP) solution, which should be able to manage both products and services in the same sales order.
As the economy strengthens, one thing has become abundantly clear: Product manufacturers are investing heavily in professional services, and services organizations are investing heavily in building products. Both of these are unfamiliar territories to the executives running their respective organizations. Managed correctly, both offer the potential for greater growth, client satisfaction and profit. A complementary product and service strategy requires leaders on both sides of the aisle to learn from each other and collaborate to develop real solutions which solve real client problems.