Outdated distinction: products vs services

For the better part of well over a century, companies would classify themselves as product- or service-oriented. Product companies often were high-margin businesses with high volatility as the investment in product R&D was largely fixed, but the sales and margins were very much influenced by the competitive landscape, the economic climate and the capabilities of the product. Service companies, on the other hand, were often low-margin businesses with much lower volatility as many customers could delay buying a product when times weren’t good, but a daily, weekly or monthly service was needed independent of the economy, revenue and profit.

Especially product companies that sold pure software products were incredibly profitable as the reproduction cost of software is, for all practical purposes, zero. So, selling the product to one customer or to a million customers created almost the same cost base, but the revenue was a million times higher in the latter case.

One of the main differences between product and service companies was the customer relation. Many product companies would sell their widget and then have no contact with the customer, except for pesky support calls, until it was time to try to win the customer again and sell them their next widget. Service companies, on the other hand, had a continuous relationship with their customers, who were receiving the service on a continuous basis.

A second main difference was the business model used by both types of businesses. Product companies got paid for the product at the point of sale and all variable costs incurred to produce, ship and install the product were paid for early on. Each product sale of course also contributed to the fixed cost, such as the R&D investment, but by and large, a product company would generate revenue early whereas customers would have to amortize their investment over the economic lifetime of the product.

Service companies, on the other hand, would have to absorb any expenses associated with bringing a new customer on board and amortize these expenses throughout the customer relationship. They typically had a continuous business model where the customer paid regularly for the service offered. Of course, many service companies looked to charge an onboarding fee to offset any initial cost, but the primary revenue and profit were generated continuously.

The third main difference was the R&D investment required. For product companies, the investment was traditionally done before the start of production (SOP). Once the manufacturing process was up and running, the preference was to avoid changes as much as possible as any change would upset the manufacturing process, which would decrease productivity and cause issues both for manufacturing and post-deployment support. Any requests from customers for new capabilities would typically not affect the current product but be used to inform the next product. In the classical triangle of technology advancedness, cost and customer intimacy, product companies generally prefer to focus on technology advancedness and use cost as a fallback strategy.

Service companies, on the other hand, were typically investing continuously in improving the efficiency of their service process and responding to changing customer preferences. This means that they were continuously adapting themselves to the changing needs of their customers. In the aforementioned triangle, many service companies focus on customer intimacy as the key differentiator.

Digitalization and the continuous value delivery that’s now expected by many customers are changing the product-service dichotomy quite fundamentally. Many product companies increasingly act as service companies and many service companies are increasingly adopting approaches that traditionally would be considered to be more akin to product companies. As a consequence, the difference between the two types of businesses is largely disappearing.

When a product company adopts DevOps, it basically commits to what for all practical purposes is a service in which the customer is provided with continuously improving performance of the product. This means that the customer relationship is changing from transactional and often more adversarial to continuous and often more collaborative. In the process, the product company becomes increasingly involved in the customer’s business and, based on this improved understanding, will focus more and more on improving the customer’s KPIs.

The business model of many product companies I work with is also changing. Although most seek to keep the upfront, transactional revenue when the customer buys the product, the continuous cost associated with providing continuous deployment of new software tends to lead to a situation where they also want a continuous revenue stream to cover the cost. Some companies go one step further and offer their product as a service. The most ambitious ones change their business model to align with the customer’s KPIs. In the latter case, new software deployments that result in improved performance of the product for the customer will also result in more revenue for the company.

In this case, however, the product company is almost indistinguishable from a service company. It gets no revenue upfront and has to finance the onboarding of the customer and the cost associated with deploying the product and then ensure that it generates sufficient revenue during the lifetime of the customer to remain profitable.

The transition from an upfront, transactional model to a continuous revenue model is often referred to as the belly of the fish, due to the shape of the cost and revenue curves. When transitioning, the revenue drops dramatically for a while as the company no longer gets paid upfront. At the same time, costs tend to go up as all kinds of R&D and other activities are required to serve the customers in a different way. Over time, the continuous revenue starts to grow, the one-time costs drop off and the company becomes profitable again. However, it’s a painful process for most companies and one of the reasons the digital transformation of many companies and industries is ridiculously slow and painful.

At the same time, in my experience, many traditional service companies are increasingly ‘productizing’ their offering. By standardizing the offering, providing a limited set of options and associating fixed pricing models with different service offerings and configurations, they’re adopting some of the playbook traditionally used by product companies. The result is that product and service companies are becoming virtually indistinguishable.

Traditionally, there were very clear differences between product and service companies. These differences included the nature of the customer relationship, the business model and the type and timing of R&D investments. With digitalization and many product companies adopting DevOps, this distinction is becoming irrelevant. Both types have a continuous relationship with the customer, use continuous business models and need to invest in R&D continuously. To end with a quote from Steve Jobs: “You’ve got to start with the customer experience and work back toward the technology – not the other way around.” It doesn’t matter whether you view yourself as a product or a service company; in the end, it’s about serving the customer in the best way possible.