What do BUYERS in 2020 want? Dogma Reconsidered: Products vs. Services.

April 14, 2020
min to read
Francis Pedraza

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In 2020… Investors still want products. But buyers want services. Entrepreneurs that reject what investors want to build what buyers want will ultimately be rewarded.

Let’s do a quick pro/con analysis. What are the strategic advantages of building software products? They are, from the investor’s perspective:

Scale: an app like Instagram can scale from 1 to 1,000,000 users with a team of 13, mostly engineers.
Margins: there is almost no cost of goods sold, other than servers. The marginal cost of adding a user is almost zero, especially if there are no support costs. Overhead is just payroll plus your software stack.
Distribution: Pricing is easier when you are selling a standard unit. Sales & marketing is easier when you have a product focused on solving a very specific need for a very specific industry or buyer role. Even if it requires expensive enterprise sales people that eat into margins, you can fully optimize your sales process around a very predictable value proposition and sales cycle, after you’ve proven “product-market fit.”

Notice that NONE of these are advantages from the buyer’s perspecitve. In fact, there are disadvantages to products from a buyer’s perspective: they are the inverse of the advantages of services…

What are the strategic advantages of building software-enabled services? They are, from the buyer’s perspective:
Customization: every buyer believes her business, her problems, her workflows… are unique. She doesn’t want to figure out how other companies think about their problems. She wants her vendors to figure out how she thinks about her problems.
Low Friction: buyers don’t want to figure out how to use a new tool, and buyers don’t want to spend time actually using the tool, even though that’s the only way to extract value from it. In fact, in 2020, buyers are exhausted by Silicon Valley’s over-production of tools. Every tool has discovery, training and usage costs. The advantage of services is that a user is not required. The service provider will use tools for you, and just give you the results.
Specialization: the fewer products and the more services you buy, and the better your service providers are, the fewer generalists (and specialists from fields other than your company’s core specialization) you need to hire on your team. In other words, you don’t need to hire people to use tools and run functions that have nothing to do with your core competency and mission as a company. There is a clear separation of labor. Your service vendors run the non-unique parts of your business, your team focuses on building and delivering what makes you unique.

In other words, you’re selling SOLUTIONS instead of tools. This is a huge, and overwhelming, strategic advantage, from the buyer’s point of view. Buyers tell you their problems, you make them go away. Inversely, the problem with tools is that buyers need to figure out what they’re for, how to use them, and then they have to actually use them. That is their inherent disadvantage. In a circa 1990s or 2000s or 2010s world with very few tools, the production of tools can be very empowering, even revolutionary. In a 2020s world with an over-production of tools, buyers are exhausted, nauseated, and practically desperate to return their focus to doing what makes them unique. In other words, the inherent disadvantage of tools is now especially acute to buyers. But because of Silicon Valley dogma, startups are not adjusting fast enough.

That may be because not very many entrepreneurs have figured out that it IS possible to overcome the inherent disadvantages of services:
Scale: a service may be as universally applicable as a product. But if there are humans in the loop, that means hiring, training, management and coordination costs. Thankfully, software can assist with all of these functions. “Humans coordinated by software,” “humans doing what they do best, software doing what it does best,” “build tools for operations, so operations can sell solutions to clients”: these are mantras for scaling the software-enabled services of the future. Lastly, services can achieve revenue scale far before they achieve user scale. Products cost less than solutions in absolute terms, because solutions price in the cost of using the product, or rather, the value to the client of not having to use the product.
Margins: In a word, automation. In two words: (software-enabled) efficiency and automation. In more words: your manual operations can get more and more effcient, the more software you use to optimize them, and more and more of your manual operations can be fully automated over time. If you start with a healthy margin on manual operations alone, software should extend those margins over time, until services margins approach product margins. One last secret: custom work isn’t truly custom. It is possible to aggregate ‘custom’ work across a large enough client base, that it turns into structured data.
Distribution: Pricing against a cost per hour is unsophisticated. Results Based Pricing is the future. It is possible to use software to quickly arrive at a unit cost, even for custom workflows. It is also possible to align incentives further by offering your biggest clients deflationary pricing over time, sharing automation gains with them, so that they have no incentive to take work back in-house. As for building a repeatable, predictable and scaleable sales & marketing machine for selling custom solutions: case studies, use cases, industry solutions, role solutions… all of these help. But the holy grail is breaking down your custom work into its atomic units, and then showing that to clients — so they can see the full range of your abilities. This even opens up the possibility of self-serve buying for a fully customized service: something that has never been done before, to my knowledge.

Shock claim: if investors overcame their dogmatic preference for products, they would realize that software-enabled services have strategic advantages too. Aside from the overwhelming advantage of being better for clients, that is…
Stickiness: Services can be as sticky as products, if not stickier. Because products require ongoing client engagement, and services do not: once you’re delivering a solution to an ongoing need, it is less likely that you are unplugged. Particularly if you are giving the client a deflationary dividend that disincentivizes them from optimizing the function in-house.
Expansion: A product’s upsell opportunity is usually limited by the number of relevant seats in a company, and/or the level of usage of those seats. But the upsell opportunity for a service is limited only by the number of problems they can solve within the company. If you have a powerful and broadly applicable (that is, horizontal) service, this means that you have practically unlimited upsell opportunities.
Defensibility: Historically, services have not been as defensible as products. Actually, come to think of it, and more to the point, products pre-internet were less defensible than products post-internet. The assumption now is that services are not defensible. That a service will never have the type of network effects defending it that, say, Facebook or Twitter benefit from. Aside from network effects, the assumption has also been that services are less technically complex than products, and that technical complexity is defensible. All of these dogmas may be overturned soon. RPA products, for example, are very technically complex, but they are becoming increasingly commoditized. And as products become increasingly specialized as they go after increasingly niche verticals, horizontal software-enabled services can build much stronger network effects: the more workflows that you’re running for a client, the more you can integrate these workflows. The more clients you’re running similar workflows for, the better, faster and cheaper you get at selling and delivering those workflows.

Behold, the world has been turned upside down.

Francis Pedraza

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