Products vs Services
A Simple But Useful Framework
There are times in business when frameworks or approaches are and will forever be purely academic and of limited value to a lower-middle-market business. Calculating WACC and mapping out the lowest risk-adjusted cost of capital is a great exercise…for a classroom or a corporate finance role. I can’t say that we or any of our clients will ever get value from this exercise, however.
But there are times when an old academic framework comes back into my mind and it hits with a new level of resonance. Today, it’s ‘product’ vs ‘service’.
In our last Letter back in March, we wrote about investing in process and the build out of ‘digital jigs’ as we called them. At the time we were in the second inning of building our own internal tools to improve the quality and efficiency of our work. What a wild few months followed. By the end of May, we had designed, built, tested, and launched a finance-and-accounting-minded agent to help us do our jobs. By June we had expanded the capabilities of this tool (called Tally for now and likely called something else once we work through the whole trademarking process) and we had built a client-facing interface allowing us to share this product with our clients. As of today, we now have around ten clients who are using this product with a range of results and outcomes (some good, some not so good).
The internal-facing component of this tool is just that, a tool for the team to do their jobs better. And it’s been a wild success. There isn’t a teammate here at Ballast who would want to go back to the old ways of doing things. We’re seeing efficiency gains of anywhere from 10% to 50% for low-value-add tasks, allowing us to either reinvest that time in more value-add work or grow with a client without having to constantly increase price.
The external-facing component of the tool, however, is in its infancy. It has surfaced a lot of very valuable conversations amongst the team, and there’s a range of opinions on how valuable it will ever be for our clients and our firm. We’re having valuable dialogue over what the hell this thing is and how it layers into our existing business.
This Isn’t About Us
But this isn’t a letter about Tally. This is a letter about a fundamental concept and a fundamental question that we must get better at asking. What we’ve learned during our internal conversations is that this topic is wildly important, it has broad applicability, and it is likely particularly relevant to our clients today.
Are you building, developing, selling, and delivering a product or a service?
The question is relevant because the business world has been muddying the water on this topic for the last decade. The line between ‘product’ and ‘service’ is harder than ever to see and understand. The distinction used to be quite simple, but the last decade or so has created a lot of blending and merging and misunderstanding. This misunderstanding has consequences.
Additionally, the recent tech shift is allowing our clients to build these aforementioned digital jigs with very valuable and specifically tailored use cases with ease and speed. It’s like handing an architect a 3D printer the size of a city block. This is further muddying the water.
Products vs Services (the annoying oversimplification)
Products are fundamentally different than services. This distinction became blurry as products moved from physical goods to digital goods and software, but fundamentally whether it’s physical or digital a product is different than a service.
A product is something delivered, with no real expectation of ongoing delivery or execution or review. Yes, there are quality expectations, and yes there is recourse for failure or a mismatch between what was marketed or expected, with what was delivered, but once a product transfers from seller to buyer, an obligation ends. There’s no ongoing management, no continued delivery, no relationship required. Back in the day when the only products around were physical, the above definition was very clear and well understood. You bought a loaf of bread and took it home. You didn’t expect the baker to follow you home to butter the bread.
A service, however, isn’t something transferred in an instant. A service is delivered, actively, over time. There are expectations around ongoing performance and delivery with a service. Services used to be the things that you’d feel, not see or touch. People used to provide services.
And then tech came along and the world SaaSified (not a real term, so don’t look it up or use it at your next cocktail party). Software providers learned to convert a one-time purchase into a recurring revenue stream. The business world fell in love with the business model and soon everything was being converted into a recurring service. This even applied to things that others and I simply didn’t, and still don’t, want turned into a service. We bought a new refrigerator the other day. We expect it to work and keep things cool. We don’t have any interest in paying a monthly fee to have it hooked up to the internet for god-only-knows-what reason.
And somewhere along the way, ‘services’ became a four-letter word. Everyone wanted to build ‘products’ but they wanted the revenue of these products to look like services. The hierarchy of revenue (recurring rev vs one-time, diversified vs concentrated, etc.) added a new element. Products became better than services.
During this transition, the business world seems to have forgotten our first point above – products and services are NOT the same thing. They are in fact fundamentally different. The distinction matters, and failure to understand this distinction can ruin a business.
Some (But Not All) Failure Modes
Managing and running a business is an active sport. Products and services are different games, with different rules, different positions, and frankly a different scorecard. Watching someone operate a business who doesn’t know the difference between a product and service is like watching someone polo-smack a soccer ball with a baseball bat while riding a road bike yelling ‘fore!’ Kind of hard to scale a business successfully operating like this. If you think this doesn’t happen or this is dramatization, you’re mistaken. We see this issue all the time.
Products and services require different resources, different planning, different pricing structures, different sales models, and distinctly different capital structures.
Thinking that you’re selling a product that the market in fact feels is or should be a service creates a real hotbed of disappointment as the customer or client expects or needs ongoing engagement and your resource model is built for a single transaction.
Think about engaging with a company to solve a problem for you. They onboard you to their tech solution and, sayonara, you never hear from them again. Did you engage with them for their tech, or did you engage with them for a service aimed at fixing the problem? Whose obligation was it to fix the problem? What was your expectation at the point of purchase?
Delivering a product when the customer wants or needs a service presents itself as attrition. Buyers buy, they engage, the seller disappears, the problem remains unsolved, at the point of renewal the buyer moves to the next offering. Hence why measuring monthly attrition and retention is so important.
Alternatively, imagine the inverse. Imagine a scenario where you sell what you think (maybe hope?) is an ongoing service, but the buyer in fact just wanted a product. You’ve convinced yourself that you’re providing a service, and so you burden your business with this cost profile to create ongoing engagement with the customer, but in reality, the customer just wanted a single transaction and they have no expectation of ongoing engagement. We’ve seen this several times across clients. It shows up as compressed margins and a disconnect in perceived value with the client.
How does this present itself in financials? We see this rear its head when retention may be strong, but margins are terrible as the seller keeps throwing ‘service’ at the buyer who doesn’t care to engage.
Back to the fridge example above, think about the costs that Frigidaire built up and continues to spend to manage that SaaS subscription they hope I say yes to. If I don’t engage and don’t buy the subscription, they’re left with unused costs and their margins decline. This is why understanding and reporting true margins in your business is so important (and yes…it often means your team has to start tracking time).
One solution that many take when presented with low margins (especially useless outsiders and consultants with little actual operating experience) is to increase prices. This type of early advice is irresistible to consultants because clients love hearing that they’re potentially more valuable than they thought, because price increases provide an almost immediate bump in earnings as the increases all flow to the bottom line, and the backlash against the price increases takes a good while to manifest.
But say you take the price increase path to pay for the added service. Think about what happens if the buyer never wanted the service. If you increase prices to cover the ongoing resourcing to support something the customer never asked for or wanted, they’ll eventually walk. When this happens, revenue contracts, and margins look worse. So the solution must be to invest MORE in the service because clearly we were not doing enough! You can see how this spirals.
The Problem with Being Able to ‘Just Do Things’
Our worry is that in this new age, this distinction between ‘products’ and ‘services’ will become even more important as the default path for most businesses will be to always do anything for anyone. We see this as a risk because this technology leap makes it damn near possible and affordable for almost anyone to build and implement and try new things. To sum up this newfound reality, we like to sarcastically quote Sam Altman when he said “you can just do things.” Whenever one of us envisions a simple or elegant solution to a complex problem, and the other person begins to rightfully explain the work and lift to fix the problem, we just respond ‘yeah…but like…it’s easy because you can just do things now,’ right?
We believe that business left to its natural state degrades into unmanageable chaos. It’s like our own business version of the second law of thermodynamics. Every stakeholder you introduce, every new employee you onboard, becomes a new Tom, Dick, or Harriet with an opinion and a new process or new solution and complexity ensues. Simplicity takes effort and active engagement.
Now that everyone is becoming the architect, the engineer, the builder, and the homeowner, we think that this natural trend towards business entropy will become even faster and even more pronounced.
Zag Amongst Zigs
We believe there may be value in doing the opposite of what it seems like everyone else is and has been doing. If they’re muddying the waters between products and services, maybe there’s value in distinguishing between the two. Distinguishing between the two could improve resourcing, pricing decisions, and forecasting and planning.
And there is another zag hiding in here too. The temptation right now is to launch ten new things or to solve new problems because now you can ‘just do things.’ But every new thing you launch without stopping to ask the product-or-service question risks pushing your business further into chaos.
Maybe the zag is to resist the urge to add anything new until you’ve sorted the chaos you have today. If everyone is zigging and searching for new problems to solve, maybe the zag is to just do what you’ve always done but do it faster and do it better.
In the land of the unfocused-do-everything-for-everyone-jack-of-all-trades, the boring-but-focused-and-highly-effective just might be king. I know it ain’t sexy, but maybe it’s just good business. What we’ve learned and what we know is that it’s a whole lot easier to do something better when you know what it is you were driving towards in the first place.
Kyle Benusa, Jack Allen