Transitioning from a service business to a product-driven company

It has been awhile since my last post as I have been busy with board meetings. In addition, I met a number of interesting companies, a couple of which were service businesses in the process of transitioning their models to become product-driven software companies. It is a familiar formula to many out there. More often than not, the principals of a service business may have developed expertise and a network in a particular industry, developed a solution for a customer, and decided that they could resell it multiple times turning their business from a service one to a more scalable product-driven company. This makes a ton of sense as the entrepreneur gets to understand a particular market and pain point for customers. In addition, the early stage business gets the customer to pay for its initial product development. Having met with a couple of these types of companies this week, it reminds me to issue a few cautionary warnings for entrepreneurs:

1. Just because one customer wants it does not mean you have a big market opportunity-do your homework to make sure the customer’s pain is not unique and that this is not a custom development job

2. Have one version of your product, not one for each customer-I have seen a number of companies that claim they are a product-driven business with 5 customers when in reality they are still a service shop because their customers all have different versions of a product.

There is one company that my team met with a couple of years ago that had a marquee list of customers, all of whom had license deals greater than $300k. However when we did customer reference checks and deeper due dligence on the technology, we learned that all of the customers had different versions of the product. We ultimately passed on the deal as it was quite evident that the business had not made the full transition to a product company. I recently caught up with the former VP Engineering who was looking for a new job. In discussing why the company failed, this is what he basically had to say. While the company had great customers, the support costs associated with supporting 3 different versions of a product killed them. He had to spend too much of his team’s team fixing problems for the installed base rather than devote most of his resources developing the next generation product. Consequently, their product suffered and did not meet the demands of the wider market.

While turning yourself from a service company to a software business may be a good idea, be extremely careful about the customers you sign and remember to make sure that you really have one product not multiple, custom platforms because that can kill you in the long run.