Services versus product companies – what would you rather have?

It’s a big question – should you go for a product company or a service company? When we look around, it seems even the giants are struggling to make the choice. Microsoft, once a true product company, has now shifted considerably towards services. Even Apple – the iPhone being perhaps the product par excellence – now offers a growing number of services. Meanwhile Google started out offering the service-to-end-all-services – Search – and now makes hardware products as well.

While it’s true that product companies can achieve high scalability and potentially larger profits, they face significant challenges in innovation, market adaptation, and upfront investment. On the other hand, service companies may not scale as rapidly but can foster stable, long-term client relationships and generate steady revenue, albeit with challenges in maintaining service quality.

So, which direction should you go? In this article, we’ll look at each model individually, examine how a product can sometimes become a service, figure out which model might be the most profitable for you, and then see how, in my view, a hybrid model is often the most robust solution.

Let’s jump in.

Services versus product companies – what are we talking about?

Let’s state this upfront. If you have to choose either/or, then I would say a product company is favourable in most cases. But there are caveats. A product company is centred around the design, development, and distribution of products that possess market appeal. To be successful, though, they must fully commit to continual innovation and enhancement of their offerings, ensuring they remain competitive and relevant in the industry. These companies often require significant investment in production, marketing, and distribution networks, and must always remain aware of changing consumer preferences.

So, what can we say about service-based companies? Often found in the B2B space, they generally focus on intangible solutions rather than physical products, with their core operation revolving around delivering expertise, consulting, skills, or other non-physical forms of value. These companies can face scalability constraintsdue to lack ofpersonnel and are dependent on and vulnerable to client decisions. It’s vital their services maintain a consistent quality of service as the business grows.

When a product becomes a service – the hybrid model

In terms of services-only companies, we might think of McKinsey & Company or Accenture. With a product company it’s a little more difficult, even among the classics – let’s say Lego or Whirlpool, who both offer some level of services.

But more than that, there’s been a sizable shift in the tech world from product to service. Before the emergence of Software as a Service (SaaS), the prevalent model was software as a product, often referred to as on-premise software. This traditional model involved the one-time direct purchase for indefinite use of software on individual computers or servers, often requiring significant upfront costs, ongoing maintenance, and manual updates.

The transition to SaaS revolutionised how software is delivered and used, using a cloud-based approach where software is hosted by the service provider and made available to customers over the internet, usually on a subscription basis. Customers pay a recurring fee to access the software, receive automatic updates, and can scale up and down to their current needs while accessing it from anywhere. So, we might call this a product/service mix – a hybrid model.

Tech companies large and small didn’t just shift to a service model for fun. Clearly, the customer retention factor and profitability played a role in this move, even though maintaining infrastructure is costly. So, when you think about your company, are you in fact selling a product that you could shift to a service model? Or at least incorporate some service elements?

Which is most profitable?

The short answer is there is no answer. But here’s what I think you should keep in mind: Once a product is developed, it can be sold multiple times without significant cost increases. For example, tech giants like Apple or Microsoft can gain high margins through mass-market distribution. The initial investment in research and development can be large, but the return on investment can be substantial if the product gains market acceptance. In this way, product companies can achieve higher profit margins once they’ve recouped the initial development costs. Expanding their customer base doesn’t usually result in significant additional expenses, hence potentially higher profitability.

In contrast, pure service companies provide intangible offerings, such as consultancy, maintenance, or subscription-based services. These firms often face challenges in scaling, as the growth typically requires proportional increases in human resources. Their profit margins might not always match those of product companies due to the cost of personnel and the bespoke nature of many service offerings. However, service firms can excel in creating long-term client relationships and steady revenue streams through retainer contracts and ongoing engagements

Factors influencing profitability

For product companies, profitability is influenced by these key factors:

• A high-quality product not only sets a company apart from competitors but also creates a strong brand affinity among consumers. By minimising production costs and optimising your supply chain, businesses can deliver quality products while maintaining financial health.

• Keeping a keen eye on consumer behaviour is critical. Understanding market needs and trends is not just about staying relevant – it’s about pre-emptively adapting to changes and holding that competitive edge.

• The effectiveness of distribution networks is vital as these are the lifelines that connect the products with the market. Product longevity is increasingly significant in an era marked by rapid technological changes, and enabling a product to remain relevant over time is a delicate balance to strike.

For services companies, these factors have the most influence over profitability:

• Specialising in a particular domain allows a business to attract top-tier clients and establish enduring relationships. This specialisation not only positions the company as a leader in its field but also creates a strong value proposition. Consistently delivering exceptional value reinforces this trust, encouraging repeat business, which enhances revenue streams.

• Cost efficiencies through lower startup costs and reduced inventory demands play a crucial role in financial health. Achieving this allows businesses to maintain agility and adapt to market changes more effectively. The growth potential of a service-oriented business is significantly influenced by its capacity to scale operations, growing the workforce in a sustainable way and matching demand without compromising on service quality.

• Building a reputation for outstanding service quality leads to increased client referrals and a larger volume of business. Targeted specialisation allows a company to operate within markets where it can offer unique value, reducing competitive pressures. Through strong differentiation, a company can command higher prices for its expertise.

Conclusion

To my mind, the binary choice between product and service is no longer a constraint for modern businesses. The emergence of hybrid models offers a versatile strategy, combining the upfront revenue potential of product sales with the sustained income and customer engagement of service offerings. This approach can leverage the strengths of both models, and it’s something new business owners should consider before choosing one at the expense of the other.