How to Make Sure Professional Services Don’t Take Over Your Software Company

Posted on Mar 21, 2013 | 28 comments


This article originally appeared on TechCrunch.

I recently wrote a blog post in which I pointed out that many investors & advisors discourage enterprise startups from having a professional services (PS) business and I think this is a big mistake.

chocolate layer cakeI think it’s important for enterprise startups to layer in professional services into your revenue stream.

PS capabilities are important for enterprise startups because they:

  • ensure your projects are more successful & thus more referenceable
  • help you integrate your product with other systems making it harder for your product to be replaced by competitors
  • make sure you do higher quality implementations because 3rd parties don’t have the same interests in over delivering on quality
  • provide you with best eyes & ears on the ground at clients to drive upsell, cross sell & rollout across more business units
  • deliver profitable revenue that while on gross margins of 50% vs. software at 85-95% it is still profits to help you cover fixed costs

[it’s all in this article if you want the details]

BUT!

You don’t want to run the risk that having a PS business that takes your eye of off the ball of growing a large software business.

So when I meet with GRP portfolio companies that do enterprise sales I try to emphasize the following:

1. Only Work on Projects That Support Your Core Product Effort
The most important thing to be careful about is to be sure WHY you’re doing the PS business. Hopefully it’s not as a way of avoiding fund raising or finding quick pockets of money.

Don’t become addicted to the quick hit of cash that a big implementation project can provide.

Your goal should be to do PS as a way of accelerating future non-linear software growth.

Therefore you need to be careful not to accept projects that are too far out of the core business. Each project should be related to rolling out your solution (or you shouldn’t do it). Each project scope should be as close as possible to being restricted to:

  • software set up
  • training
  • rollout support
  • integration with other systems
  • configuration

That is the software business.

In the Ad Tech world PS revenue often means providing “media services” as a value-add to using your product. This might mean helping customers buy traffic, arb’ing deals, helping with RTB pricing or trading, etc.

2. Minimize Any Custom Work That Will Not Feed Back Into Your R&D
While I’d like to say that you should never do custom work that changes the scope of your product that’s not wholly realistic.  But you do need to be sure your company doesn’t just become the internal R&D department for a large corporation.

If you never read my post on Elephant, Deer & Rabbits – a guide to customer segmentation – it might be worth a read.

With a well architected product that has well-documented APIs and proper core product abstractions then all custom work should be build above the API stack. Often your sales engineers can do the customizations without bugging the core eng team.

Extending the feature set of the product  would obviously be better if done by the customer but sometimes customers lack the resources to do customizations so simply telling them to get stuffed is not the answer.

3. Protect Your Intellectual Property
If you’re doing custom work restrict it to a small portion of the PS project and that you try to build stuff that can eventually find its way back into your core product roadmap improving your core offering for future clients.

In fact, if you do the PS project well and narrow the scope to features that you know you’ll eventually need to build anyways then it can actually be a great source of future innovation.

Importantly, make sure that you retain IP rights to your custom work which needs to be part of the engagement contract. At a minimum co-ownership of the IP.

If not specified in contract you might find yourself with future litigation over IP.

4. Integrate PS Work Into Sales & Marketing Processes
The reason to do the PS work in the first place is to drive future software sales. So make sure that your PS organization doesn’t become an island or a P&L unit who tries to maximize its own value by showing the most profitability and growth on that business unit possible.

The PS team is there to deliver a successful engagement. You want to make sure that they are communicating well & often with sales to drive future product sales at the customer.

You want to be sure that you get customer commitments before doing the work do agree a case study afterwards if the project is successful. You won’t get every customer to agree this but you certainly want to try with every customer. Referenceability is the lifeblood of sales. If asked to drop price we would often counter by agreeing to small price decreases in exchange for an agreement to do case studies to drive future business. Frankly, you’re going to need to drop price a bit anyways. After all, every customer wants their pound of flesh.

If you have a sales rep pushing a product implementation you want them to understand why selling PS will help them grow future revenue at that account not as a crutch to hit short-term revenue targets.

Basically, no islands at startups. Everything needs to be part of a holistic company strategy.

5. PS Business Cannot Become a Management Distraction
Another rule I outline with our portfolio companies who sell enterprise solutions is that I don’t want them to become a distraction for management.

If your CEO is having to get involved too much in reviewing project success or your core product team is getting sucked into implementing too many features to support the rollout efforts chances are you’ve gone too far.

The closest analogy I have for a PS person is a “sales engineer” who is normally a technical staff member who assists in sales campaigns. Often they have the same skills and can therefore be doubled up as PS if you are in a pinch to afford staff.

If PS involves too much management or core tech time then chances are it will overtake your software strategy and you’ve then just become a prostitute for short-term revenue.

6. Control Size of PS Revenue Relative to Software Business
So how much PS is too much?

There’s no right answer. It’s mostly a function of the stage of your business.

If you’re in your first year of developing your product chances are you haven’t yet found product / market fit and you don’t yet have enough value to sell your product for as much as you’d like.

And chances are you’re in big need of a killer customer reference.

So it wouldn’t bother me if 90% of your year-one revenue was PS provided it was done with a specific plan for year-2 software sales. It also is a great way to finance your business without facing dilution before you actually raise venture capital and when the valuation you might get from angels is less than you’d want.

By year 2 I’d like to see PS at 50% maximum, which is still high.

By the time you’re at $5-20m in software sales I’d like to see PS be no more than 25% of your total revenues.

I know that number sounds high for some people but in reality if you’re growing fast it’s not unthinkable that you’d bill out $2.5m in PS revenue on top of $7.5m of recurring revenue (MRR) software sales.

As you hit steady state I’d like to see PS as about 15% of your business.

Rough guidelines. Lots of room for debate. But a good rule of thumb for planning.

7. Don’t Pay Full Bonus to Sales Staff on PS Revenue
Finally, be careful that you don’t incentivize your sales staff to make you into a professional services firm. You can’t pay full bonus on PS revenue. Not only because it’s lower gross margin, less scalable and more consumptive of staff but also because if you make it easy for them to sell PS which is always higher revenue than paying for software you’ll be sure they sell it ALL DAY LONG.

But it can’t be zero bonus.

If you have zero bonus on PS revenue you’ll find a sales team that becomes the PS prevention unit and if you’ve bought in that this line-of-business is important to you then you don’t want your best sales teams working against you.

There’s not one answer for how to comp the sales teams. Can be margin based. Or lower spiff for PS revenue than software revenue. Whatever. And obviously you need to persuade them that today’s PS business is tomorrow’s big commission check.

Happy to take any suggestion in the comments section as to how to properly incentivize sales teams.

Next post?

“How to sell your future roadmap to enterprise customers without selling your soul. Adding precious high gross margin to support an R&D team that you need to fund anyways.”

Photo credit Food52.

  • http://www.startupmanagement.org/ William Mougayar

    Packed insights. Great post.

    I might add – Productize your PS (which I thought you almost implied early on). So, make it clear what you do or don’t do,- more or less. It makes it easier to say No.

    And if there’s something you shouldn’t do, then try to find a partner that would do it for your client. Example: In a previous case we had, our customer wanted us to go deep into their WordPress multi-site because it touched our product, but that wasn’t core, so we found them another company that specialized in WordPress.

    I think you were generous with 90% or 50% of revenues for PS, even early on. That means your product needs a lot of PS lifting. I’m not sure how quickly you could bring it down to 25% or under.

    On the SR’s commission, give them regular commission up to the average % of PS ratio for your deals, & keep lowering it every quarter.

  • Danny Smith (Choice FS)

    Great article (both) and fully agree with the sentiments. A lot of new startup companies lose sight of these needs, and how important a role they play in the image your company and offering has in the market as a whole – probably because many of them have not had this exposure or experience in previous lives.

    Key thing you correctly highlight is to make sure you keep your PS focused on activities that (i) are core to the image and perceived value of your product and solution, and (ii) provide some clear long term value-add to your own product capabilities.

    Depending on the sector you work in, PS can become a significant recurrent revenue generator – so I’m not convinced it’s something we should try to steer away from though.

    I think any VC loves to see recurrent income :-)

    However, it is true that PS should not become a bottleneck that prevents you from evolving and innovating

  • http://www.justanentrepreneur.com Philip Sugar

    To incentivize sales teams. Rule of thumb is half of the base commission rate and it doesn’t count against quota. Frankly if you are selling a recurring revenue and commissioning on the increase of revenue, increasing commission past quota and a small second year commission, if the sales person is blocking they are literally working against themselves.

    The two areas you have to be careful in are doing core work that has to be supported (easier said than done) and working nice with partners. Even when you are small there are going to be small consultants that will want to work on projects. If you suck all the air out of the ecosystem, they will quickly be the ones to block your sale. If they make money, they quickly will be the ones recommending your product. Because of this, while its tempting to measure and bonus PS team on % utilization, profitability, etc

  • CliffElam

    Hit that one out of the park.

    One thing I’ve noticed is that a lot of software companies turn to PS when they fail to get traction – it looks like market development (step five of the four steps?) but turns into what i call zombie food. Keeps the remnants of the dream alive but never is going to grow…..

    -XC

  • http://dashthis.com/ Stéphane

    That reminds me of one of my product statup few years ago. The professional services were so profitable that we put the product aside to concentrate only on the service. That’s fun to make money in the short term, but when your thing is to develop products, money doesn’t replace the long term boredom of doing service. It’s easy to lose focus I think.

  • http://robertsaric.com/ Rob Saric

    Hey Mark – thanks for the guidance. We have the 2 killer enterprise customer references and PS is still about 95% our first 6 mo’s revenue. So your points are very much in-line with our startup. Thanks again for the useful content.

  • http://bothsidesofthetable.com msuster

    On product-izing your PS – perfect addition. I agree 100%. Wish I had said it more clearly.

    On 90% … actually. For some companies this is a perfect year-1 strategy. Not everybody has savings or easy access to angels / VCs. So this strategy to get through to customer proof to raise first $$ is not so terrible. As long as you product-ize your offering.

  • http://bothsidesofthetable.com msuster

    VC recurring income … most VCs don’t see PS as recurring which is one reason they don’t like it.

  • http://www.bluecoastrecords.com/ Cookie Marenco

    Once again, great insights and advice, Mark. Not only is this great advice for software growth companies, but applicable for smaller businesses looking to change from services to products (content creation).

    In our case, we were a successful service provider for more than 20 years, in a capital intensive business that ate up our profits to maintain (commercial recording facility and music production– I can’t complain, we’ve had a great run and lots of fun doing it– but at the end of the day, the music industry ate itself).

    Big ticket projects were too tempting to turn away, even though we saw the writing on the wall in the nineties. The pull was very strong to stay in services by customers and crew, until I replaced both.. customers and crew. :)

    While we had sizable investment opportunities, very few investors understood the bigger picture. The service aspect was confusing to most investors when income from products was so small. We knew great products was key to our future so we opted to bootstrap until the product business explained itself at the bottomline.

    Since I’ve been reading your columns in 2011 (a great help to staying positive during tumultuous times) we’ve taken the business from 80/20% (service/products) to 50/50% and this year we’re headed to 20/80%. Can’t be happier about it!

    Many people thought we should dump the service aspect of our business, but we knew that eventually, having the level of service we required for our product development would give us control and cut costs. Basically, we are a service provider to our own content company and now have control over a growing vertical niche from production to consumer with proprietary processes we hold tight to. The service business has been absorbed by our own product company.

    We may never be a company of interest to a VC, but we can be profitable and offer great products doing something we’re passionate about. Thank you again, Mark!

  • http://bothsidesofthetable.com msuster

    thanks for the adds. re: small SI’s who help. I agree 100%. Always leave food on the table for implementers who have relationship with customers. It’s just that many software companies spend tons of time trying to recruit “partners” too early before they have nailed the sales process on core product sale.

  • http://bothsidesofthetable.com msuster

    good point. PS shouldn’t be a crutch for a solution that doesn’t solve enough of a customer problem

  • http://bothsidesofthetable.com msuster

    yup. for sure. can’t become a prostitue for services revenue or you’ll never scale as a software company.

  • http://bothsidesofthetable.com msuster

    just make sure not to become too dependent on it ;-)

  • http://bothsidesofthetable.com msuster

    awesome to hear about your progress toward less services revenue. congrats!

  • Danny Smith (Choice FS)

    I agree that if you’re not careful then PS is not recurring, but the answer to the same is perhaps offered in the other message stream about “Product-izing” your PS.
    Additionally, depending on your business focus, target audience and revenue model – PS can and should become a significant source of recurring income as seen (for example) by all core system vendors in the fintech space etc.
    For a startup, anything that is recurring, and as long as it is not detracting from the ability to continue to innovate – is fundamental. Many, many startups fail and suffer from losing sight of the impact of cash flow, and do not really realize how cash flow is often a make or break factor – until it’s too late – no matter how good their idea is.
    If a startup can fund its continued innovation through a steady cash flow generated by recurring income, even if it comes from PS, then their chances of success are dramatically improved.
    Don’t get me wrong – I think this article and many of your other articles, are very much on the ball, and advice and ideas are always welcome

  • http://www.repeatablesale.com/ Scott Barnett

    On commissions for PS… we paid on the margin, so the reps knew the lower the rate, the lower their $$. But we left it up to them, which eliminated the CEO time suck you talked about. We also gave an additional spiff on the product commission if the PS led to a product sale within 6 months. Kept the reps focused on the ultimate goal.

  • Stephen Candelmo

    Thanks for such a fantastic and practical post. Such an important balance to achieve if one goes down that road. My team and I were just discussing this very issue this week. I would also think that it could become a source of conflict in terms of organizational goals and product management if not properly managed.

  • Siobhan Bulfin

    another great post and something I’ve wrestled with but managed to not take on – prof services clients. What we build, we own. They pay to use it only.

  • jimmydigital

    That’s why the support agreement built into the PS contract should bring you at least another 50% on the buy price.

  • btrautsc

    thanks for the guidance on balance of PS and 1-2 year expectations

  • http://twitter.com/olivierdelfosse Olivier Delfosse

    This isn’t directly contextual, because they aren’t software businesses, but I have seen great examples of this in LA amongst the big multi-chanel networks, who have to weigh building out their networks (scaling and bringing in content partners), with providing PS that can often come with healthy monthly retainers. It seems like its been a 50/50 split between those that have decided to even go down that route of PS, and I assume that those that didn’t it was probably a big discussion point. Anyhow, this post is spot on, I saw our service provider follow these rules completely, and it has resulted in profitability and market leadership. On a separate note, it’s specific to my business, but we ended up bringing the expertise in house, so I imagine forecasting PS for certain industries can be tricky.

  • http://twitter.com/ExtensionEngine ExtensionEngine

    Mark, I bet you picked that picture of a layered cake with the idea of the various layers were alternating “services” and “software”. I actually think all of those layers are “software” and “services” is the icing on top! Here’s why http://extensionengine.com/software-vs-services/

  • http://twitter.com/iFilmFactory Film Factory

    Love hearing how this approach worked in a non-tech industry. Thanks for sharing

  • http://www.bluecoastrecords.com/ Cookie Marenco

    Thanks for your comment. Starbuck’s didn’t change the Folger’s mentality for coffee overnight and we don’t expect DSD audio will change the mp3 mentality quickly either. Mark’s advice is useful to anyone at any stage of growth.

    Truthfully, we are quite tech oriented. We had to be. Our involvement with super resolution audio required we build our own distribution system since none existed prior. We sell huge downloads and eventually the pipes and storage are going to be meaningless expenses… they almost are now.

    Our service business allowed us to pay for hiring people to develop the technology support systems. Then, we focused on the customers and our DSD content distribution. Customers demanded hardware businesses to add DSD to their systems — from one hardware device in 2011 to more than 50 branded devices today.

    Bootstrapping was/is tough. but it’s given us a chance to stay in an industry we love at a quality level we’re proud of.

  • http://www.bluecoastrecords.com/ Cookie Marenco

    Thanks, Mark! You’re an inspiration.

  • Mashala Foy

    I think one needs first to target audience and revenue model depending on your
    business focus… For a startup, whatever thing that is recurring, and as long as it is not distrustful from the ability to continue to innovate – is fundamental.

    Many, startups fail and suffer from losing sight of the impact of cash flow, and do not really realize how cash flow is often a make or break factor – until it’s too late – no matter how good their idea is

  • LaVonne Reimer

    Commenting way late but I just watched your interview of Clayton Christensen. Really looking forward to a post on that. Excellent all the way around. As to this post and the one before it and comments to both, I didn’t see discussion about how to find out how the customers prefer to or might be willing to buy. This is on my mind a lot right now because our private beta has ended up being more about that subject than product feedback. As to why it feels super important, my experience is that the model you’re describing results in a corporate culture that is quite different than SaaS or more grassroots models such as open source + services. That culture can be a lot harder to switch out than the VP Sales.

  • LaVonne Reimer