Fail to Scale — Part 3
You made a Services Business
This is the 3rd part of a 4-part series on why early-stage tech startups can fail their first few years trying to get into business, due to common and unfortunate circumstances created by their founders, that should, in this day and age, be easily avoided.
In the first and second parts of this series, we explored why domain expertise, the most revered quality of a new startup founder, conspires against a CEO founder, leaving them no choice but to assume control at the top of their company, and thus stifling innovation below them from day one.
In this part, we are exploring how a CEO domain expert, who is running the Sales function of the business, is likely to drive the business to create bespoke solutions for each customer, and thus end up creating a limited services business, rather than a scalable product business. Denying them the potential revenue and returns that they and their investors were expecting to get when the product scales.
Business Models
If you are (or were) a startup founder, c’mon let’s be honest here, when you first started your new startup, did you really understand that you were embarking on a new and different kind of business model? or even that your new venture would require a different business model than, we see in most companies out there?
Well, I think you’d be surprised to know that most non-tech founder CEOs (and too many technical founder CEOs) start out their new tech product business thinking they are doing a “project” of some sort. i.e. something that has a defined end, defined cost and budget, and a defined and detailed plan. Why is that the wrong mindset to start with? Let me show you.
The plan would be simple for most of them. It probably started looking something like this:
- Got my brilliant idea,
- now, let’s hire some people,
- build some stuff,
- sell it to some people, and
- I start making money.
Seriously, this is how they thought “success” for their business was going to be made from day one. They’ve done very little studying of what it means to build a product company, that does detailed research and development. Simply because the narrative above is so much more simple to grasp, and it seems to make sense for 90% of all the other businesses out there. Which are services businesses.
Yes, those founders may have read a couple of books, or articles about Lean Startups, and if that is all, then likely the takeaway from that was: Build, build, build as fast as you can an M.V.P before you run out of money, and by then have sold some stuff to people that will (of course) instantly love your stuff.
That is not what the Lean Startup book actually says, but that is what most people take away from it.
After these founders grasp that idea, the next logical step, then, is to define their M.V.P., raise some money to pay for the build of it, hire some people, and just get going. This M.V.P, they think, should be funded, staffed, and built as a project, on time, and within the budget that they have (or are about to have by raising some funding).
Since they see it like a project, they now consider that they can simply contract smart tech people to “quote and estimate” what it takes to design and build it for them to high degrees of accuracy and certainty! Like you might do if you were building a new home, or renovating or landscaping your old home — a “project”.
Then, all that leaves is for the founder to do, as the business visionary, is to simply tell the “makers” of their software product exactly what to build (as if they could know that), then tell the world all about it, and then sell it, as is, to a bunch of paying customers.
Boom! we have a magic and actionable recipe for instant startup success!
But that is not what an M.V.P is meant to be. A M.V.P is not meant to be a minimal version 1 of your product that will sell. It’s meant to be a platform for experimenting to discover what will actually sell. No one guarantees that any M.V.P will sell at all! That’s just a grand assumption put on an M.V.P when founders assume that they can predict what customers will buy to eliminate the uncertainty of it all.
This “M.V.P project, as a version 1” mindset, is quite often the starting mental model for a large proportion of non-tech CEO founders who start their new businesses as the leading domain expert. I see them every day at my day job.
I guess you could say, “who can blame them?” right? since, from school age, through university, at most modern workplaces, and parts of their home lives, they have learned only one way to get anything mildly complex done. That all it takes is to come up with a detailed plan that works and then do meticulous execution of the plan. That is definitely effective when the outcome is predictable.
However, the reality of building a product startup starts with understanding that there is a very different product development business model that needs to be established from day one if you want to survive. Different from any other business model that the CEO founder has probably encountered before, or worked in before. That they know little about, let alone, how things need to be run in that kind of business model.
Here is why.
Services Businesses
I need to spend some time here, explaining different business models, because I’ve learned the hard way, that not everyone actually understands them, or can even define one, let alone two of them — that I need to make this article work properly.
Most non-technical founders (and a good proportion of inexperienced technical founders also — by the way) have only experienced one kind of business model in their past careers. That would be a services business model.
This is where you have some superpower knowledge or skillset for sale, and there are people called “clients” of yours, who are willing to pay you for delivering that service to them. You find a client buyer who needs your capability, you negotiate some work that they need doing, and you scope that to some “project”, that they agree to. You then negotiate an hourly/weekly/monthly rate with them, and they agree to pay you by the hour/week/month, to perform that service for them, and it’s all captured in a written contract, with clear terms, and conditions.
Cash on delivery. Services rendered, however you like it. You simply invoice the client for your time and materials, and you/your company gets paid month to month as you go. You do your thing (to this contract) for weeks, to months to years, and once the contract is over — and you delivered what you promised — the client either extends the contract and you do more work with that client, or you move on and hunt down the next client.
This is what a Services Business does, no matter what the service is.
What a successful services business provider also does, is ensure along that contracted journey that the buyer at the client (who negotiated the contract with them) is satisfied all along the process. That is if the Service Provider (them) wants to continue providing them services after this particular contract has ended. They do this because they become dependent on these contracts that pay their bills directly, it is what gives them certainty about the future of their services business. These successful companies, understand that not only do they have to provide the service that they promised to their client (to their client’s satisfaction) but that they also have to manage their client’s ongoing expectations, as things change, to build and maintain trust into the future — for landing more contracts. This game continues on, contract after contract, until one party screws something up, and the other party wishes to move on. All good things come to an end, unfortunately. Hence the limited contract. But while it going, it is a win-win for both sides.
Now, anyone, I mean anyone, can start a services business at any time, with any skill or knowledge set (specialist or generalist). Within one to two invoice cycles, you are getting paid for your hard work! Anyone has the opportunity to make an instant and comfortable living off this kind of business model, especially if they have more than one client at a time!
Most people out there are doing exactly that.
If they start to do a really good job of it, they may build a larger-sized company, and then they will be hiring other people to join them in their company to do the same kind of stuff. In the tech world, this is exactly where most technical people are working today. In services businesses, of all shapes, colors, and sizes.
Now, the characteristics of the Services Business model that are most important to us for this story are:
- Services businesses scale one client at a time. As you take on more clients, you also (more often than not) need more people to deliver the service you are providing to them. For many services businesses, winning one more client, means hiring one or more people in the services business to provide that service. Others can deal with several clients per person, but there are hard limits on workloads. This way of operating does not scale to mass markets. Tech product companies like Microsoft and Apple don't hire thousands more tech people when they release a new product to market to millions of people. They may add a couple more people to their product support functions, but it’s certainly nothing like what a services company would have to do if they sold their service to a million more clients!
- Services businesses are all about winning and retaining the same set of clients year after year, to maintain forecasts and profitability. You only need so many clients to fill the capacity of the people you have in the service company, delivering whatever service it is that you provide. You can’t have more clients and work than you can deliver, without hiring more people. Conversely, if your current contracts end and your people don’t have work to do, you can’t afford to keep those people on your payroll, with no billable work to do in your company. Thus, the business is all about high levels of client satisfaction, repeat business, cost, and optimization of resources (billable people). All that requires meticulous forecasting, resource planning, and all the other processes needed to ensure margins are protected and the business remains profitable. It is essentially an accounting game, best played by people with a bent toward accounting.
- To maintain a solid and reliable forecast of planned work (that you must have to run the business), you need to be selling ahead of the delivery capability of the business and adjusting for a changing market (of clients). This requires dedicated sales and marketing work. When selling services, you are negotiating the delivery of whatever your specialty service is with future clients/buyers, who generally have far many more problems than your specialty services business can deliver to them. For many services businesses, this means tailoring their offerings to suit specific client’s needs. To the point that those clients buy the services from this service provider— competition is tough out there to win these contracts. In the background, the services company can be making certain adjustments to deliver on these promises even for skillsets and capabilities that they may not yet have. The point here is this: The negotiation is all about satisfying whatever the client’s wants and needs (are at that moment) to make the sale. This practice of tailoring your product or service for every client also does not scale to mass markets. You would like to think it can, but it does not.
Product Businesses
OK, so now that we understand what Services Businesses are and how they work, what their sweet spot is, and how they are limited. What does this have to do with CEO Founders starting a new Product Business?
Well, given that most of these CEO founders that are starting new tech startups have built past careers in services business models, they have learned all about how to be successful at, and optimizing, the delivery of highly specialized “solutions” to individual client’s needs, which can be described in detail, contracted, planned for, costed out, and budgeted for — to varying degrees.
For some, most of their experience of “doing business,” in any shape or form, is built on principles of serving customers’ specific needs and desires by delivering something they can deliver: knowledge, capability, or skill. It was all about selling themselves/their people (and what they can “do” and deliver) to individual clients. Furthermore, most of the Sales processes they know are all about making direct sales face-to-face over individualized contracts, over physical channels.
All of those business skills and practices that they have learned over the years are going to be super hard not to repeat in their new tech product company. After all, this is likely their first new venture into the product space, where they have little if any business model experience — no matter what their background in service businesses. They are likely to repeat what they already know to manage the more significant levels of risk they will be now faced with.
And worse, they are not going to understand why most of those practices and skills that they already know are actually going to hurt them down the road in their product company, rather than help them, build a scalable product business. This is not obvious stuff, and it’s a real problem getting Founder CEOs to even understand that this is a thing that they need to pay attention to.
Product Businesses, especially of the type that aims to disrupt a large market of customers in tech, are necessarily funded, managed, and operated differently than services businesses are. In fact, every aspect of them, you name it, is going to be different. The business model, the governance, the skills needed, the people required, the organizational structure, the work being done, the cultures, the outputs, and the outcomes are all different. THEY ARE NOT DIRECTLY TRANSFERABLE!
Not convinced? read this for the gory details.
Product Businesses, of the tech type we are talking about, are trying to make durable, generalized, and “standard products” to sell en mass to hundreds/thousands/millions of consumers to exchange for regular revenue. All those buyers have the same kind of problems (that the product addresses), but (and, here is the catch) all of whom have unique needs and problems of their own!
You simply can’t build anything, any decent product, that is specifically suited to them all, that satisfies them all, nor solves all their problems! That is the key thing to learn from day one in a product company.
Trying to do that impossible task, we call this “boiling the ocean”. Trying to do that will simply exhaust you of all your precious capital and resources, and will result in you simply creating an all-bells-and-whistles “solution” that even fewer people (in the mass market) will see any value in, at all.
Avoiding the Services Business Trap
OK, so back to our CEO Founder domain expert, and how they need to actively manage their own biases and past experiences from controlling how they act in their new product business.
The behaviors that must change here are being too centered on the needs of individual customers, rather than being focused on the needs of a larger market, and the needs of the product that you need to sell there.
In a Product Business, the Product is actually King, not the Customer. (Any individual customer, that is).
As I talked about in “Do you really have a Product Mindset”, how you think about, and how to sell to your customers, is the real distinction between having a Services mindset, and having a Product mindset. Serving the customer’s needs, versus refining the product’s needs. The later is where you need to focus.
How does this Services bias work against CEO Founder domain experts building tech product startups?
In five ways:
1. Having No Product Strategy
Too many small tech product companies fail to define and formalize their own product strategy from day one. The CEO Founder domain expert has it all in their heads. Mixed together with their business strategy, their capital plan, their payroll, their cap table, their sales strategy, their marketing strategy, their resource plans, their bank account, the mortgage, you name it. In that melting pot, all strategy is lost, they simply become overwhelmed and hyper-reactive to the latest stimulus from any source of influence. When it is fluid in your head, it is ultra-adaptable to whatever complexity comes your way. You, thus, only have to test it on the next thing that comes your way, rather than ensuring that it still applies to all the other past things you used it on. It’s magic.
These CEOs often don’t have a trusted and independent person (from the CEO) in charge of defining and executing the product strategy. a.k.a a Product Manager. Thus, the CEO falls into the trap of performing Sales driven development and relying on individual prospective customers to tell them what they should focus on — to make a sale.
We would like to think that, as adults, we are all logical and rational about what we do in business. Yeah right! I can confirm that this will not happen when things are going badly in a startup, and you are not making the sales you expected you would, money is running out and shareholders want their pound of flesh from you, and you can’t make the payroll and pay the bills.
Many early-stage tech startups don’t even have a formal product strategy. I mean: written down, communicated, shared, and discussed with everyone. That changes over time, in response to the market.
Most CEO Founders could not even define what one is, nor what it should tell them. And the few that do have one written down, don’t have anyone else onboard empowered enough to enact, defend and change that strategy as needed.
2. Selling Whatever Sells
When you have no distinct product strategy (from the business strategy), and it’s all in the head of the CEO Founder, and the CEO Founder is assuming the Sales function of the business. Then this potent concoction makes the CEO highly susceptible to dictating their vision for the product towards whatever they think does sell. As far as they can tell from all their Sales and their network interactions.
They fall into the trap of selling “whatever sells”, to whoever is interested in buying it, on any particular day.
Now, that’s good for the CEO’s ego, and it’s great confirmation bias, telling them that they are on to something, and great for generating excitement in the business, when things are down. But it is also good for generating chaos and confusion for those who have to turn these new ideas (and the ones in-the-line before them), into positive outcomes for the mass market.
It is pretty hard to say “No!” to a new opportunity that arises in a Sales call that would “NOT be on-strategy” if you DON’T have a strategy to compare it against. Or your strategy is “whatever sells”.
Or, even worse, “whatever the CEO said so, goes!”
You have to have a separate product strategy and defend it. It is what creates all of the business.
3. Falling for the Big Sale Trap
Now, every startup will, at some point, attract the attention of one or more large companies, that, in general, look like windfall opportunities, that must be had to prove traction.
Those companies, are generally trying to innovate themselves, and are looking for all kinds of help, and they have all kinds of problems to solve.
They might discover that your startup is moving into an exciting space that they are also interested in, and your CEO (who is doing the Sales) gets engaged with them on a massive opportunity to sell their future product to them. Perhaps, this company will offer to buy thousands of licenses of your SaaS product? But here is the kicker……..but, only if you “can help them solve a specific set of other problems for them too!”.
All CEO Founders of tech startups have to know, that this is going to happen to them at some point, and when it does, it is not because they are tomorrow’s genius that was just discovered on “America’s Got Talent”. Quite the opposite, in fact.
What the CEO Founder (doing Sales) is going to think to themselves, is that if they can make this sale and land this big fish, they become instantly successful at making a product that clearly (by extrapolation) lots of other companies will desire and will buy — because this notable company did! Instant validation, instant traction, instant success, and investors will be instantly envious of the CEO Founder and start dating them. All they have to do is close this one big sale, and they are finally in the big $$$!
It is so alluring, and yet, this is a giant trap waiting to spring on the Founder, that they simply cannot afford to get caught up in.
I’m not going to get into the weeds about all the reasons that an early stage tech startup should avoid this kind of deal like the plague and how it will kill their new startup. I talk all about all of that in detail, in other articles I’ve already written, which you can read, here, here and here.
Let’s just say, to summarise it all, that it ain't gonna happen for them like they expect it to happen — if at all. What is likely to happen is that the large company will simply exhaust all of the startup’s resources pampering to the needs of that one big customer — just for a big, future payday. That will probably never materialize.
Even if it did materialize, by some outside chance, and the big fish is landed, and money is made from that one deal — and that’s is not beyond the realms of possibility — the CEO founder will probably try to repeat that process again by going after another one just like it. Since they will view doing one big sale far easier than doing 10,000 smaller sales. It’s, unfortunately, quite an addictive pursuit, and a deadly one at the same time.
And if that is what the CEO Founder doing Sales does, then there is a good chance that they will have unknowingly and unwittingly made this their new product strategy.
What is wrong with that? Well, they just landed the next services contract, didn't they?
There is no doubt about it. When a large company/enterprise takes steps to invest in a small tech startup business, they are doing it because that startup has something that the enterprise does not have. The enterprise doesn’t have the capacity or capability to do whatever business-cased plan they now have funding to do. They are actually seeking out a technology partner, not a product company, to do the work that they need to get done, on a “project” contract. Furthermore, if the CEO Founder is leading by touting their greatness in personal knowledge, domain expertise, and whatever skills and experience, they have an advantage with, then this is what the enterprise will be thinking that they are buying, and why buying it from this little startup is such a good deal for them.
Now, do you see the problem?
This startup company is not being contracted to build a scalable “standard product” to sell to a mass market. It is now being contracted (sometimes with exclusivity) to build a custom bespoke “solution” tailored for this one enterprise.
That enterprise doesn't care that the startup’s business strategy might have been to disrupt some market, or to scale up across the world or to sell their genius thing to the mass market. The enterprise may recognize that, and even say, “sure, you guys go right ahead and do that if you like” they don’t care. They may even admire the startup founders for taking that on, it’s just cute to them, and proves their crusade, commitment, whatever. No, the enterprise won't care. They have a very specific problem to resolve, and they are looking for anyone to help them resolve it. They could care less about the startup’s plans and aspirations for technology innovation or disruption of whatever it is they are trying to do. It’s all about them and their enterprise innovation now. And this startup in now the sucker that has now agreed to help get them there.
Engaging in this necessitates that you are no longer building a tech product company here anymore, you are building a new tech services company for growing and managing a new set of solution offerings, and with that, a set of support offerings to manage and support customizations to these solutions for this one enterprise-forever!
This, of course, won't scale, as a business. You might even do this for a hand full of enterprises, no problem. And you can absolutely make a profitable business out of doing that for years to come.
But understand that it won’t be a product company of any kind of scale, I’m afraid.
4. Being Customer-Centric
So, why are startup CEO Founders falling into this trap of turning their product business into a services business?
- Well, obviously, this “services strategy” is likely to have been the strategy that the founders were most familiar with at their previous employers, prior to setting up their product company. Most founders (tech or non-tech) have come from a career working in a services business model, where doing what the customer wants or says is what they did — with a ribbon on it.
- Being customer-centric, and working on improving customer satisfaction is the nature of those businesses, and in the DNA of people in services companies. It is what pays the bills, it’s how you get promoted and rise to the top, it is what the business is all about and what they value and reward.
- No one has told these founders yet, that this is not what to focus on in their product business when they started it. And even if they had, they probably never studied what they should be doing instead. Being focused on your customer’s pains and struggles sounded about right to them, and familiar. It’s just that they didn’t understand the nuance of what was meant by that, in research & product development. They basically just winged it, based on their prior expertise in business, which they may be super proud of, and thus see as a superpower for them!
But it is not immediately obvious to them until pointed out, that they are not playing the services game anymore when it comes to building a SaaS tech startup.
Why is that?
It cannot scale for a business to spend so much time and money on winning each and every customer, face to face, when the risk of losing that customer is high, and the expense of supporting their individual needs is also high.
Perhaps an early-stage startup can do this once or twice to learn about their market because they have no other way to do that. But then, they have to get very intentional about changing their product strategy towards the mass market and have someone curate it, before it’s too late.
This is the thing that most CEO founders won’t have learned yet, and it generally, it takes a few startup failures before they discover that this is what they were doing wrong all along.
5. Investments
I see far too many tech companies who wanted to take advantage of building a product at scale, get trapped as a services business years down the road.
Yes, a services business model can be profitable. But the profit margins from services companies are not the ROI that product companies are built for in the first place.
The moment that a CEO Founder decides to make their strategy, a services strategy, they need to expect that their execs, employees, board, and their tech investors and shareholders, pretty much everyone, should be getting pretty angry about it, and opposing it.
Why is that?
It is because the founders, sweat-equity employees, shareholders, investors, and the board didn’t start out on this journey to build a piddly little services company scraping along contract to contract. They started out building a massively scalable product tech business that will pay them back anywhere between 2x–20x times what they invested in it!
Why else, would they have invested? Investors, Angels or VCs, don’t get out of bed in the morning for less than multipliers between 2x-20x!
A services company simply isn’t going to return 2x–20x times the investment put into it.
For example, services companies making good profit margins are going to be making like 15%–20% profit margin, tops.
This is not the 200%–1000% returns that a product company is expected to be making!
Think about it. Why else do most people want to create products in the first place? and why else do most investors invest in them?
Admittedly, some founders, OK, perhaps too many Founders, just want to be revered as having a genius idea, but that does not pay the bills, and simply won‘t attract the investment they desperately need from savvy tech investors.
In Summary
Ok, to wrap up this part of the series.
You need a good product strategy to guide the product function of the business, and to provide focus to the other functions of your business. Remember, Sales does not dictate what Product makes. Sales and Marketing are there to bring buyers to the product and then sell whatever Product has already proven is working in the market. Sure, both Sales and Marketing can inform the product, just not dictate it. If you didn’t create a product function that provides that kind of evidence and proof (from market evidence), then Sales has no choice but to sell whatever sells, and you are likely to fail to scale your product company or you will create a successful services company.
You need to have a product champion, and it cannot be the CEO domain expert. It has to be someone that they trust and someone they empower to decide what that product strategy is and how to execute it — informed by the way the market behaves.
What should the CEO be doing then? Well. If the CEO is a domain expert, then absolutely, they should also be collaborating closely with the Product Manager, sharing their knowledge. But Sales is also not their job either, but these things are their job as CEO. Focus on those things, and trust other experts to deliver on their things.
Yes, your customers (as a market) are super important to you. Pay attention to their pain and struggles as a market, not as individuals. Your job is to appeal to their needs as a market, not ask them what solutions they want as individuals. Coming up with solutions is the job of your product teams. Collectively, you are building what a large market buys and uses consistently, not what any specific customer says they will buy in a Sales call.
You may focus, early on, on satisfying a small select handful of specific customers, to learn from them, about what value you can provide in a product. But after that, don’t make this your future strategy. You have to switch to focus to the larger market; otherwise, you’ll be creating bespoke solutions that you’ll have to support forever. This won’t scale like you hoped it would, and you‘ll create a services company.
You are building a scalable product business, not a services company. This isn’t about doing whatever any customer tells you to do. It is about understanding their pain (as a market) and what they might buy (as a market) to alleviate that pain (that they all share).
No single product will resolve all their pain — stop trying to boil the ocean, or trying to be Google. You can’t. The trick is picking the most painful pain points and solving them super well — for a niche at first. Your business is about economies of scale that you only find in “building once, and selling multiple times, at scale”. Not selling door-to-door bespoke contracts.
The goal of your product business is to make a “standard product” for a large enough market to scale the business, to return on the investment out into it, and then some! It is bloody hard work, it doesn’t always pay off, and payday is years and years away, if ever, for many product businesses! So be prepared for that. There is no getting rich, quick. It takes years.
If you want a monthly paycheck, and you have an idea that requires tailoring to every client, then create a services business instead. You’ll be up and running in no time, making a salary, but no angel or VC investor will be interested in your future.
So, avoid the services company route, and try to avoid looking for shortcuts that make you rich quickly. Avoid taking shortcuts on the future of your product business, no matter how alluring they may seem from the outside, they are probably too good to be true.
In the final part of the series, we are going to see how other aspects of CEO domain experts affect how they behave, and the consequences and outcomes of that.
Next up is about how non-technical domain expert founders pair up with technical founders to create the wrong kind of organizations that destroy innovation and great products from day one.
