When it comes to startups, products and services don’t mix

Giff Constable startups


[Note: 8 years later, I’ve written an update to this post]

This post is about dancing with the devil (i.e. consulting) as you pursue your dreams and try to pay the bills.  I believe that it is near impossible to build a successful software product while maintaining a services business. (UPDATE: I should clarify that I am talking about the period *before* you have a successful product on your hands)

Keep it separate
First, what does this mean for a young, bootstrapping startup with visions of an exciting product?  Consulting work can be enticing.  While it is an unfortunate distraction from your startup, I completely understand needing to pay the bills.  My advice is to keep your consulting work completely separate from your startup. Freelance or incorporate a new S corp or LLC. It will be much more complicated to separate your product and services businesses later.

I’ll get this one out of the way although it’s a recurring theme. The basics: building a great product startup is incredibly hard and takes enormous dedication and focus.  Any distractions away from your mission slow you down and hurt your prospects.  If you can avoid doing consulting work, you will be better off. If you can’t, hopefully this post will be helpful in avoiding problems.

It is hard to turn down money
Business success can take on a life of its own, and not everyone agrees with me that there is such a thing as destructive revenue. If you are successful selling consulting projects, well you’re earning money, and as a business you’re supposed to make money right?  So let’s talk about making that money.  You need staff to both sell, execute and interface with the client on those projects.  Use contractors? Your profitability will be squeezed and quality will be spotty, leading to upset clients. Outsourcing works better in theory than reality.

Instead, resources are either going to come from your product efforts or new hires.  Actually, you need some additional skills like direct sales and project managers, neither of which can be effectively contracted out, which points towards hiring.  You also realize you need to implement new work processes to do the consulting effectively.  All this is steering you away from your core, and turning you into a different kind of business.

Conflicting Team Goals
You didn’t turn down that work because you wanted the cash, so now you’ve hired some new people.  However these new employees were hired to help with consulting work, and that’s where their skill set lies.  When you start talking about the glorious future of the business (i.e. the product), these hires start to question, “wait a minute, am I irrelevant to this future?”  That doesn’t help morale. Unfortunately, the math is simple — you’ve bloated the business with too many bodies for a lean, mean product startup machine.  Now you have extra pressure to feed the beast — a self-perpetuating problem.

Further, you have a problem in your incentive structure.  Your business is structured like a product company, with a focus on equity, but you now have a business unit which should be structured like a services company, i.e. focused on cash flow.

You also have a morale problem.  You’ve recruited people with glorious product visions, but now some of them are working for clients. Guess what, they hate working for clients.  The client staff is jealous of the product team, further worsening morale.

Skewed Priorities
Some folks think: “maybe we can build our product by doing consulting work and keep the IP?”  First, you have to negotiate keeping that IP, which probably means terrible economics.  But it doesn’t matter — you are still building a product for *a client*.  That client (the big brand you are so proud you sold) has special needs. That client wants *their* product. They are paying you; they want what they want, not what the general market needs.  If they are letting you keep the IP, they expect *even more* from you.  There is no product-market fit, only product-client fit. A glorious market of one.

(Note: one circumstance where you might be able to get away with this is when your “client” is a government organization which only cares about seeing the tech built not bossing you around on the details.)

Distraction to Death
You’ve sold these projects, so you need to make the clients happy.  However, there will inevitably be change orders, custom requests, changing client priorities, fad-of-the-day, and all sorts of little complications.  Your people end up working later and longer.

A fire drill hits and you need to complete a milestone.  With your own product, you just swallow hard and either cut features or add time. Well, you can’t do that with a client.  You promised to ship version X in three weeks and are way behind.  If you slip, at best you have an upset client and at worst you won’t get paid.  What do you do? You pull the engineers and designers working on your product onto the client gig and try to save the day.  Product? What product?  Morale? What morale?

Client services work is difficult.  If you’ve ever outsourced a software project, you know how hard it is to be happy with the results.  Do you really want to put yourself and your business on the other side of that deal? With clients demanding fixed priced work?  But again, if you have to do it, I recommend consulting as an individual or under a separate corporate entity.

The wrong investors
Sophisticated early-stage tech investors are usually turned off by services revenue.  They want a scalable business, not one that requires an hour of work to get an hour of pay.  So you end up with a different kind of investor. These new folks probably do fewer deals in tech, but they are excited about your space, the blue chip brands you are working for, and they appreciate the fact that you have revenue coming in the door (not the right revenue, but they don’t necessarily know that).

In this situation, you’ve just pulled in an investor with a very different risk profile to your dreams. You can’t do a bait and switch. When the time comes and you want to focus the business entirely on your product, you might find them to be a serious roadblock: “Wait, you want to just drop our lower-risk revenue, bet it all on an unproven product, and risk complete failure?” (of course the irony is that consulting revenue is not always that much lower risk!)

God forbid you might, like most startups, need to pivot.  These aren’t investors who understand “pivot”. You’re already in the doghouse because you want to turn down money, slim down and focus all resources on a product, but now, even worse, you’re a bozo who can’t even get the product right.  It’s not even their fault; it’s yours, because you chose the wrong investors.

final thoughts…

So a consulting business can’t create a product?
That is indeed my argument: a consulting business has the wrong structure, processes, priorities and people involved to pull off a great new product.  However, a consulting business can be fertile ground for good *ideas*, because you are exposed to lots of client pain points.  If you want to be effective at creating that idea (or whatever it pivots into) and bringing it to market , you are better off spinning out a new company with a small, dedicated, product-experienced team right at the start.

But there are lots of product businesses with strong services arms!
Lots of companies built services revenue streams on top of a product — a successful product — but I cannot think of many examples where it happened the other way around.

If you have seen examples where a services business built a great product business, please let me know.

UPDATE: great response from Scott Francis

(image from this awesome BT ad)