Why service-oriented business is not D.C.’s best growth strategy

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We all know that there are two main ways to make money in business: by selling yourself (a “service”) or selling something you create (a “product”).

I work daily on growing the greater Washington region’s innovation community, and I am constantly reminded of the fundamentally important distinction between these two business approaches. Our region’s ability to produce rapidly growing innovation companies depends on how successfully we make the distinction.

To illuminate the differences between service- and product-based businesses, I turned to members of the entrepreneurial networking group FounderCorps who have successfully built technology product businesses.

They all agree that a product-based business can grow more rapidly and achieve greater scale. “If you can find something that people want and can afford, it is easy to make lots of them,” said Dendy Young, principal of McLean Capital. This was echoed by Stefan Midford, chief executive of Natural Insight, a Sterling company that makes software to manage retail workforces, who said that a product, once created “can be sold to many companies and individuals.”

Once you understand the benefit that comes from making something once and duplicating it without customization, it’s easy to understand why “massive scale and rapid growth almost always comes from product companies,” observes Eric Koefoot, CEO of PublicRelay, which sells a media monitoring product.

Why can’t service-based companies flourish as fast? Jim Condon, principal of the consultancy CC Group, believes there is a very simple explanation. For a service business, he says, growing revenue generally requires “a commensurate growth in staff.” Ben Foster, an advisor to many local startups, adds another dimension: “service companies have to invest significant time and energy into every incremental sale, understanding the unique customer needs and building a custom solution to address them.”

So how does this affect our region?

Koefoot describes the greater Washington innovation community as being “disproportionately deep in services and businesses that deliver services.” Indeed, market data support this statement. For example, a recent survey by TandemNSI revealed that of almost 1,000 regional cybersecurity companies, only 1 in 20 is a product-based business. Similar patterns are found in the software and healthcare industries.

Because service-based entrepreneurship dominates the greater Washington region, our innovation community’s ability to provide new high-value jobs and wealth creation is constrained. We must shift to creating more product-based companies to achieve higher growth from our knowledge work.

The good news is that the greater Washington region is home to many successful product companies. Companies such as Cvent, AOL, Opower, Sourcefire, Blackboard, Weddingwire, Broadsoft and others. The challenge is to create enough density of success to allow innovators to learn how to change from a service to product-based business model.

“Many service companies fail when trying to convert to a product company – they need to be run, marketed and priced very differently,” Elizabeth Shea, CEO of SpeakerBox Communications, pointed out.

Conversion from service to product requires the development of an unexpected skill: the ability to say “no” to a customer that asks for customization, Foster added. That’s tough if you have been in a service business, where each customer relationship is based upon a unique transaction.

So local entrepreneurs agree that building a product-based business is a skill that can be taught, but that we must make an effort as a region in providing these lessons. And by acquiring this skill, we just might be able to reach our potential.

This column first appeared in The Washington Post.

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