Why Service Businesses Are Not Product Businesses

What manager in a product-oriented business has not thought about growing revenues by adding related services? What company in a service business has not weighed the advisability of offering products? Expansion often seems to make sense, but most companies creating a new offering limit themselves to approaches that are familiar and have worked before. Unfortunately, all too often those approaches are not suited to the new sector. The software industry provides examples that could help managers in other industries — particularly other high-technology industries — avoid getting injured in the chasm between service businesses and product businesses.

With the explosive growth of the global software industry, which witnessed annual revenues topping $500 billion in 1998, a striking phenomenon has emerged: software companies attempting to straddle the two industry sectors, products and services.1 Traditionally, individual software companies catered to either the service market or the product market, but competition and the need to maintain a high growth rate induced many service companies to venture into the product arena.2 To a lesser extent, product companies have started widening their offerings to include services.

It is too early to judge how successful product companies are in offering services, but the lackluster results in the opposite direction are evident.3 A recent survey shows that from 1995 through 1998, approximately 87% of the product ventures initiated by software-service companies were unsuccessful.4 Traditional explanations for their failures (such as lack of venture capital and marketing skills) are hard to accept, given the availability of capital and talent and the fact that Internet technologies have removed several location-based disadvantages in software development.5 Instead, the failures point to more-fundamental issues.

It appears that many software-service companies that attempt to move into the product sector fail to recognize the differences between the two sectors’ underlying business models. The implications for design and development practices are significant, and inappropriate transfer of organizational practices and development culture from the service sector to the product sector is a recipe for failure.

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References

1. “Software products” refers to packaged solutions that meet generic computing requirements and includes enterprise solutions (e.g., accounting systems or inventory-control systems), software-development tools, operating systems and utilities, and personal-computing tools. “Software services” refers to software-development and operations services provided to clients on a project basis and includes custom-software-development services and systems-implementation and systems-integration services.

2. R.B. Heeks, “India’s Software Industry” (New Delhi: Sage Publications, 1996); S. Torrisi, “Industrial Organization and Innovation: An International Study of the Software Industry” (London: Edward Elgar, 1998); A. Lateef, “Linking Up With the Global Economy: A Case Study of the Software Industry,” International Labor Organization report no. 96 (1997); D.J. Hoch, C.R. Roeding, G. Purkert and S.K. Lindner, “Secrets of Software Success” (Boston: Harvard Business School Press, 1999); “Irish Software Industry Survey” (Dublin: National Software Directorate, 1998); and NASSCOM-McKinsey report on the Indian software industry (December 1999), http://www.nasscom.org.

3. H.V. Sukhathankar, “Time To Ponder: The Indian Software Industry,” Dataquest India, July 30, 1997, 21–24; and A. Arora, V.S. Arunachalam, J. Asundi and R. Fernandes, “The Indian Software Services Industry,” working paper 99/19, Carnegie Mellon University, Heinz School of Public Policy and Management, Pittsburgh, Pennsylvania, December 1999; and K. Ryan, “Irish Software Industry — Lessons Learned” (proceedings of the PICMET Conference, Portland, Oregon, July 1997).

4. The author’s 1999 questionnaire-based survey involved 134 software service companies (73 in India, 42 in the United States and 19 in Singapore) that had initiated a product agenda in the prior three years. The survey data showed that 52% dropped further investment in the product after the first year.

5. For a discussion of the changing market forces in the global software industry, see C. Anderson, “The Software Industry: The Birth of a New Species,” The Economist, May 25, 1996, 35–53; see also “Forecasting a Robust Future: An Economic Study of the U.S. Software Industry” (New York: Business Software Alliance, June 1999); and R.B. Heeks, “Software Strategies in Developing Countries,” Communications of the ACM 42 (June 1999): 15–20.

6. The interview-based field study involved large and small software-service companies in India (10), the United States (7) and Singapore (4). All were pursuing product agendas to varied extents. Interviews were conducted with senior and midlevel managers. A total of 49 unstructured interviews were conducted over a six-month period; each interview lasted about an hour and covered such issues as interviewees’ business strategies in the two software sectors and the changes in their organizational structure, development practices and processes, and knowledge-management practices. White papers and other published documents supplemented the interview data. The 10 Indian companies were, on average, 8 years old, had average annual revenues of $21 million (7% from products alone) and 139 employees; the seven U.S. companies had an average age of 11 years, average annual revenues of $32 million (11% from products alone) and 148 employees; the four Singapore companies had an average age of 6 years, average revenues of $3 million (10% from products alone) and 53 employees.

7. In February 2000, Dell Computer initiated Dell E-Works, which offers enterprise computer systems and storage products in the form of services to clients. Similarly, Sony’s new business unit, Broadband Services Co., has a mandate to exploit all Sony’s hardware, systems solutions and other technology assets to create new service businesses.

8. Economists term the conditions affecting the probability that an innovator can reap the benefits of its own innovation the appropriability regime. Torrisi, “Industrial Organization,” 121, discusses how it relates to the global software industry.

9. Heeks, “India’s Software Industry,” 1–45.

10. Hoch, “Secrets of Software Success,” 38–47.

11. Indeed, the decline of several large European software-product vendors in the 1980s has been attributed to their lack of exposure to sophisticated users, and hence, their inability to build up capabilities to compete in the global software market.

12. M. Ianisiti and A. MacCormack, “Developing Products on Internet Time,” Harvard Business Review 75 (September–October 1997): 108–117; S. Bhattacharya, V. Krishnan and V. Mahajan, “Managing New Product Definition in Highly Dynamic Environments,” Management Science 44 (November 1998): 50–64; and M. Cusumano and D.B. Yoffie, “Competing on Internet Time” (New York: Free Press, 1998).

13. Torrisi, “Industrial Organization,” 91–128.

14. L.L. Constantine, “Constantine on Peopleware” (New York: Prentice Hall, 1995); and S.E. Donaldson and S.G. Siegel, “Cultivating Successful Software Development: A Practitioner’s View” (New York: Prentice Hall, 1997).

15. For a discussion on using those attributes to assess potential variability in a product domain, see R. Ramaswamy and U. Nerukar, “Creating Malleable Architectures for Application Software Product Families” (proceedings of the Workshop on Object Technology for Product-Line Architectures, European Conference on Object Oriented Programming, Lisbon, Portugal, June 1999); also see J. Meekel, T.B. Horton and C. Mellon, “Architecting for Domain Variability” in “Proceedings of the Second International Workshop on Development and Evolution of Software Architectures for Product Families” (Berlin: Springer Verlag, 1998).

16. Although a few software-product companies such as SAP, Intuit, PeopleSoft and Oracle have taken the initial steps to offer application-hosting services directly to their clients, most other product companies have a wait-and-see attitude, acknowledging the difficulty of transitioning from the product to the service sector (“Software Shakeout,” Business Week, March 5, 2001, 72–80).

17. In “Where Value Lives in a Networked World,” Harvard Business Review 79 (January–February 2001): 79–86, M. Sawhney and D. Parikh use the concept of the migration of network intelligence to show how the boundaries between the product and the service sectors in various industries are reshaping the competitive landscape.

18. D. Delano, ed., “Global Semiconductor Industry Report,” Electronic Business (1998); and K. Reeder, “Radical Changes in the Communications Industry: A Report” (Paris: Organization for Economic Cooperation and Development, 1998).

ADDITIONAL RESOURCES

In addition to the references below, readers may be interested in a 1992 theoretical article written for the journal Economics of Innovation and New Technology by S. Torrisi and F. Malerba (“Internal Capabilities and External Networks in Innovative Activities”). David Mowery edited a 1996 Oxford University Press book that provides a good discussion of the global software industry (“The International Computer Software Industry”).

R. Schware’s discussion of the software-management issues faced by emerging countries is available in World Development 20, “Software Industry Entry Strategies for Developing Countries: A ‘Walking on Two Legs’ Proposition.”

The reader also may find related information at several Web sites: the Software Industry Center at Carnegie Mellon University (www.heinz.cmu.edu/swic), the National Association of Software and Service Companies in India (www.nasscom.org), Electronic Business (www.eb-mag.com) and the France-based Organization for Economic Cooperation and Development Web site (www.oecd.org).