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About the Author
Daniel Tenner
Daniel Tenner is a full-time online entrepreneur. He has been involved in several online ventures, worked in a large consultancy in financial services, and started two successful online businesses.
His current focus is Woobius, a collaboration tool for the construction industry.
Why You Should Fire Your Clients And Launch A Product
If you were offered the choice to create one of two businesses—a web development shop where you do bespoke work for clients, or a start-up where you build your own product and sell it directly to customers—which would you choose?
Both of these business models involve the same activity: building web sites and web applications. Yet they are very different businesses. One is a service business; the other a product business. In this first instalment of a series on start-ups, we’ll look at the differences between these two approaches. Furthermore, we’ll see how they translate into what businesses are all about: making money.
A Matter of Scale
The first key difference between products and services is the question of scaling. If your business, whether it be centered upon products or services, proves so successful that potential customers are knocking down the door, can you scale up to meet that demand and make more and more profit as you do so?
We’ll look at these models in turn. How do you scale up a web design business if you find yourself with more clients than you can handle? The most obvious answer is to hire additional staff. This can be slow, difficult, and risky—it’s easy to hire the wrong person in a rush. Each hire only adds a fixed amount to your capacity to do web design work. Basically, if you have five people doing client work in your business, and you add another, your capacity increases by 20%. You can repeat that every few months, and if you’re growing at breakneck speed, you might just about double your size each year. After all, you don’t want to hire people so fast that you risk compromising the company culture, and hence the quality of your work.
Product businesses are a whole different ballgame. If the number of clients clamoring for you product greatly exceeds your expectations, all you need to serve them is more servers. Servers are much easier to “hire” than people, and they allow you to rapidly scale up from a handful of customers to a very large number of customers with minimal fuss and without having to hire anybody. If the demand is there, it’s not inconceivable foryour business to grow ten or more times bigger every year.
Given that servers are a lot cheaper than people, the chances are that your margins will increase as you scale the business up. For instance, let’s say you have three employees, costing you $40k per year each, and two servers, costing you $5k per year each, which allows you to provide your product to up to 1000 customers (500 per server). Your cost is $130 per customer. If you double the number of customers, and add two more servers, your cost per customer drops to $75. The more customers you have, the lower your cost per customer, and so the higher your margins.
In a product business, if you do decide to make a hire, you won’t do it just to serve more customers, but to provide new capabilities to your business. In a service business, each person you hire adds to your capacity, but in a product business, each person you hire multiplies your capacity.
So the first difference between service businesses and product businesses is one of scale: clearly, product businesses can be easier and more profitable to scale.
Making Money While You Sleep
Running your own web development practice allows you to transmute a fixed number of hours into a fixed amount of money. This alchemy is much more profitable than working a day job, where you’re usually paid a fixed salary for any number of hours, whether you stick to your eight hours a day or do one hundred and ten a week. It seems like a fair deal: the more work you do, the more money you get. The downside is that if you stop working to take a holiday or because of illness, you don’t get paid anything at all.
A product business behaves very differently. As a start-up founder, you won’t get paid much until the product is profitable, but once it is, you don’t need to keep putting more work into it to continue to make money. You’ll make more money if you do continue to improve your product, but even if you don’t, revenues will keep coming in for some time.
This model enables you to experience that most pleasurable of feelings: to wake up, check your sales, and find that while you slept, you made money. These earnings are often referred to as “residual income.” A well-designed start-up is like a money-making machine, which you switch on and keep running until … well, until you decide to stop it. Since it doesn’t need your constant attention and effort, you can enjoy a much more flexible lifestyle on a product business, working when you feel like it (which, at times, may be all week long from dawn to dusk!) rather than when the client deadline demands it.
It also means that if your interests change and you decide to focus on a new business, you’ll be able to do so while being sustained by the income from your first business. Many serial entrepreneurs do just that, often developing their next start-up when their previous one is just beginning to cool down.
So, the second benefit of a product business over a service business is that it allows you to continue to make money even while you’re not actively working on it, which gives you more flexibility with your lifestyle and your business pursuits.
Accruing Value
Another area in which product start-ups and web design businesses are different is in how they accumulate value, or on other words, how the effort that you put into them builds up for the benefit of future clients.
In a web design business, even if you do a fantastic job serving one client, that won’t necessarily translate into better service for your next client. There is some accrual, of course: you and your staff become more skilled, and word of mouth gains you more clients. However, that effect is not direct, guaranteed, or resilient. Even if you’ve just built a fantastic site for client A, you’ll still have to put in more or less the same amount of effort to do the same for client B. And if you don’t, client B’s site may well be sub-standard. You can’t just take the work you did for client A and use it on client B’s site as is.
A product accumulates value much more effectively. Every minute that you spend improving the product applies directly to all your customers, present and future. If you spend a week building a new feature for your product, all your customers can benefit from it. Some customers may not need the feature right away, and so won’t benefit immediately, but if you’ve picked the right feature to build, chances are most of your customers will appreciate and use it. This means you can spend more time making each feature perfect and building something of which you’re truly proud, rather than being always under the pressure of client deadlines.
So, the third benefit of a product business is that it accumulates lasting value much more effectively than a service business.