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Why is it hard to scale a services business?

Jim Collins has been researching and writing about the Flywheel as a value of enterprises. For those who may not know, here his most famous illustration - the Amazon Flywheel.
Lower prices led to more customer visits. More customers increased the volume of sales and attracted more commission-paying third-party sellers to the site. That allowed Amazon to get more out of fixed costs like the fulfillment centers and the servers needed to run the website. This greater efficiency then enabled it to lower prices further.
In another article, Jim writes - "those who drive companies into decline often abandon the big thing they already have, grasping instead for a new big thing, then another and another, falling into a doom loop of chronic inconsistency"

While not written in the article above, but my experience says that 'Consulting / System Integrator Services' is plagued by this particular phenomenon. Consulting firms are forced to move from one "next big thing" to the other constantly. This is not a fault of the company or the management but just the way services business is - customers call consultants or integrators when they don't have skills to do something internally. And since talent is usually available for most 'ingrained' work, consultants end up doing only - the 'next big thing'.

Some service businesses like actuarial, legal or accounting seem to be insulated from the 'skills' issue, but they too more often than not get pulled into managing change for their clients. [Ex. accountants need to help manage changes in taxation on an almost constant basis, lawyers have to help manage changing laws, insurance advisors often changing valuation methods and so on.]

Hence (professional) services firms never get a chance to scale "without" adding more resources to the revenue engine. Key is "without adding resources": resources here being people and their skills and hence paraphernalia like a management structure to manage people, office spaces, managing people churn etc

On the contrary, a product business has its flywheel - it can keep running faster and faster every week, month, year with the same effort [read: resources] you put in. What traction you build in the first week just gets reinforced with the second week's effort and so on. Not so in services where each relationship, each skill, and then each project has to gain momentum from scratch - they don't feed into a flywheel.

And so if you have 1 'Engagement Manager' managing 3 clients, you will need 3 to manage 9 relationships. In contrast, a team of engineers or designers can build version 1 of a product in year 1 and then add many more features to it in year 2 without losing the value of work done in year 1.

The last point - in "almost" all services, loss of human resources means 100% loss of IP. If a consultant leaves you, you have to recruit another as good or train another to become as good. But with products, the IP is (partially) captured in the product and so if a designer or engineer leaves, s/he can't take away the IP that got locked in the product. Though there will still be some loss of IP (because they'd take expertise in architecture, understanding the product etc), the loss would be less than 100% - how much less would vary from product to product.

This is one reason why it is harder to find too many billionaires who own services companies - the exceptions being the founders of IT Services Giants viz. TCS, Infosys, Wipro, Cognizant, Accenture etc. Few of them have hacked the services model to productise their service; for example Michael Dell who converted 'assembly of computers' into 'manufacturing computers'.

Another class of services business which have bucked this challenge are restaurant chains where the service of providing 'food' is hacked into providing experiences. Branding and consistent ambience play a big role in helping such businesses make the transition from 'pure services' to 'branded services'. Big 4 consulting firms also have done this in professional services as have some legal firms and 'real estate services' firms like JLL and CBRE. The existence of these exceptions, however, goes on to prove the rule - most competitors of these services 'biggies' are much smaller and local players. They play on cost and not value and hence have another reason why they can never scale.

On the contrary, there are many 'product' players who have scaled in past with or without VC funding. This could be one of the major filters that wannabe entrepreneurs can use to select business ideas on which to stake their lives.


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