In the last entry on the health of technology services, I introduced the term services buffer. This is a phenomenon that occurs to product companies when product margin dollars decrease and services margin dollars increase. There are three scenarios when the services buffer becomes critical to a product company:
1. Bottom of the S-Curve: Product revenues and margins are temporarily declining as sales for the current generation of the product slow down. Customers are anticipating the next generation offering. When the next generation offering is released, product revenues and margins will return. Revenues and margins from servicing the current generation product help bridge the gap of lower product margins.
2. Maturation of a Market: Sometimes there is no next generation product that will return product revenues and margins to their former levels. Yes, customers want next generations of the product, but they expect to pay less for the more functionality. Think PCs, Unix servers, storage hardware. In this scenario, product companies may replace declining product margins with services margins. These services revenues and margins may be used to fund endeavors into new, higher margin product markets. The example of this shift is shown in the figure below:
3. Economic Downturn: The final scenario where the services buffer becomes important to a product company is during an economic downturn. When the economy slows, customers are less likely to spend on significant capital investments such as new hardware or software unless the return on investment is almost immediate. However, customers will need to continue to support their existing infrastructure. In fact, they may even be required to invest in services designed to extend the life of existing infrastructure. In this scenario, product revenues and margins may decline abruptly while services revenues and margins increase slightly. This shift causes services to become a critical source of income until the economic downturn abates and capital spending returns.
What is interesting to note in the world of technology, is how scenarios two and three often result in permanent shifts in revenue mix for product companies. For example, the dot.com bust of 2001 significantly shifted the revenues of storage provider EMC to be slightly more services intensive. The maturation of the copier and printer world has forced Xerox to become very services intensive. I would not predict either one of these companies will ever shift back to revenue mixes that are more product-centric. The question at hand is simple: how many product-centric companies will emerge from the current economic downturn with a more services-centric revenue mix. In other words, a larger portion of their total revenues come from services.
I was in a meeting this past week, and an industry veteran related a story where a very senior executive from a very large hardware company made the following statement: “For product companies, services are for losers.” I think this sentiment runs deep in the cultures of technology product companies. However, the data doesn’t support the thesis. In fact, from all the data I review, services are for survivors.