I read a blog entry today from a venture capitalist that made me wince:
In the post, he is making the argument for why software startups need to invest in Professional Services. I am in line with the majority of his reasons. Until his last point:
And finally, the most obvious argument is an economic one.
It’s true that professional services have a lower margin (say 45-55% gross margin) than software (typically 85-95% gross margin) and professional services business are inherently less scalable.
So I’m not endorsing your building your entire company around professional services (although I think that’s a fine strategy for many non VC-backed companies) but rather not to avoid it.
Let’s say you can do $1 million in software sales in your first year of selling delivering $850,000 of gross margin. Let’s say you can supplement that with $1 million in professional services revenue at $500,000 gross margin.
Need I point out that the $500,000 is still profitable revenue that can contribute to your central costs of running your business?
I have been involved in benchmarking embedded PS organizations for the past seven years. I know exactly what best in class financial performance looks like for PS organizations within software companies. I can tell you that both project margins and overall PS profitability have been steadily improving year over year. But I can also tell you, that on average, embedded PS organizations are not generating 50% gross margin on projects. And they surely are not dropping 50% of their revenues to the bottom line to cover other company expenses.
The logic in this blog entry is based on grossly inaccurate assumptions–and that is what makes it so dangerous. I pity the poor manager put in charge of PS for a company that this venture capitalist has invested in. The expectations of the economic role of PS will be based on napkin math, not financial realities.
Building and scaling a project based human capital intensive business is hard. Having investors that do not understand the financial realities of the PS business model make success almost impossible.
Tags: Venture capitalists