Quick Observations on Services Businesses (Part 2): Productization and Commoditization

This is the second post in a series I’m writing on running a services business1.

Also, For the sake of this conversation, I’m discussing services in the context of people who want to grow their business significantly, as opposed to maintaining some sort of local maximum.

Many services businesses achieve stable success leveraging their personal networks and local community. As I wrote in the first post in this series, though, those sources of new business can be a local maximum for a company that wants to scale. Large, densely-packed metro areas lessen the effects of the ceiling, but those environments are generally much more competitive and noisy.

No matter where you are, though, if you want to grow a services business, there are generally two main paths (in my observation and experience, at least) companies tend to follow. (There are certainly hybrid business models, but that’s another post for another day.)

My working names for the two paths are “productization and commoditization” and “specialization and customization.” Today we will talk about productization and commoditization.

The path of least resistance

As a services business figures out its own product-market fit, there is a strong desire to smooth out revenue, whether the motivation is to get off of the roller coaster of unpredictable income or to create some sort of economies of scale that un-anchor the business from the constraint of simply selling hours.

The path of least resistance is to either productize things the business can sell, or sell services that are more commodities than custom solutions. Oftentimes it’s a combination of both and each component feeds the other.

Productization

Productization is the process of turning your services into “products,” whether that is splitting them out into individual services or packaging them together.

Productization has several benefits. First, it makes what you sell easier to understand. For example, selling a logo design is much easier than selling a complete re-brand or “identity.” Removing subjectivity and unknowns simplify things and tend to speed up the sales cycle.

Second, productization allows for standardization of pricing. Easy-to-understand pricing makes winning business easier, but also removes poorly qualified customers from the pipeline (because they aren’t willing to pay what you charge). Assigning value in a way that’s easy to understand is particularly helpful if the person you’re pitching knows little about the mechanics of the work you’re performing. For example, pricing catalog websites at 5, 10 and 15 page packages is straight forward. You could also sell additional “products,” like photography or content for the website.

Lastly, productization allows you to standardize your own internal process for delivery, giving you economies of scale. In other words, you are replicating a very similar set of tasks and tools for multiple customers, which means you can do the work faster and likely reuse tools for every client (or leverage a single subscription service for multiple clients). Continuing with the digital example, using WordPress or or a CSS framework like Bootstrap or even a Rails setup from another project makes the project overall much more efficient from a production standpoint, but the result—and the value to the client—is the same.

Commoditization

Productization can be a very powerful way to sell services and, to some extent, every services business packages their work in one way or another. The flip side of the coin, though, is that standardized pricing and processes work best for very similar problems, so productization of services often leads to commoditization.

In this context, commoditization means that you are meeting a need that is similar for most businesses despite differences in their business models. Finding a common denominator among many different companies generally means that there is a lower level of complexity in the problem that is being solved—wide variation and high complexity make productization much more difficult.

Examples abound, but the markets for services in website development, design, media buying, ad campaigns, photography, video, content creation, social media management, “SEO management,” etc. are extremely crowded because most businesses need those things. (That’s one reason it’s very common for a services business to start out offering one ‘product,’ then add a host of related ‘products’ commonly consumed together and “accidentally” become a full-service agency.)

Selling commoditized services can be very lucrative because the market need tends to be significant, giving you the opportunity to perform a large volume of work. One challenge tends to be that differentiation is more difficult because there’s more competition, meaning you have to work harder to sell yourself. Often differentiation is required when it comes to pricing. Competitive markets can be price sensitive and supply is abundant, so you’re often forced to either justify your prices or accept lower margins and do more work.

Scale with productization and commoditization

There are two common ways that businesses dealing in highly productized/commoditized services: driving margins by lowering costs or finding a niche.

Driving margins by lowering costs almost always relates to the business’s actual cost of hours internally. Quite simply, you find labor that is far cheaper than what you can sell the service for, even in a price-sensitive market. Hiring young talent with limited experience, or even offshoring, are common ways of accomplishing this.

Finding a niche is very effective. I recently ran across a company that creates SEO-optimized content, which is a very commoditized service, but they work exclusively for companies at a certain size of revenue, with a certain type of sales process, who need a certain type of deal. They’ve limited the size of the market they can service by catering to a very specific business model, but they are thriving in an incredibly competitive and commoditized space.


1. You can see a full listing of posts in my series on services businesses here.

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