B4B co-author and TSIA executive director Thomas Lah delivered a memorable and eye-opening TSW keynote at last month’s TSW Service Transformations conference, discussing what the B4B model means for technology services organizations. Here are some highlights from that important discussion. If you haven’t gotten your copy of the book B4B, it’s a must-have, and it’s available at Amazon. It’s a promising time to be in tech services, as we head toward the new era of B4B.
Consequences of B4B for Technology and Services Organizations
Lah’s keynote opened up with footage of an all-too-familiar scene from John Hughes’ classic 1986 movie, Ferris Bueller’s Day Off. You know the scene: it's the one featuring Ben Stein, who plays an economics teacher trying to coax the class along in grasping the ins and outs of then-recent economic events. Stein’s delivery of the scene is classic, due in large part to his droning, monotonous delivery. “Anyone? … Anyone? …”
Ben Stein and his father Herbert Stein were both well-known, notable U.S. economists. Channeling his "inner Stein", Lah took the stage, asking the audience to recall the Stein-Stein connection, and the iron-clad economics law instituted by the elder Stein, aptly named, Stein’s Law. “Anyone? … Anyone? …” Audience members played along and, in this scenario, nailed all the answers. Stein’s Law states: “If something cannot go on forever, it will stop.”
And so began Lah’s launch into a deeper discussion on “outcome-based everything.” So what does B4B really mean for companies? Lah broke his discussion down into three areas:
Area #1: Outcome-Based Financial Models
What does it mean to have outcome-based financial models? There are basically three ways that product companies like to make money:
- Sell products as assets.
- Wrap annuity services around those products (e.g., support, premium support, annuity contracts).
- Project-based services, which are also very close to the product (e.g., design, implement, integrate).
(See Figure 1.)
(Click image to enlarge.)
Historically, we know a lot about how we’ve approached those three gears. “If you think about the service activities, those annuity product services, as project services, there are two bumpers on how to approach that as a product company,” says Lah:
- If you’re a product company, you could give all of those services away at no cost (“extreme free”: focus on the product sale).
- You could charge market rates (“extreme fee": no discounts, no strategic investment).
“But the reality is, we run in between these bumpers,” Lah continues. “Product companies can’t afford to give everything away for free, but at the same time, there are synergies. When you have services with product, sometimes you do invest the services to get the product deal.”
He then pointed to two economic engines in between those two bumpers that have become very popular in our industry:
- The product provider: Companies whose majority of assets comes from selling product, 20-30 percent coming from annuity or premium support services, and maybe six to eight percent of revenue might come from project work.
- The product extender: Companies whose major gear in the economic engine comes from maintenance and support, with perhaps 30 percent of revenue coming from product sales.
“These are very popular economic engines, and there’s reason: They’re beautiful,” explains Lah. “If you run these right, you can make comfortably anywhere from ten to more than 40 points of operating income. These are beautiful models. But they are under duress.”
Lah then shared some data from TSIA’s Service 50 index (a quarterly snapshot of how 50 of the largest tech companies are performing) indicating that top-line revenues have been going down. “If we have these economic engines that that assume we’re going to have growing revenues by selling an asset, assume we’re going to have people who are happy to pay for these annuity product services, and they’re actually declining. We have a problem in our economic engines,” he explains.
In response to the duress that these historic models are in, Lah presented a newly instituted set of laws, aptly named “Lah’s Laws.”
Lah's First Law: Unsustainable business models are unsustainable.
If you’re spending more than you’re taking in, that becomes a problem. Describing what the new economic engines look like, Lah described how the financial models might look like as companies move from Level 1 and 2 suppliers, to Level 3 and 4 suppliers, citing data taken from TSIA’s Cloud 20 index (a quarterly financial index of 20 publicly traded cloud computing companies).
Based on the latest snapshot, on average, these companies are growing at a rate of 26 percent (performing much better than those in the Service 50). “Wall Street does not reward past success,” says Lah. “Wall Street rewards future potential. Investors believe more money is going into these economic engines. It’s coming out of the legacy engines; it’s going into these.”
- Lah offered six guiding principles for making these economic engines more profitable:
- Annuity services will need to grow.
- Project service margins will need to improve.
- Establish outcome-based transaction revenues.
- Sales and marketing costs will need to shrink.
- G&A costs will need to shrink.
- R&D investments will need to grow.
But there is a crossover point that we’re all going to have to race to, according to Lah. “As revenues come out of your legacy activities, you’re going to stand up new revenue streams, and you’re going to have to make these revenue streams more profitable, as you experiment, to bring the margin dollars back in to help manage, financially, through this transition.” Which introduces us to Lah’s second Law.
Lah's Second Law: Companies don't abandon unsustainable business models until they become unsustainable.
Where the legacy models just are not going to hold up, it’s going to be tough to let go of doing what you always did, but it’s a transition that deserves serious consideration. “You’re going to have to help your companies with this reality that those models are not going to hold up,” says Lah. “And so the question is, ‘Where is this new revenue going to come from?’” which led to Lah’s next area of discussion.
Area #2: Outcome-Based Services Portfolio
Lah gave the audience real-world examples of companies who are employing the outcome-based services models and are achieving success. He also described the three types of outcome-based services offerings:
- Type 1: The outcome is based on consumption.
- Type 2: The outcome is based on moving key performance indicators.
- Type 3: The outcome is based on moving financials.
He also offered some recommended reading of a recent TSIA member research report titled “The Outcome-Based Services Portfolio,” which takes a closer look at how the services portfolio of product companies will shift over time to address these challenges.
Area #3: Outcome-Based Organizational Structures
In his final area of discussion, Lah reviewed the outcome-based organizational structures. As financial models change, and the portfolio changes, what happens to our global service organizations? TSIA knows a lot about what mature global service businesses look like, and generally, they have fairly stove-piped organizations. Each of the organizations (professional services, support services, field services, etc.) has their own people, resources, and processes. “Not a lot of sharing going on,” describes Lah. But this organizational structure is not going to stand as we move to Level 3 and Level 4. It’s going to look something the illustration in Figure 2.
(Click image to enlarge.)
Lah closed out his discussion by detailing how this will all play out, and also revealing his third and final Law.
Lah's Third Law: Organizational capabilities win markets, not organizational structures.
Start by “focusing on organizational capabilities,” Lah says, describing the seven key capabilities that will be required for outcome-based services:
- Quantify the business value of your service offerings.
- Pilot and test new non-attach offers.
- Sell non-attach offers.
- Outcome-based pricing models.
- Risk management and SLAs for outcomes.
- Optimized global service delivery mix.
- Customer analytics.
It’s a lot to take in, but taking it in becomes a business imperative as you look toward the future success of your organization, and TSIA is here to help you navigate B4B. Go here to watch Lah’s keynote in its entirety. TSIA can help you on your B4B journey. This is where we are focused, and we are here to help you evolve into the new B4B era. It’s going to be a great ride, so stay tuned for updates on all things B4B.