From a distance, the logic behind combining products and services into a hybrid business model can seem simple. The two sides balance each other out: As product profits fall prey to commoditization, services can compensate by propping up revenues—and, to a lesser extent, profits. In a dreary economy, customers who may be reluctant to shell out the sums required to buy products will likely brighten at the prospect of purchasing lower-cost services.
Furthermore, as companies “productize” services—designing packages that consist of, for example, regular maintenance and upgrades—they can sidestep the kind of costly customization that chews into profit margins.
Hybrid model of growth poses managerial difficulties
Still, the hybrid model of growth poses managerial difficulties: There are fundamental differences between product companies and their service counterparts in terms of where they direct resources and what kinds of organizational capabilities they need.
A recent survey of 163 U.S. and U.K. senior finance executives, conducted by CFO Research in collaboration with FinancialForce, found that senior finance executives anticipate encountering many “pain points” while transitioning to a services-added business model. More than one-third of respondents identified each of these areas as challenging: staffing and skill sets (40%); billing, invoicing, and accounts receivable (38%); planning, budgeting, and forecasting (36%); and renewals and revenue forecasting (34%). In the CFO/FinancialForce survey, nearly two-thirds (65%) of survey respondents have titles of director of finance and above, with a plurality of all respondents serving as CFOs. Nearly three-quarters of respondents (72%) are employed at companies with annual revenues above $10 million, and more than one-third (37%) are employed at companies with annual revenues above $1 billion. Respondents represent a broad range of industries.
The growth of services business brings with it bulging body-count, while a product company’s efficiency is often determined by a robustly rising revenue per employee. And while services offerings face constant price competition—the barriers to entry are low—a fast-growing product-based company can take advantage of economies of scale and advances in automation to juice profits.
Finding the right metrics to accurately track progress
For finance executives, the challenge of blending the two kinds of businesses into one newly shaped model raises an especially difficult quandary: finding the right metrics to accurately track its progress. For product-oriented CFOs, it’s difficult to adjust to the notion of creating value from such intangibles as customer relationships.
When asked how the role of the finance leader should change to support the “new services” business model, about half of survey respondents (47%) chose “more likely to use new metrics to measure business success.” Defining the right metrics starts with identifying the drivers of customer satisfaction, establishing a baseline, and then monitoring the trajectory to track which changes are having a positive impact on customer satisfaction.
In addition, services businesses measure customer churn—that is, the number of customers who decide to unsubscribe from the company’s services during any given month. Monthly recurring revenue is also a leading indicator of the company’s financial health. Growth is the goal—but not at any price, which means keeping a steady hand on customer acquisition costs. That metric, in turn, can guide the finance function in allocating resources toward the most cost-efficient channels or strategies.
By setting (and meeting, if not exceeding) annual targets for reducing churn and improving customer adoption, a product/services combination company can implement tools for solidifying customer loyalty.
No matter what the business model—product, service, or hybrid of the two—that’s a surefire predictor of financial success. Read part one of the CFO blog series.