Part 1 of 9
Many major vendors are encouraging their services partners to build repeatable IP (products) – Microsoft, Cisco, Salesforce.com and others. Of course, they are doing this out of self-interest, to make their underlying technologies stickier, and/or to drive consumption of Cloud services, but this is one of those times when the partners’ interests align perfectly with those of their vendors.
This will be the first in a series of blogs. Today I will outline why it makes so much sense for SIs and services companies to build repeatable IP, and also the reasons why many companies that could and should do it, never do. Over the next few months I will discuss some of the key business model issues, such as whether the IP business should be opportunistic or strategic; overcoming the cash flow chasm; managing customer acquisition costs; minimizing churn; how marketing changes; building the right sales organization; sales compensation; and the organizational impact, so that you can adapt your company to build, sell and support repeatable IP.
You Are Ideally Positioned to Build a Repeatable IP Business
When a start-up, the proverbial two guys and a dog in a garage, has a great idea, they have to raise a lot of money just to replicate the infrastructure you already have as an SI or services company:
- Customer support
- And, most important, you have a customer base that you can sell to.
I am not saying that the same people handling these roles today will necessarily be the right people to make your IP successful, but you have defined roles and an understanding of how they work. You can leverage those resources and your organizational structure to kick-start the IP business without having to run out to investors to raise $10 or $20 million.
Why Do it?
Every business owner wants to make money. The goal for most of you is to grow the revenues and profitability of your company to generate a good income, and at some point, sell the business for as much as possible. A successful repeatable IP business will help you achieve both objectives.
Grow your revenues and profitability:
- Higher revenues. Repeatable IP becomes a new revenue stream, either selling to new customers or cross-selling to your existing customer base. And in most cases, solutions sold into the corporate market require services, which also helps grow your top line;
- Better margins. The gross margin contribution from IP is much higher than that of services. The typical margin from services ranges from 20-25% at the low end (e.g., basic networking, break-fix) to 50-60% for higher value services (application managed services, business consulting, BPM, etc.). The gross margin from on-premise software is 100%, while the margin for most Cloud-based applications will be in the 70-80% range. Adding repeatable IP to the revenue mix will improve your overall margins over time.
The real pay-off, however, comes when it is time to sell the business. The market value of different business models will typically fall into the following ranges:
Services firms are bought based on a multiple of EBITDA (earnings before interest, taxes, depreciation and amortization). Companies that are providing on-premise services on a project basis are usually sold at 4-7x EBITDA, depending on the types of services they provide, their profitability, the overall state of the economy, and other factors.
A company providing the same services under managed services agreements will see an increase in their valuation to 8-10x EBITDA, because buyers like the predictability of recurring revenues. It reduces the risk of revenues falling off if key people leave.
SaaS companies, though, are valued on a multiple of revenues, and the multiple is the same on revenues as services companies get on EBITDA. That means that the same level of revenues from repeatable IP sold on a subscription model could be worth 8-10 times more than from your regular business.
So, Why Don’t You Do it?
Because it requires a different business model and culture. When we speak with services companies about building out repeatable IP, there are a lot of good excuses not to do it, such as:
- Clients want to own the code. If you are building custom applications you won’t always retain the intellectual property – this can require serious negotiations and in many cases concessions on the price, or other benefits to the client in return;
- The code is highly customized for a specific client. That is often the case – not every custom app is going to be suitable for broader sales;
- Products need continuous improvements, so there will be an on-going investment;
- Building repeatable IP is harder – it has to be designed in a different way so that it can be sold and deployed on a repeatable basis;
- All of the metrics are built around billable days, gross margins and utilization. They don’t have the systems in place to manage and measure a product business;
- Team selection is different. This last point is a big one – it is a different culture, and to be truly successful will often require a different team of people.
Building a repeatable IP business is not easy, but there are at least three factors that make it compelling enough for every services company to consider:
- You have an existing client base and most of the organizational infrastructure needed to do it on a cost-effective basis;
- To get started, it can be done on a more opportunistic basis (more on this in the next blog), without requiring a big investment or disrupting your current business;
- They pay-off could be huge. Not only do you drive more revenues and profits while you are building it up, but the exit value could be orders of magnitude higher than for your current business.
- Should the product business be opportunistic or strategic?
- Overcoming the cash flow chasm
- Managing customer acquisition costs
- Minimizing churn
- How marketing changes
- Building the right sales organization
- Sales compensation
- Customer support
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