Editor’s Note: This is a guest post by Mark Suster (@msuster), a 2x entrepreneur, now VC at GRP Partners. Read more about Suster at his Startup Blog, BothSidesoftheTable.
I recently wrote a blog post in which I pointed out that many investors and advisors discourage enterprise startups from having a professional services (PS) business and I think this is a big mistake.
I think it’s important for enterprise startups to layer in professional services to their revenue streams.
PS capabilities are important for enterprise startups because they:
- ensure your projects are more successful and thus more referenceable
- help you integrate your product with other systems making it harder for your product to be replaced by competitors
- make sure you do higher quality implementations because 3rd parties don’t have the same interests in over delivering on quality
- provide you with best eyes & ears on the ground at clients to drive upsell, cross sell and rollout across more business units
- deliver profitable revenue that, while on gross margins of 50 percent vs. software at 85-95 percent, it is still profits that help you cover fixed costs
It’s all in this article if you want the details.
You don’t want to run the risk of having a PS business that takes your eye of the ball of growing a large software business. So when I meet with GRP portfolio companies that do enterprise sales I try to emphasize the following:
1. Only Work on Projects That Support Your Core Product Effort
The most important thing to be careful about is to be sure WHY you’re doing the PS business. Hopefully it’s not to avoid fundraising or finding quick pockets of money.
Don’t become addicted to the quick hit of cash that a big implementation project can provide.
Your goal should be to do PS as a way of accelerating future non-linear software growth.
Therefore you need to be careful not to accept projects that are too far out of the core business. Each project should be related to rolling out your solution or you shouldn’t do it. Each project scope should be as close as possible to being restricted to:
- software set-up
- rollout support
- integration with other systems
That is the software business.
In the adtech world PS revenue often means providing “media services” as a value-add to using your product. This might mean helping customers buy traffic, arb’ing deals, helping with RTB pricing or trading, etc.
2. Minimize Any Custom Work That Will Not Feed Back Into Your R&D
While I’d like to say that you should never do custom work that changes the scope of your product, that’s not wholly realistic. But you do need to be sure your company doesn’t just become the internal R&D department for a large corporation.
If you never read my post on Elephant, Deer and Rabbits – a guide to customer segmentation – it might be worth a read.
With a well-architected product that has well-documented APIs and proper core product abstractions, all custom work should be built above the API stack. Often your sales engineers can do the customizations without bugging the core eng team.
Extending the feature set of the product would obviously be better if done by the customer, but sometimes customers lack the resources to do customizations, so simply telling them to get stuffed is not the answer.
3. Protect Your Intellectual Property
If you’re doing custom work, restrict it to a small portion of the PS project and try to build stuff that can eventually find its way back into your core product roadmap to improve your core offering for future clients.
In fact, if you do the PS project well and narrow the scope to features that you know you’ll eventually need to build anyways, then it can actually be a great source of future innovation.
Importantly, make sure that you retain IP rights to your custom work, which needs to be part of the engagement contract. At a minimum co-ownership of the IP.
If it’s not specified in the contract, you might find yourself with future litigation over IP.
4. Integrate PS Work Into Sales And Marketing Processes
The reason to do the PS work in the first place is to drive future software sales. So make sure that your PS organization doesn’t become an island or a P&L unit that tries to maximize its own value by showing the most profitability and growth on that business unit possible.
The PS team is there to successfully engage. You want to make sure that they are communicating well and often with sales to drive future product sales at the customer level.
You want to be sure that you get customer commitments before doing the work. Do a case study afterwards if the project is successful. You won’t get every customer to agree to this but you certainly want to try with every customer. Referenceability is the lifeblood of sales. If asked to drop the price we would often counter by agreeing to small price decreases in exchange for an agreement to do case studies to drive future business. Frankly, you’re going to need to drop prices a bit anyways. After all, every customer wants their pound of flesh.
If you have a sales rep pushing a product implementation you want them to understand why selling PS will help them grow future revenue at that account and not as a crutch to hit short-term revenue targets.
Basically, no islands at startups. Everything needs to be part of a holistic company strategy.
5. PS Business Cannot Become A Management Distraction
Another rule I outline with our portfolio companies that sell enterprise solutions is that I don’t want them to become a distraction for management.
If your CEO is having to get involved too much in reviewing a project’s success, or your core product team is getting sucked into implementing too many features to support the rollout efforts, chances are you’ve gone too far.
The closest analogy I have for a PS person is a “sales engineer” who is normally a technical staff member who assists in sales campaigns. Often they have the same skills and can therefore be doubled up as PS if you are in a pinch to afford staff.
If PS involves too much management or core tech time, then chances are it will overtake your software strategy and you’ve then just become a prostitute for short-term revenue.
6. Control Size Of PS Revenue Relative To Software Business
So how much PS is too much?
There’s no right answer. It’s mostly a function of the stage of your business.
If you’re in your first year of developing your product, chances are you haven’t yet found product / market fit and you don’t yet have enough value to sell your product for as much as you’d like.
And chances are you’re in big need of a killer customer reference.
So it wouldn’t bother me if 90 percent of your year-one revenue was PS, provided it was done with a specific plan for year-two software sales. It also is a great way to finance your business without facing dilution before you actually raise venture capital and when the valuation you might get from angels is less than you’d want.
By year two I’d like to see PS at 50 percent maximum, which is still high.
By the time you’re at $5 million to $20 million in software sales, I’d like to see PS be no more than 25 percent of your total revenues.
I know that number sounds high for some people, but in reality if you’re growing fast it’s not unthinkable that you’d bill out $2.5 million in PS revenue on top of $7.5 million of recurring revenue (MRR) software sales.
As you hit steady state I’d like to see PS at about 15 percent of your business.
Rough guidelines. Lots of room for debate. But a good rule of thumb for planning.
7. Don’t Pay Full Bonus To Sales Staff On PS Revenue
Finally, be careful that you don’t incentivize your sales staff to make you into a professional services firm. You can’t pay full bonus on PS revenue. Not only because it’s lower gross margin, less scalable and more consumptive of staff, but also because, if you make it easy for them to sell PS — which is always higher revenue than paying for software — you’ll be sure they sell it ALL DAY LONG.
But it can’t be zero bonus.
If you have zero bonus on PS revenue you’ll find a sales team that becomes the PS prevention unit, and if you’ve bought in that this line-of-business is important to you, then you don’t want your best sales teams working against you.
There’s not one answer for how to comp the sales teams. It can be margin based or lower spiff for PS revenue than software revenue. Whatever. And obviously you need to persuade them that today’s PS business is tomorrow’s big commission check.
Happy to take any suggestion in the comments section as to how to properly incentivize sales teams.
“How to sell your future roadmap to enterprise customers without selling your soul. Adding precious high gross margin to support an R&D team that you need to fund anyways.”
Photo credit Food52.