In the software business companies like Microsoft make a lot of money by investing upfront in R&D to produce a product such as Office and then sell that product over and over again. Once R&D is complete the cost of making an additional copy of the software is negligible relative to the sales price, and so the marginal cost is minimal.
This is a great business model as once you’ve covered your R&D costs the gross margins are significant, often as high as 90%. This leads directly to the major problem with professional services businesses, namely that they can’t scale there business in this way.
The reason for this is that the product professional service companies are selling is their expertise. Essentially they exchange time for money. To exchange more time they must have more employees. To achieve greater margins they must either charge more or keep their costs down.
This is difficult to do. For example, imagine you work at one of world’s leading organizations and are looking to hire a firm to help you set the future direction of your company. This is a massively important task for your business, so naturally you’re prepared prepared to pay top dollar to hire the best talent around. Great news for the professional services company – they can now charge top end rates. However, you obviously expect the best people – people with ivy league educations and extensive industry experience. This is bad news for the professional services company as the more expertise an employee must have the more expensive they will be to employ.
So you see that it is difficult for a typical professional services company to increase its rates without increasing its cost base. The other alternative is to reduce costs. The same problem exists when moving costs in this direction as there is a certain minimum of calibre of person which must be hired and their salary can only be pushed so low. Anyway, who wants to hire a second rate professional services company?
This topic came about after being asked to look at clear sky accountants for contractors. Given that it looks difficult to significantly scale a professional services business without significant risk, what are some of the ideas that an organization could try to scale this type of business?
Use Products to Scale
One obvious idea is for the professional services organization to attempt to productize its expertise that is used repeatedly. Examples of the types of product a company could create and charge for include organizational health diagnostic tools, training materials, value adding accountancy software etc. In fact, if these products gain some traction within the market then it may even be worth considering spinning them out into a separate company. This business will focus solely on these products, allowing the professional services business to focus on what it does best, delivering expertise.
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