Pros and cons of starting a service based or product based company.
As an entrepreneur there are two routes you can take: either create a service-based business where you trade your skill or knowledge for money or create a product-based business where you sell products to people. If the successful business is offering a service, it typically takes less money to start and has a smaller upside in regards to scale unless you can duplicate the service offering on a repeatable basis. The successful startup business offering a product potentially takes a lot more money to start but has more upside with respect to scale and repeatability. You can design one product and sell it it thousands of times.
Both types of business can be very profitable, and there are millions of product-based and service based companies around the world. However, the money you can make selling a product may outweigh the amount you can make selling a service. Why? One word: Scale.
All of the world’s economy is based on supply and demand and in a service based business you are limited to how much you can supply which is limited to the amount of hours you can work. Yes, you can hire other people to reduce the amount of time a tasks takes therefore you can do more, but this is still limited to the amount of hours your staff can work.
Another important factor in deciding which route to take is in deciding where your strengths lay when it comes to managing and running a team. Both service and product based businesses require managing people to some extent, however hiring and managing people in a service based is far more complex and expensive than managing the process of creating products. This is because once you have a system in place for manufacturing your product a large part of the work is already done. The new challenge is drumming up enough demand through sales and marketing.
Let’s look at the key issues in deciding what kind of business you might want to create.
Time to market. If you are creating a service-based business, you can start almost immediately with little startup costs. If it’s a product based company, you do need to invest in product development but quite a few of these steps can now be outsourced to manufacturers. However, you will need to fund initial prototypes and inventory.
Scalability. In a service-based business, it can initially be hard to scale. It may be just you and a few other people. However, if your business model is to duplicate or franchise the services, then its possible to scale quickly. Obviously, once you build a product and move into manufacturing, then it’s easier to scale selling one product to many customers.
Business risk/entrepreneur risk. If you create a service-based business, you might just be risking your time as hopefully it will not cost much money to start the business. In a product-based company, you might need to spend quite a bit of money for product development, prototypes and initial inventory. You definitely want to identify ways to mitigate risk in either scenario.
Repeatability. With a service-based company, you have to identify processes and training to consistently deliver the same high quality of service. With a product, you need to ensure high quality manufacturing and service support. In either scenario, being able to consistently repeat the service or product is critical.
Profit margin. Initially, in a service-based business, your costs might be fairly low. Imagine if you were a marketer, programmer, accountant or consultant, your costs are mostly just you so your overhead should be low (home office, Starbucks, etc.) so your potential profit might be high but limited in how many hours you could work. In a product company, your initial costs would be high so you should target a 60% gross margin (or more to create cashflow) as a business goal which should yield a 10-15% profit margin. The key here is to sell a high quantity of products so as to create a sustainable business model where you can use incoming cash to fund inventory.
Whichever path you venture down, keep initial costs low, look to leverage the expertise of others, and mitigate as many risks as possible. The real goal is to succeed as a company by satisfying your customers better than the competition.