Cognitive Dissonance: Are you a technology or a service?

One of the trends I’ve observed over the past several years is that more and more technology entrepreneurs are starting service-delivery business.  By services businesses, I’m referring to the category of businesses that some venture investors refer to as technology-enabled services (“TES”). We at Meritage prefer the term network-enabled services (“NES”), which we think more accurately demonstrates the fundamental innovation in the business model, which is that there is a high-level of connectivity between the service delivery platform and the customer. Services is a big tent, so to ground it, put your mind on business models like SaaS, cloud computing, and even search.

Many casually refer to these businesses as “technology companies”, by which most intend Wikipedia’s definition of “information technology”, not the generic definition of “technology“. After all, these businesses create technology to build their service, right? Salesforce.com is a technology company; Yahoo! is a technology company; Akamai is a technology company …; AT&T is a technology company. Whoa! Hold it right there; rightous indignation time; I can hear it already.

AT&T is not a technology company! They don’t know the first thing about technology! AT&T is a communications services business.

So what is the difference? Why do we think of Salesforce.com as a technology company and AT&T as a service provider.

Cognitive Dissonance

Objectively, either all the companies in the list above are technology companies or none of them are. AT&T uses every bit as much technology to run its business as does Salesforce.com. And while some of that technology is different, much more of it is fundamentally the same. More importantly, the technology serves the same singular purpose; it powers the service.

So which is it? Are they all technology companies or are none of them technology companies?

Brace yourself; here comes the controversial statement. If you are a services business, you cannot be technology company. Salesforce.com is not a technology company; Akamai is not a technology company. They are service companies.

To Create of Consume

I’ll return to where I started this post; with the observation that I see many technology entrepreneurs moving into services businesses. Often times, such entrepreneurs bring with them a technology creator mindset, not a technology consumer mindset. And as a result, they are susceptible to a number of mistakes. The most common of these is when the entrepreneur convinces themselves that their proprietary technology is going to make there service provider successful. Here are three examples:

  • Wireless service provider that has invented a new technology for mesh wireless networking, enabling quality of service management for voice over wireless applications.
  • Tech-enabled service provider for eBay resellers that has invented a new web server technology that will make the technology infrastructure highly scalable.
  • SaaS developer who built its own platform for managing its application in the cloud.

What is the problem with these businesses? They are acting like creators of technology, not consumers of technology.

The rationale is that by creating a proprietary technology, the service provider can gain a competitive advantage over its service provider competitors. It is an alluring and dangerous trap. But fundamentally, there is no way the wireless service provider above can keep up with the R&D budgets of Motorolla, Qualcomm, Cisco and the like and create a best of breed mesh QoS technology in the confines of a single wireless service provider. The tech-enabled service provider can’t possibly out-compete the web server technologies on the market in the long-term.

Embedding a proprietary technology business inside a service provider decreases execution focus and greatly increases execution risk. Creating this kind of technology requires a different skill-set, different processes, and a broad market in which to distribute the product. The economics of spreading the costs of creating and maintaining a technology company like this over one, captive service provider don’t work. From an investors perspective, the Company will consume more capital than is required, trying to capture/maintain a lead in a core technology that creates only the illusion of competitive advantage for the service provider. It is hard enough to build a successful service provider. Why would you want to complicate it by having to simultaneously execute the creation and maintenance of a core technology you could purchase from a third-party vendor. And what if the science upon which the new technology is predicated upon doesn’t pan out. Then what?

Rather than invent and maintain truly proprietary core technologies, I encourage all of my service provider investments to be rational and ruthless consumers of technology, not creators of technology. Find best of breed wherever you can, configure it in a way that suits the needs of your particular service and drive your vendors, who have the R&D budgets and skills, to innovate on your behalf. It is much more capital efficient and the execution risk is significantly lower.

What I am not saying

Does this mean services businesses should not be inventive? I’m not saying that at all. In fact, the successful services businesses are highly inventive, but not at a core technology level; rather at a business process level. One of my portfolio companies, Pipeline Trading has developed some amazing algorithms around large block and algorithmic trading of equity securities. This invention is unique to Pipeline and highly proprietary. But it is not a “technology” in the information technology sense of the term, it is a business process. Sure these innovations are expressed through technology; lots of software to be precise. But that doesn’t make the innovation a technology innovation; quite the contrary. Any quality engineer who is given the advantage of understanding the business process expressed by the algorithms could easily write the software. The innovation is not the software itself, it is the algorithm; and that algorithm has fundamentally nothing to do with information technology. It turns out that the competitive advantage is also in the algorithm, not in the software that expresses it.

But, but but…

But what if we really have created an incredible technology (in the information technology sense of the term) in the process of building our service provider? What if I really do have the best cloud-enablement platform in the world. Great, you just hit the jackpot, because you’ve discovered and solved a problem that every other service provider like you will also experience. But don’t keep that innovation captive to your own little service provider; free it. Spin the business off; create a hardware, software or new service provider around the technology; open source it. In fact, this is exactly what the SaaS operator with the cloud-enablement platform did. Kudos; right call!

The highest and best use of a new technology innovation is to sell/license it to anyone and everyone who could benefit from accessing it. That includes the service providers with which you compete. If it is amazing and valuable new technology, you should be able to sell the technology to your competitors and a lot more customers. If you can’t monetize it directly, ask yourself again why you believe the technology innovation will be a source of advantage for your captive service provider?

Final thought

Where does this leave us? Well, if you are a technology entrepreneur coming into a services business, I’d suggest you first change your mindset from one of being a technology creator to a technology consumer. Whenever possible, focus on innovating at the business process level, not the core technology level. Avoid technology “research” projects and focus resources on expressing your innovative business process with software. And finally, if you are absolutely forced to solve a tough core technology problem and create a truly proprietary technology in the process, look for ways to free it from the shackles of your captive service provider. In the end, the technology will have a better chance to flourish and your service provider will be unburdened from the costs, and challenges of having to execute on two fronts simultaneously.

Don’t confuse the services business with a technology business. You can’t; and shouldn’t try to be both.

Derek Pilling is a Managing Director at Meritage Funds, a growth equity firm. Derek invests in technology-enabled services businesses in the Internet Infrastructure, Cloud Computing, Digital Media and SaaS sectors.Derek lives in Denver with his wife and his three children. In his spare time, Derek enjoys coaching youth soccer, skiing, hiking, spinning and hopping on his rowing machine in the morning.

Tagged with: , , , , ,
Posted in Economics, Lessons Learned, Risk, Venture Capital
Derek Pilling

About Derek

I'm a Managing Director with Meritage Funds, a growth equity investment firm based in Denver, CO. I've been working with growth stage businesses my entire career. When I'm not working, I ski, spin, coach youth sports and spend time with my beautiful wife and three kids.

I blog because the process helps me crystalize how I frame the world. I want to hear what you think. Please comment.

Twitter feed

Colorado - Entrepreneurial by Nature

Categories