In the world of business, there are generally two main types of companies – service-based businesses and product-based businesses. Service-based businesses sell expertise, time, or effort to customers. Examples include consulting firms, law firms, creative agencies, and restaurants. Product-based businesses, on the other hand, sell an actual tangible product that customers buy and own. Examples include manufacturing companies, consumer packaged goods brands, and technology hardware producers.
In recent years, there has been a noticeable shift with more and more businessmen focusing their efforts on building product-based businesses rather than service-based ones. There are several compelling reasons why product-based businesses have become the primary focus and goal for many entrepreneurs and founders. In this article, we will explore the key advantages of product-based businesses that make them so attractive and why you should strongly consider using one as well if you want to start a successful company.
Higher Scalability
One of the biggest reasons why product-based businesses have an advantage is that they are much more scalable than service-based businesses. Scalability refers to a company’s ability to rapidly increase sales and revenue without a proportional increase in costs. For service-based businesses, there is a linear relationship between revenue and the hours worked. If a consulting firm wants to double its revenue, it needs to double the number of consultants working. This limits how fast the company can grow.
On the other hand, product-based companies can scale exponentially because their products can be mass-produced and distributed with minimal incremental costs. Once the product is designed, you can sell one unit or one million units without hiring more people or increasing overhead expenses at the same rate. Software businesses are a prime example – the marginal cost of providing the software to an additional customer is near zero, allowing for incredibly fast scaling. This ability to scale rapidly is why investors love product-based businesses and why they have much greater upside potential.
More Passive Income
In addition to scalability, product-based businesses lend themselves to earning passive income. Passive income refers to money earned regularly with minimal ongoing work needed. The best example is intellectual property – once a song is recorded by an artist, they can earn royalties for decades with no extra work. Similarly, a consumer product brand builds value in its brand and distribution pipeline upfront through active effort but over time transitions to earning passive income from its products’ sales.
With service-based businesses, all income is active income that requires ongoing work to deliver the service. Product-based businesses, on the other hand, can create assets like established brands, patents, and distribution channels that generate revenue with minimal overhead. Building streams of passive income allows product-based founders to focus on innovation and creating the next version of their product. The passive income gives them an advantageous financial cushion.
Lower Customer Acquisition Costs
It is far more expensive and difficult to acquire new customers consistently as a service-based business. That is because you need to start the sales process from scratch every time and convince prospects your services are superior. Product-based businesses have an asset in the form of their brand and existing customers that already know and trust them. Happy customers organically spread awareness and refer others. Products also have more opportunities to go viral compared to services. This allows product-based companies to have lower customer acquisition costs at scale.
When you have a physical product, you can also open it up to ecommerce sales and distribution networks to reach new customers seamlessly. Overall, product-based businesses have structurally lower customer acquisition costs thanks to built-in marketing assets and distribution channels. Service-based businesses have to fight against higher costs to find and impress new clients. This makes it hard to grow profit margins.
More Value From Intellectual Property
For product-based companies, intellectual property like patents, trademarks, and proprietary data represent significant value. Because products can be protected through IP laws, product companies accrue more value from their innovations and information. Developing valuable IP is a core part of growing a defensible competitive advantage. Service businesses have a harder time building out their IP assets.
Let’s look at a software company as an example. They can patent algorithms, data models, and other tech innovations. These patents become very valuable IP assets over time – tech giants like Apple, Microsoft and Google have built up massive patent libraries worth billions. A service business simply cannot create the same IP assets and value. Overall, product businesses are far better positioned to maximize value from intellectual property.
Potential for Innovation
Products lend themselves better to innovation that disrupts industries and creates new markets. Because you control the technology and features built into a product, there is more potential to leverage innovation to differentiated yourself. Physical products can also take advantage of new scientific discoveries and engineering innovations. Just look at how advances in batteries, semiconductors, and materials have driven progress.
It is harder for service businesses to implement major innovations since they rely on human capital. You can’t disrupt the legal industry overnight by creating a radically better lawyer through innovation. Progress requires developing better products and systems. The potential to create innovative, category-defining products attracts many ambitious founders rather than building incremental service improvements.
Higher Profit Margins
Due to the combination of scalability, recurring revenues, lower acquisition costs, and IP value, product-based businesses structurally achieve higher profit margins over time. Software companies like Microsoft boast gross margins over 70% while consumer tech products like Apple iPhones still have margins around 38% even with massive global sales volumes. These types of margin levels allow product companies to turn high percentages of their revenue into profit.
Compare that to most service businesses which struggle to earn margins over 10-15% in competitive markets. The need to hire more people to drive more revenue eats away at their margins as they scale. Product businesses face fewer structural margin pressures which lets them operate at multiples higher on the profitability spectrum. This gives their owners greater cash flow and financial upside.
How to Build a Product-Based Business
Now that we have discussed the many compelling benefits of product-based businesses, here is a step-by-step overview of how to start building one:
- Evaluate your personal skills – What areas do you have deep expertise in? What problems have you solved before that could be turned into a product? Audit what skills and knowledge you can build a product around.
- Identify market opportunities – Do research online and by talking to people to find markets where customers have unsolved needs or problems. Look for existing product solutions that are lacking so you can provide something better.
- Define your differentiation – Figure out what will make your product fundamentally better than alternatives. This could be better features, lower cost, or superior design. Have a clear reason why customers will choose you.
- Design a minimum viable product (MVP) – Map out just the core essential features needed to test if users will be interested in your solution. Avoid building something too complex initially.
- Create prototypes and seek feedback – Make early prototypes of your product for prospects to try out. Get their honest feedback to refine and improve the product before committing fully to development.
- Determine required resources – Assess what funding, people and capabilities you will require to develop the full product and associated branding/marketing. Begin pulling together these resources.
- Develop the product – With a prototype validated for market fit, assemble the engineering and design team to build out a working version of your product that is ready for customers.
- File patents and trademarks – As you develop intellectual property like inventions and branding, work with a lawyer to file for patent and trademark protection. This will secure your innovations.
- Plan your go-to-market strategy – Figure out how you will attract your first customers and promote the new product. Identify sales channels and marketing campaigns you will leverage.
- Launch and continuously improve – Roll out your minimum viable product to the market, get additional feedback, and start the growth process. Use data and customer insights to rapidly iterate.
While not easy, with deliberate research, planning, and flawless execution, you can build a successful and highly scalable product-based business. Use the proven playbook that the most successful founders have perfected over the years.
Conclusion
It is clear why building a product-based business has become the top goal for many entrepreneurs today. Product companies have innate advantages around scalability, recurring revenue, lower acquisition costs, and profit margins that service businesses simply cannot match. By leveraging innovation and intellectual property, product founders also accrue more value and have greater market upside. Lastly, product-based businesses are simply more exciting to build thanks to their capacity for disruption.
If you have been debating starting your own company, take a long look at going the product route. Spend time to methodically find and validate a problem worth solving, then build a great solution leveraging proven startup principles. While not easy, with focus and grit, you can make the product-based business model work phenomenally for you. The potential rewards for both you and consumers are well worth the effort. Start brainstorming product ideas today.
