Back in the Pleistocene era of startups, in 1989 when we raised my first round, venture capitalists wouldn’t touch a service business even if you paid them to do so. “No economies of scale, no IP, no barriers to entry.” Well here we are thirty years later and three of the biggest venture-backed companies in the U.S. are service companies: Uber, AirBnB, and WeWork!
And the number one product company in the world, Apple, is struggling as the market for premium-priced smartphones is saturated and low price competitors are attacking Apple’s literally gross margins, the standard playbook for going up against entrenched competitors who have gotten too fat and happy.
Even Apple is dipping at least five toes into the services business with Apple Music, iCloud, Apple pay, iTunes Store, etc. and proudly touts the growth in this part of their business as they simultaneously hide the actual unit shipment of their products.
What the heck has happened over the past thirty years! Two things: the digitization of everything and the gig and entrepreneurial economy.
Let’s face it, Uber and AirBnb would be nothing without their smartphone apps – what they are doing would have been impossible in 1989 even though the services they are delivering, ride sharing and home sharing, have been around in other forms for decades. Similarly, WeWork is a new play on what were called “executive office suites” back when I was starting companies and lacked the cash to rent a full size office. Regus and others would provide entrepreneurs like me a small office and a set of basic business services: reception, copying, coffee, a mailing address and a conference room. Basically Regus was the grandfather of WeWork. And they are still around today, but valued as commercial real estate not as a high tech company, as WeWork is. Smartphone apps tied into cloud computing have enabled Uber, AirBnb and dozens of other companies providing services to today’s time poor, cash rich millennials and their cohorts. Food delivery, like Uber Eats, DoorDash, Instacart et al is an entire service category where VCs have poured hundreds of millions of dollars.
The other driving force behind the rise of services is the sharing economy or the gig economy or whatever you want to call it. This new economy relies on contractor labor, whether it’s drivers, delivery people or owners who rent out their apartments or houses (landlords) all to make a buck in ways the weren’t either possible or profitable decades ago. The rise of startups has also driven the need for office space with amenities, thus WeWork. Contractors are much cheaper than employees as they get no benefits: no healthcare, no vacation or sick leave, no unemployment insurance, and can be hired and fired at will.
So should founders target services business today to hop on the VC gravy train? As usual, it depends. The most important criteria are the same as they were 30 years ago: you need a large market, one capable of sustaining a billion dollar market cap company. A market that is growing, not shrinking. And it helps if the incumbents are asleep at the switch. You still need a great team and some kind of secret sauce that gives you an unfair advantage. But building products, whether they are hardware or software, can be very time-consuming, expensive and risky. May be better to add a layer of services driven by software to an existing business model, as Uber has done with ride hailing, aka taxi and black car services.
Or you may want to hedge your bets by combining services and software. Data is the new oil and how to you drill for oil when Google and Facebook own most of the oil fields? Crack that nut and you may have a successful startup.
But if you do aim for a startup keep in mind why investors historically have shied away from services companies: you need to be able to scale, you must keep your employee count low, keep overhead low by using contractors, and attack a sleepy market, as Harry’s did with shaving.
There’s a ton of opportunity out there for a smart team to solve customer problems by combining digitization with the gig-based workforce to leave the dinosaur companies in the dust. But the fundamentals of a startup must be adhered to: great team, large market opportunity, and the secret sauce. And keep in mind that if you succeed you will have a thousand imitators, so plan out how you will stay ahead of the competition, not just disrupt the incumbents. And don’t be afraid to go after VC money, because unlike the last century, they will now greet top gun teams building a service business with open arms.