Technology Company vs Services Company — by Dan Lynn

By Dan Lynn

Well, someone once asked me why we started a Services company versus a Technology company. He said "wouldn't a technology company have higher margins and enable you to scale?"

Here are my thoughts but, remember, there is no right answer. That's the beautiful thing.

Company A (the name has been changed to protect the innocent) started as a technology company. They invested about $10m into building a technology software that they could sell to Fortune 500 companies to automate search rankings and measurement. They launched right around when we launched DigitalGrit. So, it is fun to compare the two.

Company A:

-- They had to raise $10M over several rounds of financing to begin and continue the development. They were able to raise those initial funds because they were going to build a technology. VCs typically don't like to invest in service companies because - to the original point - they are too hard to scale. -- Because Company A raised $10M they obviously have some very engaged investors and a board of directors who want to ensure they get a fair return on their investment. -- Unfortunately, Company A found that they were unable to sell licenses (although the technology is actually pretty good) because the economy changed and no one was spending $100K on software packages. -- They discovered that they had to sell services using their technology as the backbone to the service. So, they essentially became a service company using the technology they built although they started as a pure technology company. -- They discovered that a recurring revenue stream is a beautiful thing! -- Because they built a technology focused on search, it is difficult for them to extend beyond search. -- Their investors are becoming impatient and are anxious to make their money back. Therefore, Company A's #1 objective over the next 12 months is to be acquired. -- Because they have a good technology infrastructure, a recurring revenue stream, and the search market is hot, I think they will be acquired. The question will be whether the investors will recover their money. Since they have about $3M in revenues, I think it will be hard in the short term. -- Per one of their recent employees who left Company A, they've got enough cash to last until about June - so they need to make something happen - fast.

Company B:

-- We couldn't raise outside money - although we tried (we did get some friends and family money -- Thanks friends and family!). No one wanted to invest in a service company because they are so hard to scale and because the real assets - the people - walk out the door every night. -- Because we didn't raise any money, we don't have anyone looking over our shoulders. We own 100% of the business. -- We found that recurring service revenues are a beautiful thing! -- Because we hadn't invested too much in "yesterday's" technology infrastructure, we can be more flexible with the services we offer - enabling us to drive twice as much revenue from a client than Company A can. And, enabling us to identify and deploy new and exciting services for our clients. -- We don't have any impatient investors so we can play out the market and choose the path that is best for us. Also, Company A's goal is to be acquired. Ours is to create a great company. Wow, what a difference. -- However, because we don't have a technology to sell or use, we aren't as efficient as we need to be. In order to scale and be profitable, we will need to buy or build a technology to deploy as our infrastructure. Plus, wouldn't it be nice to develop some technologies that we can sell to our clients - in addition to the services we offer. -- Also, because we don't have a technology it will be harder to get funding to grow. -- So, we actually need to start to develop a technology infrastructure and technology products.

Funny you asked this question because I am working on a chart for tomorrow's staff meeting addressing this very issue.

Two companies, two competitors. Both have been around the same amount of time. Both have 25 employees. Both have about the same revenues. Both approached the market completely differently. One started as a tech company and became a service company. One started as a service company and will need to become more of a technology company. Who would you rather be? Only time will tell. I'd rather be us (Company B)- but obviously I was drinking the Koolaid. I actually think Company A's CEO would rather be us - I could see it in his eyes. But, I could have been completely wrong. He could have been laughing at us. But, at the end of the day, Company A failed and Company B was a big success.

So, to answer your question. Yes, if you have a great technology idea, can get funding, can figure out how to sell it, that is awesome. I'd rather be in that situation. However, if you don't have the technology idea or the market isn't right or you don't know how to sell it, I'd rather have a more flexible service company with a recurring revenue stream, great clients, a great team, and a vision to create a great company (rather than sell out).

And, there are excellent case studies of successful service companies that became great tech and service companies. However, it is certainly a lot harder to grow that kind of a business.

Good question. No right answers.

Fun discussion.

I always wanted to start a business. I was in search of the idea. I'd lay awake at night thinking about ideas. Since I'm not a technologist, I just think a service company was easier for me to start. However, the first idea that sounded good and looked reasonable -- that was the thing I was probably going to go off and do.

There was a VC back in late 2000 who said to me "I don't think you are ever going to go public with DigitalGrit. The odds are very low. However, you have something special here. I believe you will be similar to a great, private construction company in about 5-7 years. They make a ton of money. They are not something a VC would want to invest in because it takes too long to get your money back. But, boy, they sure are great businesses. Cash machines."

I don't know, I guess there could be worse things. Right? But, by 2007 we had built a great company and were acquired by a large private equity company - so we did ok.