37signals started out in Chicago as a three-person web design shop. Co-founder Jason Fried made a decent living but hated the feeling of being beholden to clients: "I found project-based consulting frustrating because we would work on a site for months and hand it over to the client, who would inevitably make changes and drag us through their politics. It was rare that what we actually built saw the light of day."
Fried and co-founder, David Heinemeier Hansson, continued to serve their clients, but as their projects grew larger and more complex, they found themselves looking for a piece of software that could help them better manage jobs among a growing network of staff and contract help often operating from different locations. They considered using existing software like Microsoft Project but found it overly complex. Having evaluated a number of off-the-shelf tools, they decided instead to build a simple piece of project management software for their own internal use.
37signals' clients saw the simplicity of the software and started asking where they could buy it. It wasn't long before Fried and his partner realized they had built a product that other companies might like. They polished it up, gave it the name Basecamp and, through their blog, announced that it was available. A year later, Basecamp was more profitable than the web design business, and so 37signals stopped being a service business and started being a product business.
Today, tens of thousands of small businesses use 37signals software, and the company hasn't built a website—other than its own—since 2006.
Making the switch
As I interviewed Fried, also the co-author of the New York Times bestselling book Rework , I was reminded of my former research company Warrillow & Co., where we spent seven years as a project-based service business before we redesigned our model into a subscription-based product company. In my case, changing from a service to a product business made it more predictable, enjoyable and ultimately sellable.
In the case of 37signals, Fried has no plans to sell but loves the freedom of running a product company. "When you're a consulting business, you have to say yes to big clients, who end up telling you what to do. You become beholden to the giant corporation who is paying you $60,000 for a project," he explains. "I love the feeling of control I have now. We build the best products we can for tens of thousands of customers. We try to make decisions that will benefit all of our customers, not just one giant corporation waving a big cheque. It is so satisfying to say no to some huge company because you know you don't need the money or the hassle."
Based on my conversation with Fried, coupled with my own experience, here are four steps for turning a service business into a product business:
Step 1: Develop a subscription offering
In the case of 37signals, customers buy software on a subscription model. Tens of thousands of customers pay the company a small amount of money each month, so Fried and his partner can predict their revenue well into the future. Predictable future revenue diversified among many customers gave 37signals the courage and resources to eventually turn off its service business.
At my company, we went from project-based consulting to having a single subscription to our research, which allowed us to see how our revenue was shaping up well into the future.
Step 2: Build an audience before you make the switch
37signals had authored a popular blog for seven years before it announced the Basecamp product to readers. With a direct line to thousands of daily readers, 37signals was able to use the blog as its primary marketing vehicle to sell subscriptions.
At my company we had been running a conference since 1999, so when we made the switch to the subscription model in 2005, past attendees of the conference made a natural audience for us.
Step 3: Don't give yourself an out
In a service business, clients always take priority, so it is hard to find the time to work on your product offering. In the case of 37signals, it needed project management software to better serve its clients. So it had a burning platform: either develop the product faster or risk losing clients.
At my firm we did not have such a built-in sense of urgency, so we had to manufacture it: we quit accepting consulting projects cold turkey, which was made possible because we charged tens of thousands of dollars up front for an annual subscription. Once we had a couple of subscribers, we had the money in the bank to finance the drop in consulting revenue.
Step 4: Start saying no
In the case of 37signals, it took a year to build up enough subscribers to start turning away projects. Fried remembers the day the company stopped offering consulting services: "It was so satisfying to know we were in control of our own destiny. We didn't need to grovel for business and kowtow to clients anymore."
In my own case, it was tempting to accept consulting projects, but saying no triggered the opportunity for us to talk about our subscription. We would explain to prospects that we did not offer custom consulting but would go on to describe how our subscription offering could help solve their problem.
The best way I can describe the feeling of making the switch from a service to a product business is to imagine completing a jibe turn in a sailboat. Rather than "coming about" and slowly stalling the boat's progress by pointing its nose into the wind, the jibe requires the captain to yank the tiller toward his or her body. The boat starts to pick up speed, lurching up onto its gunnels as it heads downwind. Your momentum allows you to execute a sharp, violent turn, the sail quickly fills with wind, and you're off in a new direction.
The jibe requires a strong stomach. You need to commit to bringing the tiller toward your body even though it results in an unnatural feeling coupled with a scary sudden acceleration. When things get tough, your mind tells you to push the tiller away, but you must override your instincts and continue to yank the tiller toward you until the turn is made and you're safely on the other side.
Moving from service to product requires conviction as customers will inevitably keep asking you to provide your service, but if you can make the switch, and keep your nerve, the reward on the other side is the sense that you own a business you control. You, not some overbearing client, decide what you sell, to whom, when and how. If entrepreneurship is about the freedom to be your own boss, then a product business is the ultimate escape.
Special to The Globe and Mail
John Warrillow is a writer, speaker and angel investor in a number of start-up companies. He writes a blog about building a valuable – sellable – company. Follow him on Twitter @JohnWarrillow.