It’s No Longer Product vs. Service

December 24, 2004

Case categories include: Strategy & Planning   

By Robert Sher
Don’t we all envy software manufacturer margins?  Build the software once, then sell hundreds or thousands of copies for big bucks, and the marginal cost for each copy is a buck, two tops.  Randy Wheeler of Valley Oak Systems, Inc., is a software manufacturer, making good money, receiving awards like the Inc. 500 Fastest Growing Companies.   The average sale price of his software sale was $250,000.

So why would he EVER start a division with 10 clerks, processing medical bills, day in and day out?  Why dive headlong into a service business with high transaction volumes and lots of management headaches?  Was he just looking for headaches?

The Case
Valley Oak Systems had been developing, selling, and supporting claim management software for insurance companies for10 years.  Randy Wheeler, CEO and Founder, knew the business well and was growing it remarkably.  As the acknowledged industry leader, the benefits of marketplace domination were on the horizon.

By early 2002, the company was a well-established software development firm. The software, once developed, was sold to public entities, private entities, pools, carriers, and TPAs, with each customer requiring custom modifications and ongoing support, which was delivered by highly skilled personnel.

But many customers asked Valley Oak to expand their business to include a related function – the actual review of medical bills submitted for claims. 

Valley Oak resisted.  These services were typically supplied to the industry by third-party bill review companies, a fragmented marketplace comprised of hundreds of small providers.  A few of Valley Oak’s customers did the bill reviews themselves.  In order for Valley Oak to step in, they would have to develop additional software, hire hourly employees to review the bills, and the most daunting of all, be prepared to learn a new business with all its surprises.  Most medical bill review firms promoted the idea that bill review was “difficult,” and required constant judgment by seasoned medical professionals.  The matter had been a subject of discussion with his Alliance of Chief Executives peer group a number of times.

Finally, one customer who wanted to outsource the bill review function – but not add another vendor – offered to partner with Valley Oak, teaching them the ropes, and investing in the software development.  Valley Oak moved on the opportunity, but had an out clause a few years down the road.  By June 2002, they were performing the bill review service for their partner, and it went so well that by January 2003, they had decided to offer the bill review service to all their clients.

By the end of 2004, bill review was 24% of their total revenues. It had the highest growth rate, and the second best margins.  The bundled software and service package was synergistic, and offered a competitive advantage that helped close more software sales . Valley Oak’s strategy was validated further when their primary software competitor bought a bill review firm so they could offer the same bundle.

The Analysis
For Randy, the issue was one of product versus service.  He viewed his firm as a product firm – developing software that could be sold at nice margins.. The notion of becoming a bill review service provider was discomforting.  Clearly, there was no product, and the service was provided by hourly employees – clerks.  Not only was the mind set of that type of worker different, but the management structures would be different too.

But the product versus service paradigm is an old one, and in many circumstances, must be replaced.  It presumes a clear distinction between tangible things (products), and intangible things (knowledge or service).  The new paradigm is (repeatable) process versus customization.

There are some services and products that require significant customization.  Remodeling a room in your home is very customized, just as your legal representation in a lawsuit is, and your custom designed and built motorcycle is as well.  Substantial parts of the process of delivery have to be figured out and created each and every time by knowledgeable and trained people.

But likewise, some services and products are very standardized.  A pre-fab home, setting up a simple C-Corp, and an off-the-shelf Kawasaki motorcycle have no essential element of customization.  The process of manufacture/delivery is figured out once, then repeated exactly and often, “assembly line” style.

Today, with the help of computers and connectivity, many services are repetitive.  Processes can be built around them carefully and with many decision trees built into the process, so that the delivery of those services have the look and feel of manufacturing.  The only difference is that instead of delivering a tangible “thing,” we deliver an intangible “thing” – a result, a determination, an answer.

Randy made a tightly controlled process out of this service business.  Utilizing the data already in the  client’s database managed by Valley Oak’s software, he was able to hire clerks to do 90% of the routine work, with a medically trained staff on site to make key decisions in an efficient manner.  While his bill review business looks on the outside like a service, it really is a manufacturing operation, taking in thousands of “bills” and producing decisions (whether to pay, how much to pay, etc.).

Try setting aside the “parts and service” paradigm, and think about what your business does.  Is your business highly customized now?  Think carefully if pieces or segments could be delivered via a standardized process at lower cost.  Don’t let your competition be the first.

Are you manufacturing a standard product or service now?  The offshoring of manufacturing and standardized services may mean a different future.  Are there elements of customization that you can offer your clients that will add value or give you a competitive advantage?  A service may appear customized to your customer, but can be driven by an internal, repeatable process.

Randy Wheeler didn’t get a headache, or a service business.  He got another engine for profits and growth.

Takeaways:
• The old paradigm of product versus service is gone, replaced with process vs. customization.
• Identify whether your firm is best at using its knowledge to make great processes that automatically generate revenue, or if it is best at customizing for each interaction.
• Evaluate new opportunities based on that strength.

Robert Sher is principal of CEO to CEO, specializing in assisting CEOs and business leaders as they navigate critical passages.  He is the author of The Feel of the Deal; How I Built a Business through Acquisitions.  He may be reached at Robert@ceotoceo.biz.

Company: Valley Oak Systems, Inc.
Person: Randy Wheeler, Founder and CEO
Alliance Member since: 2003
Business Founded: 1994
Annual Sales Volume: $12 million
Growth Rate: 430% total in last 5 years
Head Count: 66
Product: Claims management software, services and support for the insurance industry
Typical Customer: Private and public companies, carriers, pools, third-party administrators
Written: December, 2004