An entrepreneur asks this question, which not so long ago would have been quite an absurd thing to contemplate:
Why do we see more product companies than services companies? When investing, do VCs also tend to have a bias?
Actually, if you ask any tech-focused investor in India, they will lament that there aren’t enough product companies in India. Even some of the companies that claim to be product companies actually have a strong services orientation.
In contrast, VC-funded startups in Silicon Valley are predominantly product or market-place startups, and rarely services companies.
The reason for favoring product companies is because they have high gross margins and high operating leverage. Generally speaking, services companies have low fixed costs and high variable costs, which means that the cost of servicing customers (usually manpower) moves in tandem with revenue growth, necessitating constant investment back in the business. In contrast, product companies don’t have particularly high growth in variable costs as sales grow.
Note that this doesn’t mean that product companies are ‘better’ than services companies. For example, a services company may be able to more quickly respond to changes in customer needs, whereas a product company may need to go back to the drawing board. The first big development of the Indian IT industry in the 90s was clearly based on a services model and several entrepreneurs and their employees and investors made a lot of money.
Note also that the distinction between a product and a services company isn’t always cut and dried.
From my latest column at Yourstory.