In the software business not all revenues are created equally. Revenue from subscriptions or licenses is significantly more profitable and scalable compared to revenue from professional services. When talking to entrepreneurs I like to get a feel for the mix of revenue from subscription/license vs professional services. One of the simple proxies for this is the number of employees they have in professional services.
Here are some notes on professional services revenue for software startups:
- Professional services revenue as a percent of total revenue is often super high for early stage startups still looking for product/market fit (e.g. they are doing consulting work to pay the bills)
- Once a product takes off services revenue is typically a small percentage of overall revenue, especially if channel partners (value added resellers) are used
- As the core business and market matures, many software companies add more services as a way to grow even though margins decline
- Some services companies masquerade as software companies when in reality the software is for lead generation for their consulting work or their product requires so much customization it doesn’t get much in the way of economies of scale
When thinking through startup opportunities, and evaluating companies, it’s important to understand how the services component fits in.
What else? What are some other thoughts on professional services revenue as it relates to software startups?