Commoditization is Actually a Good Thing

I’ve been in the business of providing a service for several years now and one thing I’ve noticed is that there’s a general disdain amongst service professionals toward commoditization. Example: I used to be in the mortgage business (before the shit storm) and the idea of selling mortgages as a service, where the mortgage broker/loan officer acts more like a financial adviser than just a salesman is heavily promoted as a way to really succeed over the long-term in that business. It influenced me quite a bit, but the more I learn about business and the more time I spend running my own business, the more I’m starting to realize commoditization of services is actually a good thing for both the client and the service professional.

In practice, service professionals really deliver a product, the end result of whatever service they provide. A tax account is a service professional, but ultimately, he’s really delivering a product, tax savings (or simply tax preparation), without which, I have no need for him. The real mark that distinguishes service professionals is that the product(s) they deliver tend to be, to varying degrees, customized to the individual client, which is why we tend to think of “service” as a separate type of business, when in reality, a service is nothing more than a product that hasn’t found a large enough market to profitably commoditize it yet.

Now that last sentence may sound strange, but consider that what we define as products tend to be anything that can be mass produced and services as anything that may not be able to be mass produced. Consider my tax guy…he could (and probably does - I haven’t asked) separate his specialization into sub-specialties. For instance, tax prep for web designers, tax prep for independent internet marketers, tax prep for software company owners, etc… Now, 10 years ago, such tax prep was very customized to the client if for no other reason than he may only have one or two clients in the same technology specialization…there really aren’t enough clients to make it worthwhile for him to develop any kind of automated system. If you took a look at his business today, however, he may have 20 web designer clients, 20 software company owners, and 20 independant internet marketers…now that each specialization is larger, he can start to develop some automated systems to help him get to the finish line faster…because now, saving 10 minutes on each of 20 clients in any particular specialization is worth it. So my tax guy can start to move a little bit toward mass production of tax prep for each client specialization.

If my tax guy implements some basic automation (read: production) to save 10 minutes per client, he can afford to charge a little bit less per client with each new client he gains. To make it more clear, imagine Mr. Tax guy has the 20 clients in each of 3 major tech. specializations described above. He spends $2,000 on some system to automate some of the tasks he’s performing regularly…for example, he could pay a programmer to develop a software app for him that allows a client to log on to the web and fill out a premade form with the exact questions Mr. Tax guy needs for each specialization. Now imagine that system saves him 10 minutes per year, per client of collecting information personally for each client…and suppose he charges each client an hourly rate of $100. So he’s invested $2,000, but he saves 10 minutes on each of 60 clients, which amounts to 10 hours of work saved. At $100/hour, that’s $1,000 he’s saved in the first year…that system pays for itself in 2 years (assuming Mr. Tax guy doesn’t get any new clients), and after 2 years, all things being equal, Mr. Tax guy has an extra $1,000 per year.

Now, this is a very small-scale example…imagine a company with thousands of clients. The more that company can automate, the more money they save, and hence, the greater their profits…the only thing that prevents Mr. Tax guy from spending $100,000 right now on a system to automate the entire process is that he doesn’t have enough clients in any particular specialization to make that profitable.

So, back to the main point of this article…as Mr. Tax guy retains more and more clients in the same or similar specializations, the more automation he can implement, resulting in higher profits. If Mr. Tax guy does enough of this, he ends up with a company like Quicken, which automates the entire process. Suddenly, and for no other reason than Mr. Tax guy found more and more clients with the same or similar needs, Mr. Tax guy has transformed his business into mass producing a product.

So, what do you think…is the level of demand for the deliverable the only thing that separates a product from a service?