Fernando Suarez Explores Software Product Firms and Service Revenue

in Faculty, Information Systems
December 8th, 2011

Fernando F. SuarezSuarez & Co-authors’ Article is Forthcoming in Management Science

Some product firms, such as SAP, Oracle, IBM and Hewlett-Packard, increasingly rely on service revenues as part of their business models. But are organizations turning to services to generate additional profits when their product industries mature and profits decline? If so, is this an effective strategy?

These are among the questions explored in a new article, forthcoming in Management Science and written by Fernando F. Suarez, associate professor,  dean’s research fellow, and chair of the Strategy and Innovation Department at Boston University School of Management, and co-authors Michael Cusumano of MIT Sloan School of Management and Steven Kahl of the University of Chicago Booth School of Business.

Is the shift toward services good or bad for product companies? Should product companies invest more in services or work harder to protect their products business?

The article, “Services and the Business Models of Product Firms: An Empirical Analysis of the Software Industry,” examines the role of services in the financial performance of firms in the prepackaged software products industry from 1990 to 2006. Suarez and his co-authors reveal a non-linear relationship between a product firm’s fraction of total sales coming from services and its overall operating margins. As expected, firms that manage to keep products as their main source of revenues are the most profitable, but such “pure product strategy” is not always available.  Rising services correlate to declining profitability.

The authors also find, however, that there is an inflection point where additional services start to have a positive marginal effect on the organization’s overall profits. In their sample, this shift occurs when service offerings move from a minority to a majority portion of a product firm’s sales, even after controlling for traditional industry maturity arguments. This implies that by focusing on and strategically managing their service activities, product firms can still achieve attractive levels of profitability.