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Consulting revenue won't scale
Consulting as a first step
Early on, a company building software can make money by selling consulting to other companies. Optimizely, which built software to help companies run A/B tests, got companies to pay it just to go in and build A/B tests by hand. The first version of the product was a tool the team made to be more productive at that consulting work.
It answered the first important question: is this something anyone will pay for? The answer was yes.
The scaling trap
The danger is getting addicted to the consulting revenue. Revenue can always be pushed up by taking on more consulting, but a business that depends on human labor can't become a big one.
Ambitious growth targets are the way around it, and they are one reason investors push startups to set big ones. A consultancy can't grow 10x in a year, and a real software business can. That is one way to tell a consultancy or small business from a startup that could be Stripe or Airbnb one day.
Why can't labor-based revenue grow 10x quickly?
Consulting revenue rises roughly in step with the number of people doing the work. Doubling revenue means hiring and training close to twice as many consultants. Hiring takes months, and every new person needs managing. Software has almost no added cost for each extra customer, which is why it can grow much faster.
How do software margins differ from consulting margins?
Software companies often report gross margins above 70 percent, because copying software to another customer costs very little. Professional services firms usually report far lower margins, since most of their revenue goes to paying the people who do the work. Investors value the two kinds of revenue very differently as a result.
Why do venture investors demand huge growth targets?
Venture capital returns follow a power law, a pattern investor Peter Thiel describes in his book Zero to One. A small number of investments produce most of a fund's gains. Funds therefore look for companies that could become very large, and growth rate is one early sign of that.
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