Why Product Development Services Consolidation is Failing

Over the first half of this year, the Product Development Services (PDS) sector has begun to collide with the digital transformation market. In doing so, we have started to see the initial phases of consolidation within the industry.

Unfortunately, the consolidation that’s happening may be pushing the sector — or at least many within it— towards irrelevancy in the broader digital market.

Until recently, the PDS sector has led the revolution of the IT Services space to a large degree. By focusing on the development of software products— those systems that touch customers and drive revenue— the sector has managed to deliver highly value services and help companies navigate the transition towards the software-based economy.

Because of this lead, investor interest in the sector has hit new highs. Large private equity funds and strategic acquirers are swarming, looking to capitalize on what is expected to be explosive growth throughout the next 3-4 years and strong growth for the next decade.

Moreover, as traditional IT firms begin to see their value further commoditized, many have looked to product development specialists to stay relevant.

Why Product Development Services Consolidation is Failing

As mergers and acquisitions have begun, two fairly typical strategies have emerged:

  • Financial Scale: The first group of acquirers seems to believe that reaching scale is essential. They are combining outsourced product development services companies in an effort to gain market share and claim “tier 1” status.
  • Service Diversification: The second group of acquirers seem to value service diversification. These firms are widening their aperture and looking to compete in the wider digital market.

Challenges exist for both of these strategies.

Those seeking financial scale, in many cases, are combining commodity service provider with commodity service provider. Their pure focus on financial scale tips their bias towards towards the most mature portion of the sector — engineering and quality assurance capacity.

While engineering expertise and quality assurance are undoubtedly the core of the sector, isolated, pure play engineering, and quality organizations fail to differentiate from the vast majority of “IT Services” organizations that provide development capacity. It is probably that these firms will quickly dissolve into “me too” organizations competing with traditional IT services firms that take the plunge and embrace digital realities.

On the other hand, those organizations seeking service diversification are seeking to combine engineering organizations with digital agencies. This is the technical equivalent of combining oil and water. The two cultures simply don’t mix. Industry stalwart GlobalLogic attempted this strategy in 2011 with their acquisition of Method. By all accounts, the company has failed to find a way to integrate the two organizations and realize the leverage the acquisition contemplated.

What is the right strategy?

Ironically, the Product Development Services sector has overlooked the importance of product and has become drunk on revenue and enamored with social media and sexy designs. In the process, they are failing to deliver differentiated value and the innovation that the sector truly needs.

A report released by Forrester, “Wanted: Digital Engagement Providers,” outlines how five types of firms — digital agencies, management consultancies, mobile boutiques, systems integrators, and telecom — are competing with product development firms to own the digital transformation market.

It’s clear that in order to thrive in the digital transformation market, Product Development Services companies must differentiate by providing exceptional Product Lifecycle Management. They must excel at innovation, build a strong product culture, and deliver product results, not just software.

The leading organizations will build strong product management and customer experience practices that are fully integrated with their engineering discipline. They will develop a product culture and will deploy lean product methods to go with their agile software development methodologies. They will be prepared to mentor clients through the process of becoming a product organization. They will be consultants as much as they are engineers, but they will consult in the realities of execution, not just the strategy.

The product organizations that do this will not look like yesterday’s IT Services organizations. Their culture, their business models, and the way they scale will all be different. This is primarily because product development success is reliant on more than technical capabilities. True innovation and product development success requires a product culture (see the recent research published at http://PDSInsights.com).


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