Design Services companies often focus on their specialty, their focus technology fields and engage with potential customers on a basis of incoming contacts and the ability to execute. For the Management Team it is important to ensure a steady flow of projects and their engineers being paid for [through customer projects]. Founding teams also go for the most challenging, leading-edge projects because of the opportunity to establish their reputation by delivering their IP at the leading edge. Depending on their strategy and business model, they might actually miss out or delay (IP) revenue as volumes are often run at nodes at least two to three generations back.
Strategy, roadmap, and business model determine to a significant degree the type of projects and hence the type of customers a design services company should be after. Although the technology focus might indicate a specific type of customer (e.g., companies developing wireless products), it should not be taken as “any customer in that segment is good enough”. Segmenting your market based on the customer types is critical to ensure that you build the right mixture of customers within the market you operate in. This is not something that will work right from the start. First priority when starting is to ensure enough projects are gathered to build not only the business but also a reasonable buffer (more on this in a later posting) for when the market is tightening down, and projects are postponed or even cancelled. However, even at the earliest stages you might have options to choose from. At that time, you need to understand what types of customers are operating in your market and have your strategy ready.
Most design services companies focused on pursuing a staircase model to build their value, develop a fitting customer strategy.
A common model we have used is a pyramid-type where we, as a simplification, distinguish three types of customers:
(1) new customers as the bottom layer;
(2) returning customers as the middle layer and
(3) strategic customers at the top.
The pyramid structure provides a natural progression of customers: starting at the bottom and based on their projects, their roadmap, their market traction, a customer can progress to the top of the pyramid. It is this process which requires close tracking and in fact, the company needs to be managed with a strong focus on building value in the top of the pyramid. Although this looks like a simple one-variable tracking, the reality is that the process is much more complex to track and to manage. Not just because of the time factor but also because of the need to keep track of key customers’ progress in their markets, the success of their strategies, the specifics of the customer’s needs. It requires a strong business development team which is able to balance the needs and priorities of existing strategic customers against upcoming new customers and be able to pick winners while balancing direct business interests.
A fundamental factor in the design services business is the outside dynamics. Semiconductor players (IDM, fabless, ….) all keep an eye on the design services market. They provide a key (temporary) extension of resources when needed and when providing the opportunity for strategic growth, acquisition is one of the possible options. Here the larger the design services company and the more aligned it is with the customer’s business and roadmap, the more attractive the option of acquisition becomes as its impact will be more significant.
One of the challenges that comes with design services is the cyclical nature of the services business. When the economy tightens and corporates are watching their operational expenses, the first step will be to halt any external contracts/contractors which are not deemed absolutely essential.
Whereas the earlier (staircase) model is a good approach in scaling up revenue and creating new revenue streams, the foundation of the company is still based on the service model: headcount continues to be the main driver (typically up to 60-70% of revenue). In terms of (enterprise) valuation the additional revenue streams, however, will already make a significant difference.
Design services companies typically start small (some exceptions when it concerns management buy-outs) and natural growth is a slow process as it requires hiring and training of engineers based on/driven by the revenue stream of the company. Growth of business is tied to growing the team and it is not always easy to find the engineers.