IT Services vs. Product Companies: Differences in Business Economics

Same Industry Label, Different Businesses

India's listed technology sector is dominated by IT services companies that build, run and maintain software for clients around the world. They are often grouped with software product companies, which sell the same product to many customers. The label "IT" covers both.

But the two make money in almost opposite ways. One sells people's time. The other sells copies of something built once. That difference shapes their margins, their risks and how they should be valued.

Revenue That Scales With People

An IT services company earns revenue roughly like this:

Revenue ≈ Billable employees × Utilisation × Billing rate

To grow revenue by 20%, it usually needs about 20% more billable people, or higher utilisation, or better rates. Employee costs are typically the largest expense, often more than half of revenue.

This creates stable but capped margins. As the company grows, costs grow with it. Large Indian IT services companies have long reported operating margins in a fairly narrow band, typically in the low to mid 20s. Margins move a few points with utilisation, the rupee, wage hikes and the mix of offshore and onsite work, but they rarely jump.

The model has real strengths: steady demand, long client relationships, low capital needs and strong cash generation. Indian firms also benefit from earning in dollars and paying most costs in rupees.

Revenue That Scales With Code

A product company builds software once and sells it many times. The cost of serving one more customer is small. Most costs are upfront: research and development, and sales and marketing to win customers.

This creates operating leverage. Early on, costs run ahead of revenue and the company often loses money. Once revenue passes the fixed cost base, most of each new rupee of revenue becomes profit.

Subscription businesses, often called SaaS, add a useful feature: revenue from existing customers recurs each year and often grows as they buy more. Net revenue retention, which compares this year's revenue from last year's customers with last year's revenue from them, is a key measure. Above 100% means existing customers are spending more.

A Worked Example: Doubling Revenue

Illustrative example. Two companies each grow revenue from ₹1,000 crore to ₹2,000 crore.

Services company. Employee costs stay near 60% of revenue and other costs near 18%. The operating margin stays at about 22% at both sizes. Profit doubles, from ₹220 crore to ₹440 crore, because revenue doubled.

Product company. Gross margin is 80%. Research and development rises from ₹300 crore to ₹360 crore, sales and marketing from ₹250 crore to ₹400 crore, and administration from ₹150 crore to ₹180 crore.

The product company's profit grows more than six times while revenue doubles. That is operating leverage, and it is why investors pay much higher revenue multiples for product companies that are growing.

Different Risks

Services companies face:

• Pricing pressure from clients and competitors, especially in renewals.
• Client concentration, where a few large clients make up a big share of revenue.
• Labour costs and attrition, since people are the product.
• Visa and immigration rules. In September 2025, the US imposed a $100,000 payment on new H-1B visa petitions, raising the cost of sending staff onsite.
• Currency, since a stronger rupee cuts rupee revenue.

Product companies face:

• Winner-take-most markets, where the second or third player can struggle.
• Churn, where customers leave for a cheaper or better product.
• The need to keep investing, since a product that stops improving loses ground.
• Long periods of losses before scale arrives.

AI Changes Both

AI tools that write and test code reduce the effort needed for many tasks. For services firms that bill by effort, that can shrink revenue per project even as clients ask for more work. Many are shifting toward fixed-price and outcome-based contracts to keep the benefit.

For product companies, AI can make features easier to copy, which weakens some moats, while also letting small teams build products faster. Neither model is safe from change.

Valuing Each

• Services: P/E, EV/EBIT and free cash flow yield work well, because profits and cash flows are steady. Dividends and buybacks are a large part of returns.
• Product, early stage: EV/revenue, growth rate, gross margin and net revenue retention matter more than current profit. A common screen is the "rule of 40": revenue growth plus operating margin should be at least 40%.
• Product, mature: once growth slows, value moves back to free cash flow, like any other business.

The Indian Context

India's listed technology sector is overwhelmingly made up of services companies. Product companies founded in India have more often stayed private or listed abroad: Freshworks, for example, listed on Nasdaq in the US in 2021. A few Indian-listed companies sell software products, and several internet platforms have listed in recent years, but they are a small part of the sector by market value.

That means Indian investors comparing "IT stocks" are usually comparing services firms with each other. When a product company does list, it should not be judged against services peers on P/E alone, nor services firms against product companies on revenue multiples.

Habits for Reading Tech Companies

1. Classify the revenue: time and materials, fixed price, subscription or licence.
2. Track utilisation, attrition and revenue per employee for services firms.
3. Track gross margin, net revenue retention and customer acquisition cost for product firms.
4. Check client concentration in the annual report.
5. Match the valuation method to the business model.

The Reframe

Services companies rent out skill. Product companies sell copies of a single piece of work. Both can be good businesses, but they scale, fail and deserve to be valued in very different ways.