In a global marketplace, where goods flow freely across borders, manufacturing companies are continually striving to sharpen their competitive advantage. Faced with challengers from developing countries with significantly lower production costs, along with evolving customer needs, a number of product-focused businesses are moving into value-added services.
This “servitization” is essentially the move from organisations selling products to selling instead the solutions or outcomes that the products provide.
One of the most well-known examples is Rolls-Royce Aerospace’s performance-based “power by the hour” model. By broadening the company’s scope to selling engine power (the outcome), instead of the jet engines themselves (the product), Rolls-Royce has taken on the downtime risk related to engine failure, at the same time differentiating its offering from competitors and seeing the bottom-line benefits of creating an entry barrier to its market. The company is charging for the capability provided by its products, rather than the products themselves.
At the core of servitization is a win-win situation whereby the provider’s interests are aligned with the customer’s. “In the past, if I sold you a product, I would only get involved again if something went wrong,” explains Andy Neely, director of the Cambridge Service Alliance at the University of Cambridge. “So, in some ways, it would be in my interest for this to happen, as I would make money from repairing it. If instead I sell the ability to use the product to achieve an outcome, then it is in my interest to make the products work for as long as possible, requiring minimum maintenance. This is also what the customer wants.”
What the customer wants
What the customer wants is another driving factor in the shift to offering hybrid value-added services – moving from simple transactions to long-term, valued relationships. “If you are contracting for outcomes or contracting for capability,” Neely says, “often you will be much more closely involved in delivering the outcome over a long time period. In terms of strategic rationale, you want to deliberately lock your customer in and nurture that long-term relationship.”
Bart Kamp heads the strategy department at Orkestra, part of the Basque Institute of Competitiveness, a policy think-tank that aims to underpin the competitiveness of firms in the Basque region of Spain. He states: “In the international race to build a competitive business model, servitization is vital. It provides firms with better chances to enter into frequent interactions with customers. Provided the job is well done, this helps build a lasting bond and lowers their willingness to look for alternative service providers.”
The added value from such a customer relationship flows both ways, with the provider benefitting from quicker entry to market alongside direct access to information that can be used to inform product design.
Models of servitization
Daniela Buschak of German consultancy Fraunhofer Institute for Systems and Innovation Research (ISI) conducts research into the sustainability of servitization, and outlines: “Services can improve competitiveness of a provider as well as the efficiency of a customer. When you bring an innovative technology to market, customers may be nervous to take on the risk of something new and untested. If you provide related services, it reduces this risk, so your product can penetrate the market more quickly. It also enables you to obtain first-hand information about your product in use, which can be fed back into the design process to make improvements.
“More comprehensive services are not easily replicated by competitors. It allows you to differentiate your business, and removes the pressure of competing solely on price.”
The Fraunhofer offered examples of the service business model in its German Manufacturing Survey:
- Availability guarantees: This concept guarantees the customer a pre-defined level of availability for the product. The provider monitors the operating conditions of the product and/or extends this by comprehensive maintenance activities.
- Guaranteed total costs of ownership (TCO): With this service concept the customer gets a guarantee of the total occurring operating costs of the product over its entire life cycle.
- Continuous optimisation: This allows the customer to fully exploit the productive potential of the product, as the provider brings in its expertise by integrating and operating the product in the customer’s specific production system.
- Pay on production: The customer pays a preliminary fixed price for the output produced with the product (for instance, parts produced). All operational activities to produce this outcome are assigned to the product manufacturer.
- Chemical management services: This service offers the customer the possibility to buy only the function of the chemical, not the chemical itself.
Competitive advantage – for now
So far, the opportunities offered by servitization are mainly being exploited by Western manufacturers. The concept is particularly popular in Germany, with Mittelstand firms using it as a way to protect their renowned stability. Take Kaeser, which until relatively recently focused on production of large air compressors. Now the company is bundling its product with real-time business control of the compressors, using an internet connection to monitor their performance and sell services around this. The business model here is to sell not the machine but a specific amount of air for a transparent fixed price.
Kamp adds: “Servitization is one of the last straws that Western companies can clutch at in order to distinguish themselves from low-cost competitors in the same sector. China and India might be catching up technologically and in production processes but are lagging behind in the integration of multi-faceted value propositions and adding services. It is therefore crucial to strategically embrace and maintain this lead.”
However, the lead may already be closing. “When I first started looking at this area six years ago, around 58% of US manufacturing firms had servitized,” Neely says. “In the UK, the figure was around 20%, and in China it was less than 1% – which tallies with the idea that this is a strategy for developed economies.
“By 2011 the US figure had actually fallen slightly to 55%, the UK had increased to 40%, and the Chinese figure had grown to 20%. This highlights that manufacturers in China will not remain the world’s workhorses, concentrating on the low value-added manufacturing activities.
“Western companies should not be in any doubt that this is very much a global race to recognise the value in selling services.”
Where is the value?
The argument for servitizing is convincing but, before making the change, there are several issues to consider. It is not usually the case that services can simply be bolted on to an existing business model. “The first thing to think very carefully about is the value proposition – the end outcome that the customer or customer’s customer is looking for,” Neely says.
Bose, for instance, is starting to think of itself as a company that delivers sound, not a company that sells speakers, he explains. This focus on outcomes expands the scope of what you can do, and who you can work with to deliver it – for example, working with a building contractor to fit wires within walls to build sound into a house.
“The big question to ask yourself is, ‘What does my customer really value, and how can we better configure our business to deliver that?’ ” Neely adds.
Before this question can be answered, however, manufacturing companies have to learn to value services and how to sell, deliver and bill them. Often, organisations that have built up their wealth through production activity can feel protective of their industrial roots, and have difficulty adapting. Training is crucial for a whole company to have in-depth awareness of the economic value of servitization. “It’s not simply enough to know what your machine does; you need deeper and wider knowledge embedded into your culture,” Kempermann says. “This level of communication and understanding of where the value really lies in a business can be difficult to achieve.”
There is also a resource issue, as rarely does a single organisation have the skills in-house to deliver the full range of services required. This aspect of the servitization business model overlaps with the benefits offered by open innovation, and is of particular interest to SMEs, enabling them to provide more complex services.
“What you see here,” emphasises Kamp, “is that the final value proposition is like a configuration of assets and services, where often there is a central orchestrator which acts as a gatekeeper to the final client. Services and materials provided by this gatekeeper are then added to the services provided by others.
“Servitization essentially provides ‘piggy-backing’ opportunities for smaller firms to get into bigger companies, and it also opens doors to overseas markets.”
Assessing the risk
“The key starting point for any business which wants to move from selling products to providing integrated solutions is cost structure,” Kamp says. “How can you place a cost on an outcome? What can you charge for what your product offers? If you have a good view of your cost structure and can fractionate your offering into pay-per-use terms, this is the best start for modelling your value propositions on a servitization basis.”
Part of this is accurately assessing the value your customer assigns to avoiding downtime. “Then, of course, you have to be sure that your customer base has an interest in engaging with you on this basis, or that you can convince them of the benefits of doing so.”
Adds Neely: “When you’ve got your internal processes tied down, you have to look wider, at the ecosystem. What role might regulation play? Legislation? How might your competitors react?
“If you are taking on responsibility for a bigger value proposition and partnering with other organisations to deliver, you are reducing your control over the network of resources required. This increases exposure to risk. Really understanding the consequences of the contract you are taking on as you seek to servitize is fundamental. You could otherwise risk making your business unsustainable.”