How-to-Move-to-a-Servicization-Business-Model
Turning products into scalable service-driven solutions—are gaining a competitive edge
Services now comprise more than 70 percent of the U.S. economy. But many companies—large and small—continue to be in the business of designing, building, and selling products to their customers. This product-focused model has its advantages. A product sale can generate significant margins. A product model fits in well with the company’s historical approach to marketing. The sales force has typically built its competencies around product sales. In many cases, customers source spare parts and maintenance from cheaper and more proximate third-party vendors. This allows the company to close its books and aim to conquest the next customer, at least until it competes for business when the customer needs to replace the product. Not surprisingly, when a product rolls off the service floor, the immediate push is to get it off the company’s inventory by selling it, effectively moving it to the customer’s inventory.
This product-focused model is dominant across industries ranging from elevators and locomotives to air compressors and industrial paints. Unfortunately, this product-focused model has many drawbacks. Companies often don’t sufficiently evaluate these drawbacks. Some of the drawbacks lurk just over the horizon, invisible to managers who don’t take the explicit effort to ferret them out. But there is an alternative model every product company should consider—servicization.
Defining servicization
Servicization is the design of product-as-a-service business models which aim to maximize company profits by using the product as a component in a broader and scalable service-intensive solution that resolves customers’ problems.
This definition packs in a lot. A real-life example is the best way to unpack it.
A group of us once visited the factory of a leading company that made outdoor terrain-management equipment. On one factory floor, we noticed that the equipment they manufactured, close to its final production state, was being transported by overhead conveyors through what was literally a hole-in-the-wall into an adjacent manufacturing space. On probing further, the managers informed us that the destination was an adjacent painting shop that was run by the paint supplier. The freshly painted equipment was returned to the customer through a different hole-in-the-wall, after which it was subject to some final touches and prepared for delivery. Thus, rather than supplying drums of paint, servicization involves painting the product for the customer as a service.
The benefits of servicization for the supplier
The product-focused model is dominant across an array of industries, and it has many drawbacks that servicization can address.
First, when products are sold to the customer, the supplier has a limited ability to learn about product usage patterns. Remote monitoring technology is helping create some insight in this area. But in many industries that is a poor substitute for on-the-floor visibility into the broader challenges customers face and into how the supplier can help address those challenges.
Second, with the product model, suppliers often lose the parts and services business. In many industries, this is the highest margin component of the entire product lifecycle. Servicization can help recapture those revenues.
Finally, when the time comes to replace the product, the supplier is back at square one, engaging in intense price wars with numerous “me-too” competitors to regain the customer’s business. This shrinks profits. In contrast, with servicization, the supplier is embedded in the operations of the customer, leading to stable relationships.
The benefits of servicization for the customer
It is tempting to think that servicization benefits the supplier even while hurting the customer. In contrast, when implemented well, servicization offers significant benefits to the customer as well.
First, suppliers often breathe a sigh of relief when they move the product from their balance sheet to those of customers because of product “sales.” But that amounts to just passing off the problem to the customer who now must carry the product on their balance sheet. Servicization—which does not involve an outright sale—helps the customer maintain an asset-light balance sheet.
Second, the customer may not have core competencies in the usage or application of the product in its value addition processes. The customer may misuse or overuse the product, leading to frequent breakdowns and low productivity. With servicization, the supplier can leverage their product expertise to ensure the optimal usage of the supplied product, increasing the value delivered to the customer.
Third, servicization aligns incentives to the benefit of the customer. Assume that the terrain equipment company discussed earlier operated under a typical product model where it purchased barrels of paint from the supplier. If the customer wasted a significant fraction of the supplied, on account of inefficient application then the supplier had every incentive to simply “sell more paint.” But when the supplier is paid for every piece of equipment that is painted to contracted specifications, the supplier has the incentive to operate efficiently and save paint.
While servicization is not the perfect answer in every situation, it offers a range of benefits to both supplier and customers. At the least, every company must consider it seriously.
How to embrace servicization
Servicization works best when both supplier and customer converge in the middle. This requires that both suppliers and customers make some changes.
Supplier actions
Rethink customer needs: Suppliers must refocus their thinking from matching products to customer requests to rethinking customer needs themselves. They must spend “days in the lives” of their customer shopfloors uncovering and understanding their articulated and unarticulated needs. For example, spending time on the customer’s shop floor can help them realize that the customer is using their supplied product inefficiently.
Redesign their financial model. Suppliers must become comfortable with carrying their products on their own balance sheet. They must be comfortable with replacing the upfront sales revenue with usage-based revenues over time, increased parts and services revenues, and more predictable revenues from stable customer relationships.
Build new execution competencies. Suppliers must build their ability to operate their products on customer shop floors and within customer value networks. Beyond just operating and servicing the products, this calls for the ability to design and integrate the best solution into their customers’ operations. This may sometimes require sourcing and building on products from third parties, which is a task that customers would usually undertake.
Customer actions
Rethink the value network: Customers must challenge the configuration of their value networks. They must challenge their current interfaces with suppliers and be ready to hand off the management of some interfaces to their suppliers.
Restructure the financial model: The customer’s operational costs at the supplier interface will no longer be fixed costs; they will primarily be variable costs that are linked to the consumption of the supplied resource. For example, the customer will no longer pay for the compressor but for compressed air. The advantage is that the customer avoids a large upfront cash outflow; instead cash outflows scale with production. If the furnaces are not churning out iron from iron ore, there is no need to pay for compressed air to fuel the furnaces. While the supplier must live up to contracted standards of quality and reliability, overall, this yields a less risky business model for the customer.
Redeploy freed-up cash. The amount of cash not invested in purchasing capital equipment from suppliers can be substantial. To fully benefit from servicization, customers must think through the optimal redeployment of the liberated cash to maximize total return on investment.
How SLK Catalyst Partners can help
As experts in building service-focused business models, we can help by:
- Taking inventory of the entire range of company-supplier interfaces to demarcate potential areas for servicization.
- Work with customers and suppliers to help design mutually beneficial servicization models and contracts.
- Oversee the execution of the servicization models from multiple perspectives, including the underlying technology infrastructure.
- Help reshape your company’s value creation network around these servicization models to ensure that the entire value network operates smoothly.
For more information on how SLK Catalyst Partners can help, visit SLK Catalyst Partners.