Bestserv Report II Final

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Ville Kosonen

BestServ

Industrial Service Business Strategy

Generic Framework and Case Examples


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Technology Industries of Finland

All rights reserved. No part of this publication may bereproduced, stored in a retrieval system, or transmitted,in any form or by any means, electronic, mechanical,photocopying, recording, or otherwise, without the priorpermission of Technology Industries of Finland.

Publisher

Technology Industries of FinlandEtelranta 10

00130 Helsinkitel. (09) 19 231http://www.techind.fi

Printed in Finland byPainoprssi Oy, Helsinki, 2004

ISBN 951-817-853-4


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TABLE OF CONTENTS

PREFACE.............................................................................................................1EXECUTIVE SUMMARY......................................................................................21 INTRODUCTION ...........................................................................................3

1.1 BACKGROUND...........................................................................................31.2 OBJECTIVES .............................................................................................31.3 STRUCTURE OF THE REPORT ......................................................................3

2 BUSINESS STRATEGIES.............................................................................52.1

TEN SCHOOLS OF STRATEGIC MANAGEMENT ................................................5

2.1.1 Design school..................................................................................52.1.2 Planning school ...............................................................................62.1.3 Positioning school............................................................................72.1.4 Entrepreneurial school.....................................................................82.1.5 Cognitive school ..............................................................................82.1.6 Learning school ...............................................................................92.1.7 Power school.................................................................................102.1.8 Cultural school...............................................................................102.1.9 Environmental school ....................................................................112.1.10 Configuration school......................................................................122.1.11 Conclusion.....................................................................................12

2.2 INDUSTRIAL SERVICES .............................................................................122.2.1 The siren call of industrial services................................................132.2.2 Different industrial service levels ...................................................142.2.3 Should my company enter the industrial service business? ..........15

2.3 INDUSTRIAL SERVICE BUSINESS STRATEGY AND OVERALL STRATEGY............162.3.1 Industrial services as a positioning tool .........................................162.3.2 Services as a way to learn.............................................................172.3.3 Impact of other strategic management theories ............................18

3 FROM MANUFACTURING TO SERVICES ................................................20


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3.1 PROVIDING INDUSTRIAL SERVICES ............................................................203.1.1 New business models....................................................................203.1.2 From inter-firm rivalry to networks.................................................223.1.3 Forward integration........................................................................243.1.4 Customers as partners ..................................................................25

3.2 TRANSFORMING THE ORGANIZATION .........................................................263.2.1 Organizational structures...............................................................263.2.2 The process of change ..................................................................28

3.3 SERVICE INNOVATION ..............................................................................293.3.1 Adopting a systemic approach ......................................................303.3.2 Systems technology ......................................................................31

3.4 INDUSTRIAL SERVICE BUSINESS TRANSITION FRAMEWORK ...........................324 CASE EXAMPLES......................................................................................34

4.1 CASE METSO..........................................................................................344.2 CASE VAISALA ........................................................................................354.3 CASE INVISION TECHNOLOGIES................................................................374.4 CASE SUN MICROSYSTEMS......................................................................384.5 CASE INDUSTRIAL EQUIPMENT MANUFACTURER..........................................40

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CONCLUSIONS..........................................................................................42

5.1 REASONS FOR ENTERING THE INDUSTRIAL SERVICE BUSINESS.....................425.2 TRANSITION IN THEORY AND IN PRACTICE ..................................................435.3 MODIFIED TRANSITION FRAMEWORK..........................................................455.4 DIFFERENCES BETWEEN FINNISH AND AMERICAN COMPANIES .....................46

6 SUMMARY ..................................................................................................47REFERENCES ...................................................................................................49


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PREFACE

This report was prepared for the BestServ Forum, a research project aimed atimproving the competitiveness of the Finnish industry through research on the

possibilities offered by industrial services. This study was conducted during mystay in VTTs Silicon Valley office in California, USA, and I would like to thankTapio Koivu and Petri Kalliokoski for giving me the opportunity to work there. Iwould also like to thank the interviewees for their contribution. And finally, mythanks go to the members of the BestServ Forum who funded the project andassisted in the making of this study: the member companies, VTT, TechnologyIndustries of Finland, TEKES and Oy G. Andersson Management Consulting Ab.

I hope this report succeeds in outlining the key challenges related to industrialservice business strategy and will be useful for experts and novices alike.

In Espoo, 27th September, 2004

Ville Kosonen


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EXECUTIVE SUMMARY

This report was prepared for the BestServ Forum, a continuation of the BestServfeasibility study conducted in 2003 that was funded by TEKES (The National

Technology Agency of Finland) and eight companies. This study introduces theconcept of industrial services, identifies the main problem areas associated withindustrial service business strategies and presents a generic framework to helpin the transition from a pure manufacturer to an industrial service provider.

In the first part of this study a theoretical framework based on a literature study ispresented in which the key issues related to the transition from a traditionalmanufacturing strategy to an industrial service business strategy are illustrated.The framework is tested with a case study involving two Finnish and twoAmerican companies: Metso Oyj, Vaisala Oyj, Sun Microsystems Inc. andInVision Technologies Inc respectively. Based on the results of the case study, a

modified framework is presented.


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1 INTRODUCTION

1.1 BACKGROUND

The aim of the BestServ Forum research project is to chart the possibilitiesoffered by industrial services to the Finnish industry. It is a continuation of theBestServ feasibility study, which mapped companies interest and developmentneeds around the subject. Eight companies participated in the feasibility phase(Metso Oyj, Wrtsil Oyj, Vaisala Oyj, M-Real Oyj, ABB Oy, Tamglass Oy,Valmet Automotive Oy and Patria Vammas Oy), and since then more companieshave joined in so that the BestServ Forum has 20 member companies. One ofthe topics of interest that came up in the feasibility study was industrial servicebusiness strategy, and this study was prepared for the BestServ Forum project toserve as a short introduction to the subject.

1.2 OBJECTIVES

The purpose of this study is to familiarize readers with industrial services andindustrial service business strategies in an international context. The mainobjective is to identify the main problem areas of industrial service businessstrategies and to build a general strategic framework that managers can use as abasis for creating industrial service business strategies for their companies.Detailed analysis of different strategies is intentionally left out of the scopebecause it would require a far more extensive study than this one.

1.3 STRUCTURE OF THE REPORT

The first part of the study, Introduction, is as the name suggests a shortintroduction to the background and objectives of this study.

The second chapter, entitled Business Strategies, defines the concepts ofbusiness strategy, industrial services and industrial service business strategy.Different people use different terms for describing the same phenomena, andthus clarifying the terms used in this study is important.

In the third chapter, From Manufacturing to Services, the changes that occur in

an organization during the transition from a pure manufacturing company to anindustrial service provider are discussed. Changes in business models,organizational structures, and research and development functions are outlined.

The fourth chapter, Case Examples, describes the actual changes that haveoccurred during the transition in four companies. Two of the companies areFinnish and the other two American. The cases are based on interviews of keyexecutives.


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In the fifth part, Conclusions, the theoretical framework presented in chapterthree is compared with the actual results of the case studies presented in chapterfour. Based on the comparison, a final framework is presented.

The sixth chapter, Summary, summarizes the key outcomes of this study.


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2 BUSINESS STRATEGIES

Before discussing how companies should implement industrial service businessstrategies, it is important to understand what they are all about. As it turns out,

even defining the word strategy is not that simple. In this chapter it is put intoperspective by introducing ten different schools of strategic management. Afterthat, the concept of industrial services is introduced, and finally industrial servicebusiness strategies are analyzed with respect to the different schools.

2.1 TEN SCHOOLS OF STRATEGIC MANAGEMENT

The traditional view of strategy is that it is a hard science; consultants who knoweverything about different strategies can tell managers what strategy works bestfor their company. In reality however, strategy is a much more complex issue. It

should be the guiding force of an organization, yet there is more to it thanmanagerial wisdom put into words. It is about vision, action, organization, culture,people, environment and much more. Certainly, the consultants analyses are anessential part of it, being efforts to conceptualize something tacit into moreexplicit guidelines that can be easily followed. But taking the concepts for grantedand forgetting about everything else that strategy involves will most probably leadto failure, just as companies are likely to fail if the analyses are completelyignored. Mintzberg et al (1998) have identified ten schools of strategicmanagement, each with different views on the subject. Consequently, each hasits own advantages and limitations, described in the following.1

2.1.1 Design school

Strategic management literature that can be categorized under the design schoolfirst appeared in the early 1960s. It represents the aforementioned hard scienceside of strategic management and is still very influential after some 40 years. Thebasic idea behind this school of thought is that strategy should be a matchbetween the companys internal capabilities and the external environment. Aftera detailed analysis of the companys strengths and weaknesses, and the marketenvironments threats and opportunities (the famous SWOT analysis), managersshould be able to create a successful strategy.

Naturally, all kinds of tools have been developed to support the detailed analysisrequired to come up with the strategy. What the actual content of the strategy isdepends of course on the organization, but the idea that strategies should bebased on a formal analysis is universal. After the formulation of an explicit

1Based on Mintzberg et al. (1998)


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strategy, it is formally implemented. In time, changes in the environment and thecompanys capabilities call for a new strategy, and the cycle begins anew.

The drawback of detailed analyses is that they oversimplify things. Basingstrategies on subjective views about the state of the organization and the

environment is risky. After all, organizations and environments are complexentities that cannot be very accurately assessed. And simplifying things alsoleads to inflexibility; explicit strategies do not leave room for improvisation.Furthermore, separating planning from implementation inhibits fast adaptation tonecessary changes, especially in turbulent markets. This is not to imply thatanalyses are not needed, managers should strive to understand theirorganizations and their environment. But relying solely on them in creatingstrategies is not the best solution.

2.1.2 Planning school

The planning school emerged in the 1970s, focusing on the process of strategyformation. Its roots are in the design school, but the focus was not on what to do,but on how to do it. It adopted the views of the design school with all theanalyses, and perfected them into an art of strategic planning. Companies wereexpected to hire a whole department of planners working directly with topmanagement. This department would turn the managers visions into detailedplans that the organization could execute.

As in the design school, the idea was that managers would conduct detailedanalyses of the organization and its environment. But instead of creating anexplicit strategy, they would establish a clear vision of the companys future andcommunicate the vision to the planning department. Following a welldocumented planning process, the department would then make plans for almosteverything, ranging from R&D and operations plans to divestment anddiversification plans: the plans were the strategy. They would be implementedand reviewed, and feedback given to managers as inputs for the next round ofplanning.

After a short boom in the late 1970s, companies gradually abandoned such acomplex and rigid system because it failed to work in practice. The main reasonfor this was that the process dominated over the substance, taking all theattention and rendering the strategy inflexible; planning was even more detachedfrom doing than in the design school. Also, the bits and pieces, i.e. the different

plans, often failed to make up a coherent strategy. Critical core businessdevelopment plans received the same attention as more trivial but sometimesmore interesting topics like mergers and acquisitions. But, once again, despitethe drawbacks the whole idea of strategic planning should not be dismissed.Plans are a good way of formalizing parts of the overall strategy, but strategy hasto be formulated prior to planning. First and foremost, planning is a tool.Nowadays literature falling under the category of strategic planning deals with


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scenario building and the like, useful tools but not the sole basis for strategicdecisions.

2.1.3 Positioning school

Perhaps the most influential of all schools, the positioning school, emerged at thebeginning of 1980s based largely on the work of Michael Porter (e.g. 1980,1985). It adopted the ways of thinking of the design and positioning schools, butinstead of the strategy-making process the focus was on the content of strategy.The basis of the whole school is the idea that there are only a few genericstrategies that a company can adopt in order to succeed in generating above-average returns. These generic strategies can be identified as positions in themarketplace, hence the name positioning school.

Porter (1985) argued that there are basically two ways for a company to gain acompetitive advantage: low cost and differentiation. Low-cost strategies translate

to high production volumes and low cost per product allowing competition onprice, whereas differentiation strategies focus on product quality to enable sellingwith premium prices. Add to these two a second dimension of competitive scope,i.e. whether to serve mass markets or specific niches, and the total number ofgeneric strategies a company can adopt is four. The generic strategies lay thefoundation for all other strategic actions a company takes. Adopting the views ofthe design and planning schools, the decision on which strategy to adopt shouldbe based on detailed analyses about the competitive environment and the firmscompetencies. In addition to the traditional SWOT analysis, Porter (1980, 1985)also presented other tools to support decision making. These included thefamous Five Forces Model and the value chain, which are still widely used.

While certainly influential and insightful, and promoted especially by the strategyindustry, the theories behind the positioning school should not be taken forgranted. As discussed earlier, basing strategic decisions solely on analysesabout the industry and the company itself can be dangerous. Furthermore, thegeneric strategy options are biased towards big businesses, and even certaintypes of businesses. They might reflect reality accurately enough in big, matureindustries but industry dynamics are somewhat different in new and rapidlyevolving ones. And is there even one best way of doing things? Doescompetitive advantage arise from doing things the same way but only better thancompetitors, or from creating novel ways of doing business? Probably both, butthe positioning school does not take the latter much into account.

Despite these shortcomings, managers will do themselves a great disservice byignoring the theories of the positioning school. The promoted practices willprovide valuable insight into the strategy-making process, as long as they are notallowed to limit decision making. The theories have inspired many highlysuccessful managers and the positioning school definitely deserves its status asone the most influential schools in strategic management.


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2.1.4 Entrepreneurial school

The first three schools of strategic management emphasized the importance ofanalyses in defining strategic direction, leaving little room for management insightor intuition. The entrepreneurial school does exactly the opposite; it is based on

the notion that managers (or even a manager, the CEO) have a clear vision ofthe companys future and that strategic actions can be derived from this grandvision. The influence of this school can clearly be seen in that almost everycompany these days has an official vision, be it a real entrepreneurial vision ora nicely articulated statement with no true insight behind it.

When talking about a grand vision, one immediately thinks about the leader of anorganization, the captain at the helm guiding the company safely through thestorms of competition. An entrepreneurial organization needs strong leadershipand the will to make the vision reality. A vision is not totally explicit, but arisesfrom tacit knowledge and expertise. This also implies that the actual detailedstrategy to implement a vision is more or less emergent rather thanpredetermined. The company sets out to do something and as problems arisethey are quickly solved using the vision as a guideline.

The drawback of all this is, of course, that everything is dependent on thecapabilities of company management or, in some cases, one manager. As thereis no clear process of strategy making and no formal analyses to base decisionsupon, the strategy-making process is more or less a black box. Take the visionsof the management, put them in the box and see what comes out not a veryscientific approach. The good thing is that this encourages creative thinking, asthere are no predetermined categories into which the strategy has to fit. Thisway, novel strategies that break the rules of the competition and lead to success

can be formed. Although the entrepreneurial approach is clearly best suited forsmaller companies, bigger ones too should take heed of innovative and flexibleways of creating strategies.

2.1.5 Cognitive school

The cognitive school takes a whole different approach to strategy making,studying how strategies emerge from the psychological point of view. After all,strategists are human beings and are guided and restricted by the ways humansthink. For example, one could ask a few people to describe the competitiveenvironment of a company. The answers would differ from each other, as each of

us sees the environment in a different way depending on the inputs we get. Thequestion is does a quantifiable environment really even exist, or is it just createdby our ways of categorizing things so that we can better understand them? If wecould understand the limitations of human thinking and the factors that mostshape our views, we could be more objective. Resistance to change for exampleis inherent in all of us to some degree, sometimes to the point that necessarychanges to strategy are hindered. Learning to take this better into account wouldhelp managers in their efforts.


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Due to the abstract and complex nature of its approach, this school has receivedsomewhat less attention, and quite understandably especially among managers.Its biggest contribution is perhaps the awareness that strategy making is not justabout analyses and visions, but has a much softer side as well that mightsometimes play a big role.

2.1.6 Learning school

Proponents of the learning school look at the strategy-making process as aprocess of learning rather than as a process of deliberate analysis. Theunderlying thought is that action comes before thinking, and while acting theorganization learns to act better. In time, the different actions form a pattern,which is the strategy. The strategy therefore emerges from the actions taken,whereas the first three schools presented suggest the opposite: actions emergefrom strategy. The entrepreneurial school falls somewhere in between these twoviews, suggesting that the final outcome of strategy is deliberate but the path

leading to it is emergent.

The learning school emerged as a counterbalance to the strictly analyticaldesign, planning and positioning schools.2 The analytical models were popular,particularly in America, but Asian companies had always been somewhatskeptical about them. They had always relied more on informal managementpractices, emphasizing learning and the role of tacit knowledge in runningbusinesses. Managers did not just sit in their offices browsing through reportsand analyses, but really got their hands dirty and learned to know theirbusinesses better. This helped them in making the right decisions, even thoughthey did not base the decisions on formal analysis.3

But relying on organizational learning in creating strategies can be hazardous aswell. Without some sort of grand strategy, an organizations actions can easilybecome incoherent, lead to sub-optimization and fail to create an effective overallstrategy. The processes of learning are also deeply embedded in humancognition, and are not very well understood. Fostering learning, and thusimproving organizational performance, is therefore more or less a leap of faith.As with all the other schools, strictly following the theories of the learning schoolwill probably not lead to the best possible results, but some of the views arecertainly worth adopting. Learning is an important aspect of organizationaldevelopment, and organizations that are able to learn faster than theircompetitors will achieve advantages in the long run. Quick learners will alsoadapt faster to the environment when changes occur, and in times of disruptivechange an experimental approach can be far more efficient than an analyticalone.

2Recommended reading about strategic learning: Pietersen (2002)

3For a popular theory of organizational learning, see Nonaka & Takeuchi (1995)


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2.1.7 Power school

Introducing yet another different viewpoint to strategic management, the powerschool has actually two different approaches. Research under the micro powerschool studies strategy making as a struggle for power between individuals within

an organization, whereas the macro power school concentrates on the impactthat other organizations and stakeholders have on strategy. After all, in mostorganizations the strategy-making process is also about politics.

Especially the entrepreneurial school, but also the design, planning andpositioning schools, assumes that the companys CEO always has the final sayabout strategic decisions. In reality, however, especially in bigger companies,there are several interest groups involved that can influence decisions. Theseinclude powerful individuals or alliances within the company as well asorganizations outside the company, such as labor unions or even thegovernment. Strategy is therefore more or less a compromise between what themanagement thinks is the best possible strategy, what internal interest groupspromote and what external pressures dictate. Managers that make strategieshave to take this into account and play the political game correctly; alliances(both internal and external) can be formed, information either disclosed orwithheld, support bargained for and so on. This implies that strategy is moreemergent than deliberate, as it is formed by the political play between individualsand organizations.

The theories of the power school are perhaps most relevant in situationsinvolving major changes to strategy. While hardly never absent, it is hard toimagine that politics would seriously affect the course of a company during timesof relative calmness, involving only slight modifications to existing strategy. The

power school certainly makes a very good point but, as we have come to see, allof the schools have managed to describe just one part of what there is tostrategic management. This is also the case with the power school.

2.1.8 Cultural school

An organizations culture has a big impact on its performance, and that impactalso involves strategic management. The cultural school is actually the mirrorimage of the power school; it studies the influence of collective culture to thestrategy-making process, whereas the power school concentrates on theinfluence of individual stakeholders on strategy. According to cultural school

theories, strategy arises from the social interactions between individuals,mirroring the beliefs and understandings of the organization as a whole.

Strategy is seen as the way an organization uses its resources and capabilities togain competitive advantage. It can be deliberate, but it is never totally conscious,as its foundations are rooted in culture. It is therefore also impossible to fullyimitate the strategy of another company; the exact same strategy would not workbecause it would conflict with culture at least to some degree. This is why


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mergers and acquisitions often fail, even if they look perfect on paper. In order tochange strategy, culture has to change, too.

There is a certain amount of resistance to change in every organization, and thiscan sometimes discourage the management from executing necessary changes

if culture is given too much emphasis. Changing culture in order to inducechanges is very hard, as management and decision-making styles,organizational values etc. are deeply embedded in the organization. They will,however, change in time and sometimes culture has to be ignored when thecircumstances demand radical changes. Ignoring culture altogether is not a wisething to do, however, as it is fairly easy to destroy a good culture and therebyradically downgrade a companys performance, but hard to build one thatsupports the chosen strategy. If strategy changes radically, active efforts tochange culture are needed as well.

2.1.9 Environmental school

The environmental school takes a entirely different view on the subject ofstrategic management from all the other schools. The environment is seen assomething omnipotent that cannot be changed or influenced, but should beadapted to. Strategic management is therefore about survival, interpreting theenvironment and ensuring that the organization adapts to it.

Theories of the environmental school resemble those in the field of biology; thebasic assumption is that the environment provides a limited amount of resources,and the resources can only support a limited number of companies. Newindustries have enough resources to support most companies, but as an industrymatures the carrying capacity of the industry is exceeded and the weakestcompanies die.

What the theories fail to take into account, however, is that unlike biologicalcreatures companies can change themselves and influence the environment inwhich they operate. As pointed out in connection with the cognitive school, theindustrial environment might not even exist in exactly the same way as thebiological environment exists. The industrial environment is more dynamic andcomplicated, constantly changing, and exists perhaps more in our minds than inreality. The theories of the environmental school suggest that companies do notreally have a strategic choice, but that the strategy is more or less dictated by theenvironment. This is not entirely true, however; there are plenty of examples of

innovative companies breaking the rules of competition, doing something thatwas previously thought to be impossible. This is not to say that the theorieswould not be valid in some cases. The environment does influence companiesand their strategies, and sets the rules of competition. In mature and stableindustries where it is harder to break the rules, it might pay off to look at thesituation from an evolutionary point of view. Looking at the big picture instead ofimmersing oneself in the details is sometimes helpful.


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2.1.10 Configuration school

The configuration school sees strategies as configurations of resources, alignedtowards the accomplishment of a set goal. The configurations are relativelystable for long periods of time, but sometimes circumstances require a major

change and the resources have to be reconfigured. During this short period oftime, the organization is in a state of transformation. Strategic managementaccording to the configuration school is therefore about maintaining equilibriumduring calm periods and managing change when it becomes necessary.Contents of strategies or how they emerge are irrelevant in this theory.

Configuration theorists have identified general categories into which mostcompanies fall. They are organized and use resources in a similar way.Categorizing helps managers in understanding their organizations better, howthey evolve over time and how different parts of organizations combine with eachother. Also, recurring stages can be identified in the cycle of transformation.These configurations form patterns, making it possible to estimate the direction inwhich an organization is heading, or should be heading, and to anticipatechanges. A lot has been written about organizational change and changemanagement also in the context of other schools, but in the theories of theconfiguration school it is perhaps the most essential part of strategicmanagement.

However, change does not always have to be radical. A company can move fromone configuration to another in a process of incremental change, just as it can doso in a process of radical change. There is always the question of accuracy, too.All categories are artificial and they do not tell the whole truth; sometimes theycan even be misleading. But we need to simplify things in order to comprehend

them, which is what all theories do. If the limitations of configuration theories areunderstood, they are a useful tool especially for managing change.

2.1.11 Conclusion

After having read about all the schools, how each of them contributes to ourunderstanding of strategic management and how each of them has limitations,the conclusion should be obvious: all of them are partially right and none of themis wrong. Strategic management is about all of them and even more. Being ableto draw from all of the schools is essential, as all of them address importantissues. Strategists should not limit themselves to the theories of a single school,

seeing the big picture is what counts.

2.2 INDUSTRIAL SERVICES

Now that some light has been shed on strategic management, it is time to look atthe concept of industrial services and why companies are interested in industrialservice business strategies. In this study the term service refers to industrial


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product-related services, i.e. services that are targeted to optimize the use ofindustrial products and to increase their value for the customer (Catinaud, 2003).Other terms meaning approximately the same thing are also used in theliterature: product-service system and servicizing are perhaps the most commonones. In practice, this means that manufacturers of industrial products are

moving partly into the service business. Certainly, manufacturers have beenoffering services like installation and maintenance for their products for a longtime, but in most cases this has been seen more as a necessary evil than as aprofitable business. And only in rare cases has the business model supported theprovision of industrial services so that manufacturing and service businesseshave been interrelated. In an industrial service approach, the product functionsas a platform for service delivery (White et al., 1999), so that the businesses arecombined.

An industrial service business strategy requires a very different approach than apure manufacturing strategy. A pure manufacturing approach concentrates onselling products, whereas in a service approach suppliers try to fulfill theircustomers needs as thoroughly as possible and commit themselves to improvingtheir customers businesses. This is a very demanding approach, however, andrequires commitment also from the customers. Collina (2003) captures the veryessence of the industrial service business by calling it a solutions-orientedpartnership approach. The core product and services together form a solution tothe customers needs and, as explained later, companies have to work togetherin apartnership for the concept to work properly.

2.2.1 The siren call of industrial services

Several factors have contributed to the rise of industrial services. First of all,increasing competitive pressures are forcing companies to seek new ways ofprofit creation. The development and standardization of technology lead toincreasing difficulties in differentiating products and, at the same time,deregulation and globalization open up markets to an increasing number ofplayers (Mont, 2001). Intense competition and diminishing profit margins fromtraditional manufacturing businesses increase the appeal of moving into theservice business, which usually has higher profit margins and more stabledemand (Frambach et al, 1997; Wise & Baumgartner, 1999).

In addition to competitive pressures, changes in the composition of the productmarkets make the position of product manufacturers more difficult. As productquality has improved and product life spans have extended, the installed base ofproducts has steadily expanded. In many industries, the number of units soldannually is an order of magnitude lower than the number of units in the installedbase. In the car industry for example, the ratio is 1:13 (Wise & Baumgartner,1999). The expanding installed base has pushed value away from new productsinto the after-sales market. Moreover, the value added in new products is alreadybeing largely created in non-material ways like branding, design and intellectualproperty (Mont, 2002). In the future, moreover, the share of manufacturing is


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likely to diminish further. Industrial services can be used to tap into the after-sales value stream to provide new ways of profit creation for manufacturingcompanies.

The outsourcing trend has also contributed to the rise of industrial services.

Focusing on core competencies and outsourcing all that is non-core is popular,due to the fact that specialized organizations can achieve better efficiency. Fewcompanies identify manufacturing as their core competence, and therefore evenif most are not willing to outsource their entire manufacturing operations they areinterested in outsourcing some aspects of it like equipment maintenance, forexample. Industrial equipment manufacturers are sometimes even expected tooffer certain types of services, and in the process they are also increasinglybecoming aware of the possibilities of the industrial service business.

2.2.2 Different industrial service levels

The level of service and the degree to which companies enter the industrialservice business may of course vary. Five different levels of involvement wereidentified in the BestServ feasibility study (Kalliokoski et al., 2003), illustrated inFigure 1.

Figure 1: Industrial service business steps (Kalliokoski et al, 2003)

The lowest level, machine supplier, stands for a company with a traditionalmanufacturing strategy. A solutions provider will provide customized solutions toits customers needs, which usually but not necessarily includes providing somekind of service as well. The next level of involvement, service partner, means that


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the supplier will be partly responsible for some of the customers operations likemaintaining equipment. A performance partner will have some responsibility overthe customers whole process, and finally a value partner is actively involved inimproving the customers entire business. As responsibilities increase, thesuppliers competencies have to increase as well. For example, a performance

partner has to have a thorough understanding of the customers manufacturingprocess in order to be able to manage it efficiently.

2.2.3 Should my company enter the industrial service business?

The decision to enter the industrial service business, and to what extent,depends on a variety of things. Although the new markets might seem lucrativeat first, not every company should start climbing the industrial service businesssteps illustrated in Figure 1. The main issues are the expected profitability of theventure, customers and available resources.

Customers

ResourcesProfitability

Figure 2: Industrial service business strategy vs. manufacturing strategy

Wise and Baumgartner (1999) suggest looking at the ratio of installed units toannual new unit sales, customers usage costs relative to product price, andprofitability of downstream activities relative to product margins. The size of theinstalled base and product usage costs hint strongly at the possible revenue fromthe industrial service business and are fairly easy to assess. Profitability, on theother hand, is more difficult to estimate and is linked to customers. Moving intothe industrial service business adds another dimension to the challenge ofunderstanding markets and customers, and it is crucial to understand theconditions under which providing services will bring savings to both customersand the supplier (White et al., 1999). In cases where a win-win situation emergesbetween the customer and the industrial service provider, services will generatehealthy revenue, but if the conditions are not suitable for a profitable partnership,manufacturers are probably better off sticking to their old business.

Customer needs, of course, also dictate whether companies should or should notenter the service business. For customers, buying industrial services can in some


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cases be the golden mean between own manufacturing and outsourcing.Companies that outsource manufacturing also cease to invest in processdevelopment, which can lead to some serious problems: product innovationsoften require simultaneous process innovations (Pisano & Wheelwright, 1999),and contract manufacturers are not always willing to develop their processes

according to the needs of a single customer. In an industrial service businessmodel the equipment manufacturer can be partly in charge of the customersmanufacturing process and process efficiency improvement, thereby releasingcustomer resources and providing some of the benefits of outsourcing, butproduction assets still remain under customer control. Necessary processinnovations can therefore be introduced without any further ado and theequipment manufacturer, with its expertise in equipment technology, can help intheir implementation.

In fact, equipment manufacturers might sometimes be in a position where theyare the only party with the necessary expertise to provide certain kinds ofservices. This is usually the case with complex products requiring special skills tomaintain. In that case customers might even demand that manufacturers provideservices, which will act as a strong incentive to enter the industrial servicebusiness. Turning industrial services into the main business in that case will beeasier than starting from scratch.

The availability of resources is another big issue in the decision to enter theindustrial service business. Successfully providing services requires an extensiveservice organization, which is costly to build. Smaller companies might simply nothave the necessary resources (Mont, 2001), and even larger companies mightrather opt to invest in boosting their existing businesses than in venturing intosomething new. Also, the transition process is a risk in itself. It takes time before

a radical change in strategy starts bearing fruit and, in the meantime, thecompany is more vulnerable. Not all companies have the ability to take the risk.

2.3 INDUSTRIAL SERVICE BUSINESS STRATEGY AND OVERALL STRATEGY

In addition to the reasons that arise out of the companys operating environment,the companys overall strategy will also dictate whether industrial services are aviable option or not, and to what extent. Theories from nearly all the schools ofstrategic management are relevant in the context of industrial service businessstrategy, and their impact is presented below.

2.3.1 Industrial services as a positioning tool

According to the positioning school, one of the dimensions on which strategicdecisions should be based is source of competitive advantage. Companiesshould choose either to be low-cost manufacturers or differentiate their productsfrom competitors offerings. Services fit in very well to this theory as a means todifferentiate products.


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Particularly when the traditional differentiating variables of the marketing mix(product, price, place, promotion4) are more or less neutralized, like in many oftodays highly competitive industries (Frambach et al, 1997), industrial servicesare a good way of adding to the competitiveness of the customer offering in orderto be distinguished from the mass. Industrial services enhance the value of the

product for the customer, especially as industrial customers are increasinglystarting to demand turn-key solutions to their needs. Furthermore, industrialservices should lower the costs of using products by improving processefficiency, for example. This, too, adds to product value, although this kind ofextra value, which materializes only after the point of sale, is harder to quantifyand to market to customers.

Industrial services can also be used as a basis for market segmentation in afocusing strategy. For example, services can be targeted at one significantcustomer segment, at all segments simultaneously or at different segments atdifferent times (Pullman et al., 2001). All in all, services are a good tool forstrategic positioning, adding a new dimension to the possibilities of bothdifferentiation and focusing.

2.3.2 Services as a way to learn

According to the learning school of strategic management, an organizationsperformance and the strategies it adopts are very much dependent on its abilityto learn. One of the key elements of learning is to learn to serve customersbetter; in order to improve their competitiveness, industrial companies have todevelop their understanding of and sensitivity to their customers needs(Frambach et al, 1997). Industrial services are very customer intensive and close

interaction with customers enables companies with industrial service businessstrategies to learn rapidly from their customers. In pure manufacturing strategies,interactions are limited to the point of purchase, which inhibits learning.

Industrial services can thus be seen as a tool for enhancing organizationallearning and improving company performance. The industrial service businessstrategy should be in line with the organizations competence development goals,and vice versa. Strengthening competencies in the field of customer relationshipmanagement for instance might help the company in overcoming the firstdifficulties on its transformation path from a manufacturer to a customer-orientedservice company.

Learning from customers is also important for being able to move up theindustrial service business steps (Figure 1), as higher levels also require morethorough understanding of the customers business.

4See e.g. Kotler (2002)


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2.3.3 Impact of other strategic management theories

The theories of other schools of strategic management also have an impact onindustrial service business strategy. Although perhaps not as big and influentialas the positioning and learning schools, some of them have theories that are also

very valid in an industrial service setting and should not be ignored.

As theories of the cultural school suggest, strategy is an incarnation oforganizational culture. The transformation from a manufacturer to an industrialservice provider is thus a big cultural challenge as well. Company culture has tosupport chosen strategies and an industrial service strategy requires a verydifferent culture than a manufacturing strategy. Customer orientation, forexample, is a prerequisite for the success of an industrial service businessstrategy, as is a cooperative spirit between different departments in the company.Nurturing these aspects of organizational culture is both important andchallenging. If no attention is paid to cultural issues before and during thetransformation, the existing culture might conflict with the new strategy and atleast slow down, if not hinder, the transition.

The entrepreneurial school, in turn, emphasizes the need for a unifiedmanagement vision. At least in bigger companies, where the implementation ofstrategy lies in the hands of many managers instead of one, a perfectly unifiedvision is hard to achieve, but a general consensus of the future state of thecompany should be reached. This consensus would then act as a guideline formanagers in their decision making. Having an implicit vision and anunderstanding of where the company is heading is important, as a written explicitstrategy always fails to describe the intricacies of a strategic approach. At leastthe managers in charge, but preferably also other employees, should truly

understand what the company is striving for.

The change from a manufacturer to an industrial service provider is also achange in the companys configuration. Resources have to be reallocated andorganizational structures changed. Simplifying organizational change with thehelp of configurations can be helpful in understanding the transition process, justas strategic positioning can be helpful in understanding general strategicdirection. As a tool among other tools, configuration theories should work well ina service setting.

Finally, there is the question of power. Radical changes are always problematic,

and, like a conflicting culture, internal quarrelling may also delay or even hinderdecision making. It can be hard to get the major strategic changes that areinvolved in moving into the industrial service business approved. Strugglesbetween power factions are likely to arise, and achieving the aforementionedunified management vision can be difficult. Preparing for the struggle beforehandcan save a lot of trouble. Also, issues of external power in the form of demandsfrom customers or investors for example can play a role in the transition.


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Figure 3 summarizes the factors that need to be taken into account whendesigning industrial service business strategies.

ndustrial

service

usiness

strategy

Internal

issuesExternal

pressures

ning,

competence

devel.

esource re-

allocation

Company

culture

Strategic

positioning

Company

vision

Figure 3: Strategic factors related to industrial service business strategy


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3 FROM MANUFACTURING TO SERVICES

In this chapter the changes related to the transition from a pure equipmentmanufacturer to an industrial service provider are analyzed. If, after having

carefully considered its strategy and all relevant aspects of it, a company decidesto adopt an industrial service business strategy, some major changes have totake place; the foundations of strategy, organizational structures and productdevelopment functions have to be aligned with the new approach.

3.1 PROVIDING INDUSTRIAL SERVICES

Traditionally, manufacturing strategies have been built on three foundations:superior products, economies of scale and mainly backward vertical integration.In pursuing an industrial service business strategy however, a different approach

is required. In order to capture value from downstream operations, companieshave to redefine their value chains, shift their focus from operational excellencetowards customer allegiance, and rethink the strategies of vertical integration(Wise & Baumgartner, 1999). The whole business model has to be turned upsidedown and rebuilt on the new foundations.

Superior

products

Economies

of scale

Backward

integration

Customer

allegiance

Redefined

value chain

Forward

integration

Manufacturing strategyIndustrial service

business strategy

Figure 4: Foundations of strategy (Wise & Baumgartner, 1999)

3.1.1 New business models

The traditional view of services as a means of pinching a sale is not valid in anindustrial service business strategy. Instead, the sale should be viewed as a wayto open the door for the future provision of services. The value chain does notend at product installation; this is what redefining the value chain means. Valuecan be extracted throughout the life cycle of the product, which ends when theproduct is disassembled and recycled. In fact, value from the downstream


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operations can be much more important than the initial revenue from the sale, asit provides a steady high-margin revenue stream. Needless to say, the businessmodel should reflect this. Metrics and incentives have to be re-defined andaligned with the real drivers of profit for the company; sales margin cannot be theprimary measure, because it does not define overall profitability (Wise &

Baumgartner, 1999).

Since the profit of an equipment manufacturer with an industrial service businessstrategy is to a large extent dependent on after-sales revenues, the next step isto figure out how they can be maximized. Building profitable and lasting customerrelationships is crucial. Successful industrial service providers should offercomplete solutions to their customers needs and, depending on the level atwhich they operate on the industrial service business steps, use their expertise toimprove their customers operational efficiency, thus generating significantsavings. A business model that links customers profits to the suppliers profitscreates an incentive for both parties to work for the common good, whichdeepens the relationship. In a traditional model, the supplier has an incentive toincrease material consumption in order to sell more and get more revenue,whereas the buyer wants to do the opposite. Stoughton & Votta (2003) suggestthat the new business model should be designed so that both parties have anincentive to lower life cycle costs, but an even broader approach would be to tryto increase the life cycle value of the product (Figure 5). In other words, volumeshould be decoupled from profitability and the focus should instead be onfunctionality (Maxwell & van der Vorst, 2003). In this kind of a model, value isbased on functionality instead of material content, which shifts the focus fromsales to efficiency.

Traditional business model Industrial service business model

Material(cost, volume)

Life cyclevalue

BUYERwants to decrease

BUYERwants to increase

SUPPLIERwants to increase

SUPPLIERwants to increase

Figure 5: Aligning incentives (modified from Stoughton & Votta, 2003)

This way the economic value for individual stakeholders can be coupled withoverall systemic performance. When the system is more efficient and uses fewerresources and/or achieves better results, its value over the life cycle is increasedand the gains can be shared among the stakeholders. The stakeholders are allthe companies that work together to achieve the results, which in addition to theservice provider and the customer might include the providers subcontractors forexample. The business model dictates the way in which the gains are distributed,and care should be taken to design it in a way that a balanced and sustainablewin-win situation emerges. It is not a zero-sum game; if any one stakeholder


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becomes too greedy, the others profits and thus incentives to cooperate arelowered, which decreases the overall gains from the system and lowerseveryones profits. If the stakeholders are not able to cooperate fully and fail tocommunicate the goals of the system to each other, the situation will deteriorate.

5

The business model need not, of course, be based on profit sharing; othermodels are also suitable especially at the lower levels of the industrial servicebusiness steps. A lot depends also on the customers willingness to radicallychange their relationship to their suppliers. The business model can be anythingfrom charging customers for individual service deliveries to offering pure needsfulfillment. In the latter, all life-cycle costs would be aggregated to the serviceprovider and the customer would pay according to the benefits it receives(Heiskanen et al., 2000). If taken to the extreme, customers would not even haveto own the equipment themselves. Such a model in which service providers leaseequipment and customers pay for the benefits might be appealing especially tosmall and fast growing customer companies that do not want to tie up capital inexpensive equipment. The possibilities are numerous and the business modelcan even vary from customer to customer. However, a model that is not basedon profit sharing exposes the service provider to a paradox pointed out by Olivaand Kallenberg (2003): increasing service quality extends product life andreduces replacement sales, and on the other hand increasing product qualityreduces service revenues. This conflict in interests does not encourage thesupplier to invest energy in providing quality products and services, and in thelong run this kind of a model might undermine the feasibility of the industrialservice business concept. A good solution is probably to gradually shift thebusiness model from a more traditional one towards the profit-sharing model asthe customer relationship develops and the supplier climbs higher on theindustrial service business steps (Figure 1).

3.1.2 From inter-firm rivalry to networks

In general, pursuing an industrial service business strategy is much moredemanding than a pure manufacturing strategy. Service providers need to havean extensive service infrastructure in place and need a wide range ofcompetencies to handle both product and service aspects of their offering. At thesame time the trend towards outsourcing non-core functions creates specializedorganizations that excel in a narrow competence area. It is thus becomingincreasingly difficult for any one company to acquire sufficient competence in alldisciplines. Building a network of partners is necessary to provide access toadditional competencies and resources.

Furthermore, equipment manufacturers are not alone in the service markets:component manufacturers, system integrators, end-users own service functions

5Familiarizing oneself with game theory may provide insights for business model development.

See e.g. Gibbons (1992) or http://william-king.www.drexel.edu/top/eco/game/game.html


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and third parties, among others, compete in the after-sales market (Oliva &Kallenberg, 2003). Although equipment manufacturers have some clearadvantages in the after-sales market (established customer contacts, in-depthproduct knowledge etc.), they still face heavy competition. Returns tend todiminish in a competitive market but, instead of competing on their own, different

kinds of players can form alliances and this way improve the competitiveness ofall players in the network. As said, providing a complete set of services is hardfor any one company, but by working together companies can pool theirresources. Each companys core competencies can be utilized more efficiently,which lowers costs and improves efficiency.

Building an extensive and well functioning network is not easy, however. Allparticipants need to be convinced of the benefits of working together, whichmight be difficult as in most cases it requires a major cultural change. The bigquestion then is who should take the leading role in building and coordinating thenetwork? The equipment manufacturer is a strong candidate, as it is in themiddle of the network between the customer and subcontractors. Or thecoordinator could be the biggest and thus most influential company, or the mostforward-thinking one. Whatever the case, strong leadership on the part of onenetwork member is probably required to get others involved.

In order to be able to build and control the network, it is crucial to thoroughlyunderstand the functioning of the entire value chain, including customersoperations, and the operation of customers customers and suppliers (White etal., 1999). It is essential to take a systemic view where the interests of allstakeholders are taken into account, which requires a deeper understanding ofthe business as a whole (Shireman, 1999). In an industrial service businessmodel where customers and suppliers profits are coupled, the value chains

merge together; one possible example is illustrated in Figure 6. Third parties mayalso be involved, which depending on their role can be members of the network.As the profits of all parties involved depend on the efficiency and functionality ofthe joint function, all have an incentive to contribute to the best of their ability.Ideally, all of the network members have specialized competencies that can beused to increase the efficiency of the whole system.


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Rawmate-rials

Manu-facturing

Distr./instal-lation

Disp./recycling

Rawmate-rials

Enduse

Distr./instal-lation

Disp./recy-cling

Manufac-turing

Use &maint.

3rd partyservices

Material flows

Figure 6: A possible example of an industrial service business value chain

As companies seek synergies by building networks, it might very well be the casethat competition gradually shifts from competition between individual companiesto competition between networks of companies. Globalization further drives theneed for networking; in some countries it is not even possible to do businesswithout an alliance or a joint venture with a local company (Drucker, 1995). Beingable to form alliances with other companies and efficiently function as a part of anetwork will be crucial to success in the future.

3.1.3 Forward integration

Traditionally, manufacturers have integrated backwards to secure the provisionof raw materials. Forward integration into distribution has of late become one ofthe key elements in the strategies of many companies, and moving into theindustrial service business further drives the need to integrate forward in thevalue chain. In an industrial service business model where close customerinteraction between the equipment manufacturer and the customer is needed,there is no room for an intermediary; the value chain dynamics would not functionproperly if distribution would be handled by an outside party. It also makes senseto further integrate forward to provide services throughout the whole life cycle of

the product. Once the service organization is in place, it becomes more or less afixed cost. This implies that capacity utilization becomes a key driver ofprofitability (Oliva & Kallenberg, 2003). By extending the service offering to coverthe entire life cycle of the product instead of just installation and commissioningthe capacity of the service organization can be utilized more efficiently. Extensiveforward integration is thus necessary.


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Even at the lower levels of the industrial service business steps, where it wouldbe viable to sell services through an intermediary, it should be consideredcarefully. Although in many cases relying on large distributors will providemanufacturers with much needed visibility, there is also the danger thatdistributors will become too powerful. It is not unheard of that distributors at some

point replace the manufacturers service business with their own, thus becominga competitor (Wise & Baumgartner, 1999). Carefully considering distributionstrategies is necessary to secure a solid strategic position.

3.1.4 Customers as partners

In the past, the combination of superior products and economies of scaleprovided a significant competitive advantage in any market, but not anymore.Differences among the products of different manufacturers have becomemarginal in many industries and economies of scale are easy to replicate orcircumvent. Customer allegiance has therefore become the most effective barrier

to competition (Wise & Baumgartner, 1999). Earning the loyalty of the largest andmost profitable customers and building sustainable relationships that span theentire life cycle of the product is critical.

Industrial services are a means of creating the sought-after sustainable and moreintensive customer relationships (Frambach et al, 1997). Services cannot bemass produced for an anonymous market, but can be provided only afterinteracting with the customer first. In an industrial service business model wherethere is a joint interest in improving the efficiency of the customers processes,the customer becomes more of a partner than a customer in a traditional sense;the customer should be a co-designer rather than a pure consumer of services

(Piller, 2003). Frequent interactions with customers should build up the serviceproviders knowledge of their needs, which makes it possible not only to meet butto exceed customer expectations and to find new ways of co-operation that thecustomer might not even have thought about (Mont, 2001). Once a successfulrelationship with frequent interactions has been established, it is very hard forcompetitors to intervene.

However, in order to be successful, companies need to build not just one butmany sustainable customer relationships. It takes considerable effort to build andsustain them as each customers needs are unique, but it helps if there is somekind of a common platform that each relationship is built on. Having a system inplace to customize the offering for each customer is called mass customizing,which has been a hot topic in manufacturing, but there is no reason why a similarapproach could not be applied to industrial services as well. The goal of masscustomization is to have learning customer relationships, in which there is a largevolume of business over time in a permanent relationship (Pine et al., 1995). Thisis a valid goal for industrial service businesses as well. To repeat, learning toknow the customers needs is crucial. A system, for example, in the form of aproduct/service platform to help in customizing service offerings for individual


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customers would reduce the amount of effort needed to build learning customerrelationships.

3.2 TRANSFORMING THE ORGANIZATION

When a companys business model is radically changed, its existingorganizational structure often becomes unsuitable for the new way of doingbusiness, or at least does not support it well enough. Building a proper serviceculture into the organization and changing its structure to meet the needs of thenew business model is as important as it is challenging.

3.2.1 Organizational structures

Services are more difficult to imitate than products because they are less visibleand more labor dependent, and can thus be a source of sustainable competitive

advantage (Heskett et al., 1997). On the other hand, services cannot be patentedand competitors are free to try to copy them. The best way to protect againstimitators is to build an effective organization that supports the provision ofservices well. The role of the organization is bigger in the industrial servicebusiness than it is in manufacturing, because controlling the quality of services ismuch harder. Products that do not meet quality standards can be screened outbefore they are delivered to customers, but as services are produced andconsumed at the same time this is not possible. From the customers point ofview, the service experience is also much more holistic. It includes everythingfrom the appearance of the suppliers employees with whom it deals to thequality of the actual outcome of the service. Organizational structures thatsupport the service process and a culture that promotes overall service qualityare not only important factors in achieving customer satisfaction but also nearlyimpossible for competitors to directly imitate.

Nowadays, most manufacturing companies already provide some kind ofservices with their products, and are in that sense already in the industrial servicebusiness. Service functions are, however, often fragmented and handled bysmall units all over the organization (Oliva & Kallenberg, 2003). In a businessmodel based on services their provision has to be much more coordinated. Thereare essentially two possibilities: either to have separate organizations forservices and manufacturing or to have both services and manufacturing underthe same organizational unit (Figure 7).


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Manuf.division

Jointentity

Customer

Customer

Products

Services

Complete solution

Service

division

Figure 7: Different approaches to the provision of industrial services (White et al., 1999)

If the functions are put under the same roof there is a possibility of internalconflict because the incentives of services and manufacturing have traditionallydiffered from each other (Mont, 2001), for example with respect to product qualityas mentioned in section 3.1.1. Although it should be possible to resolve theconflict by aligning the incentives of both groups to reflect total customer valueadded, the units might still battle over influence and not work well together as ateam. On the other hand, tight integration allows services to drive manufacturingand product design changes to increase efficiency (White et al., 1999). Ifcoherence is achieved, and services and manufacturing work together as oneunit to increase the value of the product-service offering, the result will likely bebetter than if they were separate units.

According to a study by Oliva and Kallenberg (2003), a critical success factor inthe transition from manufacturing to services was to create a separateorganization to handle services. This finding suggests that internal conflicts arevery hard to resolve in practice. However, the study only covered the transitionphase and, given the fact that organizational culture changes very slowly, it islikely that the risk of conflict is at its highest in the beginning and decreases withtime. Having services and manufacturing as separate units at first and combiningthem later when the organization has learned the ways of the industrial servicebusiness might be a viable solution around the problem.

Besides the suppliers corporate culture, the customers culture also impacts onservice offerings. Pullman et al. (2001) found out that different cultural groupspreferred service attributes that were in line with their cultural norms. Servicesshould thus be customized according to the customers culture as well, which in aglobal business poses additional challenges. Oliva and Kallenberg (2003)identified the creation of a global service infrastructure capable of handlingproblems locally as a problem. Collina (2003) suggests that suppliers need to


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organize a network that can provide localized solutions from a global array ofproducts and services, i.e. a global platform. Local companies have to participateactively in the development of the localized solutions. This implies structuringoperations as a global network of local sub-networks, something like the networkillustrated in Figure 8. Another variant of the network would be to have a global

service hub in the middle that coordinates all service functions globally.

Field office

Local partner

Local subcontractor

Figure 8: Global network with local sub-networks

3.2.2 The process of change

Once it has been established what kind of an organizational structure isdesirable, the change has to be implemented. The first challenge arises fromchanging company culture from product- to service-oriented. This includes allcompany functions, from management and R&D to manufacturing and sales; thewhole company has to learn to appreciate industrial services and the way theyare offered. For a traditionally thinking manufacturing organization this is not aneasy task.

First of all, traditionally thinking organizations might not believe the economic

potential of providing industrial services (Oliva & Kallenberg, 2003). A servicethat yields a few thousand dollars a year for a piece of equipment worth a milliondollars is not something that most people get excited about. It is hard to see thatlittle drops of water eventually make up a stream. Second, industrial services canalso be viewed as a threat within the company. The manufacturing operation andsales might oppose the idea, because it can be perceived as harmful to theirprofitability (White et al., 1999). And third, implementing an industrial servicebusiness strategy requires diverting resources away from manufacturing, which


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for most companies is a major source of competitive advantage. Divertingresources from the core function is a risk that some companies are very reluctantto take.

Overcoming the resistance to change within the company may require

substantial effort and, once initiated, the change in the companys configurationtakes time and money to complete. Building competencies and successfullydeploying an industrial service business strategy is a long process that requireslong-term financial commitments. The actual cost of the transformation is alsovery hard to quantify, as it involves all kinds of indirect and opportunity costs. Theleap should thus be made when the company is still competitive, not when theeffects of weakened competitiveness can be clearly seen in the financialstatement.

From the customer perspective, product-related services demand closercooperation with the supplier, more trust in them and more understanding ofcosts than is typical for a customer-supplier relationship (White et al., 1999). Forexample, customers might not be too happy about giving away what they feel issensitive information about their core competence areas, even though suchinformation is essential for providing industrial services (Mont, 2001). Asuccessful customer relationship hence requires a cultural change in thecustomer company as well. White et al. (1999) also found out that there werehigh costs associated with making the feasibility of services clear for customers.Significant costs related to managing products may go unnoticed amongcustomers and therefore buying product-related services might not seem asappealing as it in reality is. Customers were naturally unwilling to pay for theextensive studies needed to prove the feasibility of the service approach.

As major cultural changes are required at both supplier and customer ends,proceeding too fast and trying to change everything at once is a great risk.Taking it one step at a time and using pilot projects to prove the concept and tolearn is probably better than turning the whole organization upside down straightaway.

3.3 SERVICE INNOVATION

In contrast with product development, where formal innovation processes arecommon, innovation in services has traditionally been characterized by ad-hoc

methods. In a strategy based on industrial services this can no longer be thecase. Since company competitiveness is dependent on the service offering,services have to be developed systematically and efficiently. Innovation inmanufacturing costs three times as much as innovation in services (Sirilli andEvangelista, 1998), so money should be no object either.


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3.3.1 Adopting a systemic approach

As has been noted, successfully adopting an industrial service business strategyrequires that customer needs are thoroughly understood. This understanding ofthe customers business has to be integrated into product design and

manufacturing as well (White et al., 1999). The core product and accompanyingservices should be designed concurrently as a system; in other words, R&D hasto adopt a systemic approach. This also includes infrastructures like ITinfrastructure and logistics infrastructure, which have to be taken into accountand developed accordingly, while also giving attention to network partners.

The potential of system innovations is much greater than that of mere productdesign. Product innovation can be compared to sub-optimizing a part of asystem, whereas system innovations optimize the functionality of the wholesystem. Brezet et al. (2001) outline the generations of eco-innovation, rangingfrom product improvement to system innovation (Figure 9). The impact onefficiency increases with the complexity of the approach, which is true for anyinnovation. The biggest impact can be achieved when the whole system isredesigned so that the new business model is taken into account. In the industrialservice business the product and accompanying services form a package thatdoes not function properly if its parts are designed separately; concurrency of thedesign processes is important.

Time

Efficiency

improvement

Productimprovement

Productredesign

Functioninnovation

Systeminnovation

Figure 9: Innovation generations (Brezet et al., 2001)

Technologically, system innovation is rarely challenging. Product-servicesystems often rely on existing technologies and are therefore relatively easy tointroduce (Manzini and Vezzoli, 2003). Their novelty value does not arise out of


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radical innovations, but out of the way existing or emergent technologies arecombined and systemized. Shifting from product design to system designrequires a major cultural change; the main barrier in creating system innovationsis not the organizations ability to innovate in general, but the lack of willingnessto change in a radical way and to innovate beyond organizational boundaries

(Bijma and Haffmans, 2003).

Although technologically not very demanding, system innovations are complex inthe sense that a large number of different elements have to be taken intoaccount. This often requires a multidisciplinary approach; innovations are a resultof combining knowledge from different areas. As the complexity of the systemincreases, it becomes increasingly difficult for a single company to acquire therequired competencies for itself. As with the provision of industrial services, thevalue of networking increases also in research and development. Cooperationbetween the members of the strategic network should thus cover R&D as well ifnecessary.

3.3.2 Systems technology

Although the technology mostly used in product-service systems is not radicallynew, it nevertheless plays an important role in the functionality of the system.Proper use of technology can radically lower the costs of providing industrialservices, directly affecting profits.

Intelligent systems are often associated with industrial services. Intelligence inthis context means that the product contains technology that enables it to gatherinformation from its surroundings and itself, and is capable either of sending theinformation to another system for analysis or of using it to adjust its operation, orboth. Accurate information is often the key to providing better service andsometimes the very thing that enables certain services. For example, productusage data can be used to forecast future maintenance needs and to improveprocess efficiency. There are also indirect ways for using information, e.g. usagedata can be fed back to the R&D department where it can be used in productdesign to improve product durability, for example (Oliva & Kallenberg, 2003).

Technology can also serve as a means of protection from competitors.Equipment manufacturers that have adopted an industrial service businessstrategy may try to expand their markets and offer certain services also for theircompetitors equipment. Embedding technology that competitors cannot utilize

into products will provide a major cost advantage that makes it more difficult forthird parties to intervene.

It may even be possible to use technology to automate certain services. Wiseand Baumgartner (1999) talk about embedded services, which means thattechnology embedded in the products actually performs the service. Thisapproach is a double-edged sword, however. Although customers at first wouldbe willing to pay for the equipment feature as if it were a service, services of this


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kind have a tendency to become standard product features in the long run(Rekola & Rekola, 2003). This happens at the latest when competitors introducesimilar features to their products. Embedded services are thus not a sustainablestrategy by themselves and the industrial service business model cannot besolely based on them, but they might be a good complementary approach.

3.4 INDUSTRIAL SERVICE BUSINESS TRANSITION FRAMEWORK

As a summary, Figure 10 illustrates the most important aspects that should bechanged during a companys transition to an industrial service provider.

Networks &alliances

Businessmodels

Valuechains

Organi-zationalculture

Customerrelation-

ships

Sales &marketing

R&DOrgani-zational

structure

Transition toindustrial

servicebusiness

Figure 10: Industrial service business transition framework

The business model should be changed so that the incentives of the supplier andthe buyer are aligned, which means focusing on life-cycle value instead ofmaterial content. A win-win arrangement and true collaboration with customersare prerequisites for a service business model to work properly. Expanding thevalue chain to cover the whole product life cycle, i.e. to supply services for allstages of the product life cycle, is also an option for increasing service revenue.

In a business model based on collaboration, the value chains of the supplier andthe buyer merge partially, reflecting changes in earning logic. The supplier needsto integrate forward in order to expand the value chain, enhance interaction withcustomers and protect itself from competition. Understanding how the valuechain works and where the money comes from is essential.


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The importance of networks and alliances also increases as it becomesincreasingly difficult for any one company to acquire for itself the growing numberof required competencies. Partnering enables companies to tap into externalsources of expertise and other resources. The nature of competition slowlychanges from competition between individual companies to competition between

networks and, in order to be successful, companies need to be able to functionwell as a part of a network. This requires changes in company culture.

In order to secure close cooperation with customers, which is the basis of asuccessful service strategy, customer relationships should become deeper.Customers should be partners and co-designers of services rather thancustomers in a traditional sense. Suppliers need to be able to continuously learnfrom customers and their businesses in order to provide good service.

As customer relationships change, sales and marketing should change, too. Thesupplier has to be able to respond to each customers unique needs. On theother hand, suppliers should be able to manage a large number of customerrelationships. A system to customize offerings should be in place to help inbuilding unique solutions from a common set of products and services.

Furthermore, organizational structures that support manufacturing businesseswell are not necessarily suitable for the needs of industrial service businesses.Changes in the organization often need to take place to resolve internal conflictsbetween manufacturing and services and to enable efficient cross-functionalcooperation within the company. For a global company, building an efficientservice network that is capable of responding to local customer needs isimportant as well.

Culture is another big issue in the transition. Resistance to change is a commonphenomenon which has to be overcome before the new business model canwork properly. Manufacturing and service cultures differ significantly from eachother and it will take time for a traditional manufacturing organization to learn toappreciate industrial services and to excel at serving customers well. Changing aculture from product- to customer-oriented in not easy and, in addition to internalcultural changes, the new partnership-based business model requires changes inthe customers culture, too.

Finally, research and development functions have to be aligned with the newbusiness model. Adopting a systemic view and developing the core product and

services concurrently is important. Product technology can be used to supportservice provision, and services can give feedback to product development, butthis is possible only if R&D and services work closely together. The increasedcomplexity of the system might also require R&D networking to acquire know-how that does not exist within the company.


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4 CASE EXAMPLES

In order to validate the transition framework in practice, four companies that hadimplemented industrial service business strategies were chosen to be analyzed.

Two of the case companies were from Finland and the other two from the U.S.,which enabled a comparison of practices in two different cultures. In addition,one company that had made a clear strategic decision not to enter the industrialservice business was included to provide a different point of view. A seniormanager from each company was interviewed to find out why (or why not) theircompany had decided to adopt an industrial service business strategy and howthe company had changed in the process.

4.1 CASE METSO

Metso is a global supplier of process industry machinery and systems. It is theworlds largest supplier of paper making lines as well as rock and mineralprocessing equipment, and its other businesses include process industryautomation systems, drives and panel board machines. Metso is headquarteredin Helsinki, Finland.

Changing customer markets are the main driver behind Metsos ongoingtransformation to an industrial service provider. The paper and mineralsprocessing industries in Europe and in the Americas are mature and thusfocused heavily on increasing the performance of the existing installed baserather than investing in new capital equipment. Initiating the change was a clearstrategic decision and the goal was to expand the customer offering from capitaldelivery to cover the entire life cycle of the product. Metsos aim is to have life-cycle services as a significant source of turnover in the future. At the moment,turnover still comes mainly from product sales, but efforts are being made toincrease the share of services. The business model is being changed gradually,with the goal of attaining fixed-price maintenance and process improvementcontracts with leading customers. Some pilots are already in progress andcustomer feedback has been positive.

Metso has service organizations within its business units that are capable ofhandling customers maintenance needs and it is also an owner in a fewseparate service companies that provide daily operational services. So far,

external partners have not been needed, but in the future when the servicebusiness grows partnering will become necessary. Metso has always providedmaintenance services, but now the target is to move on to a solution-basedmodel in which services would be an integral part of the customer offering. Inorder to speed up the implementation process of the new strategy, theorganizational structure was recently c

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Bestserv Report II Final