- Dr. Martin Lockstrom

Driving Revenue Through Service Innovation

INSIGHTS

IntroductionMost company executives have ambitious growth plans. It’s not uncommon to see revenue growth targets of 10-15% per year, even though overall markets might grow at a more modest rate of 2-5% depending on geography. Obviously, this means that it is not sufficient to simply protect one’s market share and grow with the market, but more importantly, to create new revenue streams from new products and services. In recent years, many manufacturers in developed markets have been struggling to stay competitive as competition especially from manufacturers in emerging markets has mounted. Those that have survived and are still thriving all have something in common: they have made a transition from a product-centric to service-centric organization.

Servitization – What is It?As products across all industries are becoming increasingly commoditized, many companies are trying to adopt a more service-oriented business model. The development is logical: research suggests that Western companies have to reduce their cost by at least 30% in the mid-term in order to stay competitive. Servitization means that a producer bundles the products with services into a solution, with the objective of creating new revenue streams.

There are also other rationales behind; for instance, a service solution is more intangible in nature vis-à-vis a pure product, meaning that it is harder to analyze and imitate by competitors, meaning that profit margins potentially

should be higher, at least in the short to medium term. Furthermore, a service solution is also more outcome-oriented, meaning that the producer gets paid for helping the customer to reaching an end rather than providing a means to an end. This also helps in negotiations, as the rhetoric can effectively be shifted away from pricing toward value.

One of the pioneers in this area is Rolls-Royce, which launched its “Power-By-The-Hour” concept in the 1960s (Figure 1). It is important to remember that servitization is distinctly different from leasing, where the latter is merely a way of spreading a cash flow over an extended period of time, whereas the former is about creating new revenue streams.

Table 1. Producer and customer benefits of servitization

Figure 1. Servitization at Rolls-Royce

POWER-BY-THE-HOUR AT ROLLS-ROYCE

Situation:

In the 1960s, RR wanted to improve customer service and help them shift CAPEX to OPEX

Solution/Innovation:

RR took responsibility for delivery, operations, maintenance and repair throughout its lifecycle. Basically means paying for a jet engine as a service only when it is used (and working) through a fixed-fee per flying hour. Usage time was manually recorded and approved mutually on trust basis

Outcomes:

Reduced total cost of ownership (TCO) for customer and higher revenue for RR, lower capital expenditure

The Case for ServitizationCustomers increasingly adopt more of a variable-cost structure with as low upfront investment as possible, i.e. buying construction and industrial services on demand instead of a one-time purchase. A viable way of winning and keeping customers is to reduce complexity and simplify for the customer, particularly through servitization of product offerings, e.g.”pay for a hole instead of a drill”. An overview of servitization benefits for customers and producers are shown in Table 1.

As can be seen above, there are clear benefits to both parties involved, which can explain the success of the model. Servitization has taken place in most industries; an overview of illustrative cases is shown in Table 2.

PRODUCER BENEFITS

• Predictableandconstantrevenuestreamfromsubscribed individuals for the duration of the subscriber’s agreement.

• Reduceuncertaintyandtheriskinessoftheenterprise.

• Greatercustomerintimacythroughmoreregularcustomer interaction.

• Higheraveragecustomerlifetimevalue(ACLV)thanthat of nonrecurring business models

• Morepotentialforupsellingandcross-sellingotherproducts or services.

CUSTOMER BENEFITS

• Noneedforupfrontinvestments

• Morepredictiablecashflow

• Lowerthresholdformakingpurchasedecision

• Greaterincentivetomaintainrelationshipswiththeir customers (after all, why should they care once they’ve received their money?)

• Betteropportunitiesofalignmentwithcustomer’sgoals and expectations

• Thecustomerthatreceivesvalueismorelikelytobuying the service and possibly at an increased rate in the future.

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Author Profile

Dr. Martin Lockstrom Principal Consultant, Building Tomorrow’s Enterprise, Infosys Labs

Martin is a specialist in Supply Chain and Operations Strategy, Outsourcing/Offshoring and International Management. During a six-year stint in China, he established the research and education activities at the SCM, Sustainability and Automotive academic centers at China Europe International Business School, Shanghai.

He established the first endowed chair for Purchasing and SCM in China at Tongji University, Shanghai, and was also responsible for setting up Supply Chain Management Institute China, an international network of SCM research and education hubs.

Martin co-founded Procuris Solutions, an IT company specializing in SCM-related solutions, offering consulting services to companies like Accenture, Ariba, BMW, Clariant, Dell, Dow, Ernst & Young and Intel, among others.

He has a Ph.D. in Supply Chain Management from European Business School, Germany, a bachelor’s and master’s degree in Industrial Engineering and Management, from Chalmers University of Technology, Sweden. He speaks Swedish, English, German and Chinese, has published over 50 articles and papers and presented at more than 60 conferences.

Summary and ConclusionServitization has become an imperative in today’s economy, especially in developed markets. Product companies that do not embrace this concept will face serious competition from low-cost manufacturers particularly in emerging markets and risk becoming forced out of the market in the long term. Servitization helps improving the inimitability of products offered, as

well as helping creating new revenue streams, ultimately leading to deeper customer relationships. It is also very attractive from the customer’s perspective as it reduced the need for upfront investments, instead allowing a more stable and predictable cash flow over time. From an overall perspective, the mutual benefits are so compelling that the concept cannot, and must not be neglected.

Company Industry Project Focus

Southwest Airlines

AirlinerSouthwest Airlines compete on service and constantly innovate, using their innovative culture to maintain a competitive advantage.

Mayo Clinic HealthcareThe Mayo Clinic is constantly innovating how they deliver their services to their “customers”

AppleConsumer electronics

Apple sells iPods but makes money with the iTunes service

Royalty Food retailerThey are exporting their innovations and other countries are paying the “royalties”.

Retail ClothingCreated a new retail category by focusing on an unmet customer demand

Atlas Copco Machinery Predictive maintenance services

Bank of America

BankingBank of America has over 300 people with Innovation in their title, the best Canadian bank has around 10.

Table 2. Cross-industry servitization examples