Servitization benefits both manufacturers and suppliers

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How can manufacturers overcome low-cost competition, strengthen customer relationships and build a revenue stream that will persist through good times and bad? Servitization provides most of the answers.

If you want – or need – a new piece of capital equipment, essential to remain competitive and to serve your customer base, how are you to get it? The conventional route is to buy it outright, either with a bank loan or, if your company is financially very sound itself, from capital reserves.

But two questions immediately arise: is this the best use of capital? And what if broader economic conditions mean that banks and other finance sources are tightening their purse strings?

Servitization – which has also been called "performance-based service" – replaces "sell and move on" commercial relationships with a model that has demonstrated the ability to improve product availability and reduce the cost of ownership by tying a supplier’s compensation to the output value of the product generated by the customer1.

Other questions that experience will ensure are on the list include matters of maintenance, service, upgrades and breakdowns. The key factor will be uptime, but all these things matter – and who better to ensure the equipment is running effectively than those who know it most intimately, the people who made it?

Cut costs, improve performance

Any servitization relationship should include incentives for the supplier to reduce costs. It should share risks, financial risk especially, and it should be based on achieving the highest performance possible. The optimal contract consists of a fixed payment or fixed price, cost-sharing and performance-based compensation.

The concept does not just apply to hardware, and it is not brand new. More than 10 years ago, Castrol helped Caterpillar’s Perkins Engine plant in Peterborough, England, to cut waste fluid disposal by more than 90%. The relationship was started with a contract for Castrol to install and manage coolant reprocessing and laundering equipment in the main metal cutting facility, which produced cylinder blocks and heads. During the three-year contract, waste fluid volume was reduced from 466,000 liters to 45,000 liters — a cut of over 90 percent. The company achieved its target of zero emissions to landfill by 2010, years ahead of schedule. Total lubricant costs were dramatically reduced, but at the same time and while it was supplying much less product, the contract became more profitable for Castrol as well.

Making a virtue of necessity

Rolls-Royce plc passed a milestone in 2014, when it announced that more than 50 percent of its revenues came from services. This was not accidental; it was the result of a conscious decision to change Rolls-Royce from a company selling engines, to delivering "Total Care" that improves their customers operations. Its decision to change was driven by costumer demand – major carriers such as American Airlines were demanding a model that had them pay only when planes were flying – and a recognition that the company was missing out on lucrative aftermarket sales, which were being scooped up by third parties.

The key elements

Servitization is a word whose meaning is only just beginning to be understood – and there are several different interpretations of it. Something that they all have in common, whatever they may be called in practice, is the absence of a heavy, upfront charge that must be either financed or come from the purchaser’s capital reserves.

Its champions argue that servitization can help manufacturers develop long-term, secure relationships with their customers, even to the extent of shutting out competition; if a manufacturer has a multi-year contract with a supplier, involving regular and planned support at no extra cost, there is no easy opportunity for others to lever their way in. It can aid in overcoming low-cost competition. It also helps to provide manufacturers with reliable, long-term revenue streams that are not as reliant on the potential famine or feast of new product sales.

Challenges include financing, and this is especially the case for SME suppliers. Large companies may well be able to fund the necessary initial expenditure out of their reserves, but smaller companies can find that foregoing the large inflows of money that come with outright sales can be rather off-putting.

Investment in technology is also key. Equipment must be monitored closely, in order to ensure that usage is within specified parameters and that repairs and maintenance are undertaken so as to keep the equipment working. The Internet of Things (IoT) is looking like an essential element.

Practicality

Servitization shifts financial risk from the purchaser more towards the provider, so manufacturers providing it will usually be at the larger end of the scale. It is not impossible for medium-sized or even smaller companies to operate in this way, and to get the financial backing from a bank or asset financing company to do it, but servitization isn’t just about spreading the payments. It involves the ongoing provision of service and maintenance support that will keep the equipment operating, and the manpower to do it is the responsibility of the seller, not the purchaser.

That being the case, the seller must make sure that their product does not become a financial drain.

No need for revolution

Although servitization changes the commercial relationship from sell and subsequent service on an "as needed" basis to something more integrated and complex, it does not require a complete upheaval or need to turn the business model upside down. It definitely does require understanding the risk and how it is being redistributed, and how it can be managed.

The risk being carried by the provider is that the cost of the service provision will be higher than was anticipated, so it is essential that machine performance is optimized.

Successful servitization begins with OEE, with the close monitoring of performance in real time, in order to minimize service and maintenance costs. Planned and predictive maintenance is the heart of the strategy. If you don’t understand and embrace that, then expect trouble, uncontrolled costs and continuous surprises and unplanned events.

The collection of machine status information used to be semi-manual; the "guy with the clipboard" taking down temperature readings, physically sampling oil condition, and observing performance in practice. Hopefully, everyone has now moved on to automating the collection and recording of data, by connecting sensors and monitoring equipment.

Big Data analytics brings together information collected from several sources – including on different sites – to utilize wider experience to improve performance in practice.

Data capture and capitalization

Operational systems, operations and supply chain sensors, and PLM (product lifecycle management) databases – the whole IoT (Internet of Things) space – are the tools that enable effective servitization. Capturing this data and managing it effectively enables better service and faster support to customers, and for the rationalization of performance data across multiple plants, as well as better, wider and deeper analysis of it. Understanding performance in practice enables the minimization of breakdowns and optimization of machine usage, to begin with – but it goes further. Analysis of lubricant performance in use, for example, can leverage best practice across the organization and multiple sites. Understanding the performance can stretch overhaul intervals, if it’s known that it can be done safely. It can also help to reduce energy consumption and spot if and when particular units are performing outside normal paradigms.

Orange Business Services has been working with various partners, including Siemens and Microsoft, to enable manufacturers and suppliers to provide effective servitization offers. While each company will have its own characteristics and requirements, it will come as a relief to know that anything up to 80% of the equipment needed to do so is available on a COTS (commercial, off the shelf) basis – indeed, a lot of it may already be in place. It’s vital to ensure that the basics are right – down to confirming the sensor and monitoring equipment and the location of the appropriate USB ports.

The balance includes things like the dashboard, which must be tailored to supply the information needed, where it’s needed and in a comprehensible form.

Reward

While the advantages to the customer are obvious, what does servitization get the supplier? Broader and deeper understanding of their own equipment’s performance provides the means to improve performance and specification. The immediate advantage is a closer relationship with customers. A service that involves daily interaction inevitably means working together more closely. That proximity brings better understanding of client needs – and the means to satisfy them. Getting closer to customers makes the barriers to entry for competitors higher. Deeper relationships become longer and stronger.

If your company has the right scale and financial strength, it should actively investigate servitization as a route to growth, improved financial stability and greater profitability.

 

Discover how servitization can turn your products into recurring revenues by joining this exclusive webinar on 25 October 2018, and hear from McKinsey, Orange and boiler manufacturer e.l.m. leblanc (Bosch Group). Register here.

 

1 Morris A. Cohen, Serguei Netessine, Wharton professors of operations and information management, and doctoral student Sang-Hyun Kim.

Werner Reuss
Werner Reuss

Werner joined Orange Business Services in 2017 as Head of IoT Industrial Vertical, to support the development and deployment of Orange’s verticalized business development strategy.

During his experience of more than 20 years, Werner has developed an extensive experience in B2B across Europe, with a focus on Industry 4.0 and digitalization. Prior to joining Orange Business Services, Werner spent more than fifteen years with Microsoft in Germany, gaining a strong IoT expertise. He has a solid marketing and business development background, complemented with a great managing experience.