Tuesday, 5 March 2013

Why Servitize: Alternative Rationales

I have often thought about the reasons why firms servitize (sell services as well as products). Usually I categorise these under three broad headings - economic, strategic and environmental. The economic reasons for servitization include:

1. The challenge of competing on cost - in many developed countries firms find it difficult, if not impossible, to compete on cost alone. The reality is that their underlying costs bases are too high in comparison to lower cost economies and so they have to compete through innovation and differentiation - services valued by customers are one route of differentiation.

2. The installed base argument - in capital goods industries, where products have long-life cycles, the installed base can be significant. In 2010, for example, Boeing had 19,410 commercial planes in operation and delivered 462 new planes, giving a ratio of 42 operational planes for every new plane delivered. Providing service and support for the installed base is a significant market opportunity.

3. Stability of revenues - particularly important in recent years, in many capital goods industries product revenues can be lumpy. Significant revenue is gained when products are sold and delivered, but this doesn't happen every day. Ongoing service and support revenues provide a more stable income stream, smoothing the effect of lumpy product sale revenues.

In strategic terms there are four key reasons for servitization.

1. Locking in customers - a traditional business model that has been used for years. Products are sold at or slightly above cost, money is made on the provision of spares and consumables. Think razors and razor blades; printers and ink cartridges.

2. Locking out competitors - especially important in industries with a high installed base. As demand for high margin service and support grows, new entrants are attracted to the services market. Many original equipment manufacturers make strategic moves to partner with their customers and in doing so seek to lock out potential new entrants to the services market.

3. Increasing differentiation - some customers value the stability that service and support contracts offer. A fixed price can mean predictable maintenance costs and a transfer of risk from the customer to the service provider. These benefits provide a differentiation advantage to original equipment manufacturers.

4. Customer demand - the final strategic reason I often talk about is customer demand, in the sense that customers demand that their providers offer service based contracts. In public procurement, particularly the defence sector, this is becoming an increasingly important trend. Government Departments are asking to contract for capability, by the right to use the assets (ships, ground vehicles and planes), rather than taking ownership of the assets.

A final, and potentially increasingly important, rationale for servitization is the environmental rationale. Here the idea is to question whether transfer of asset ownership is neccessary. Think of car sharing schemes, such as StreetCar and ZipCar, or DVD sharing schemes, such as Netflicks. Do consumers really need to take physical ownership of assets or can we share access to them, thereby reducing the environmental impact of production.

While these three rationales have stood the test of time, the reasons for this blog is I came across a new strategic rationale at a recent conference - the idea of service as a pre-sale opportunity. Volvo Cars run an active programme with their dealers where they seek to persuade them that every service encounter is also an opportunity to build customer loyalty and hence secure a repeat purchase - hence service as a pre-sale. The data that Volvo presented are illuminating. They clearly show that, at least for Volvo Cars, repeat business is a function both of product quality and service quality. How many of your service staff see service as a pre-sale opportunity?

Andy Neely
Director, Cambridge Service Alliance