Before venturing further, let us first define ”servitization”; it is a business model in which a machine (i.e. forklift, truck, order picking robot) is not sold, but is accessed by an end-user through a multi-year fixed-fee outcome-based service-contract. A servitization focused contract is primarily landed at the time of the delivery of a new or used machine. The service typically encompasses the following 15 elements:
- The equivalent of an operating lease is supplied; machine ownership is never transferred to the service recipient. Many of these machines in the future will be autonomous.
- The Intellectual Property [IP] of a machine’s embedded software configuration is not controlled by the service recipient, but by the owner of the machine.
- Solutions are supplied to maintain (i.e. break/fix) and improve (i.e. upgrade) a machine’s capability (i.e. lift 5,000 pounds), employability (i.e. 95% uptime in a 24 hour period) and deliverability (i.e. 8 hours of operation per day).
- An outcome-based fixed-fee is typically aligned with the customer’s revenue streams; in fact the fee becomes a variable cost. For example a public warehouse forklift user could be charged a fee of $3.75/ton for movements from storage to staging and loading of a vehicle; the fee would be directly aligned with their handling charge of $4.50/ton for the same movements to its customers.
- Solutions are delivered for a continuous period of time during the post-production life cycle of a machine; when over 1 year, revenue recognition financial reporting is required.
- The performance levels of solutions delivered are assured. For example technicians will arrive on-site for a break/fix event within 2 hours of being notified within any 24/7 period.
- Amendments are incorporated to the contract, such as up-selling or cross-selling; will often occur as a result of changes in the business environment of the customer during the multi-year contract duration.
- Contract renewal is aggressively pursued; it is a major end-game of the business model.
- A supplemental fee schedule is established; for solutions delivered that are not supported in the contract.
- Guidance for the price and configuration for quotes of the pre-landed contract is overseen by one entity.
- Higher profitability for seller; typically 25-150% higher than that of a product.
- “Stickiness” of buyer-seller relationships; continuous contact for years.
- Higher sales commissions for account managers; multi-year worth of booked sales.
- Optimized budgeting for buyer; converts CapEx to OpEx and reduces # of transactions.
- One “button to push” by buyer to address any performance issue with seller.
Currently, the decade-plus employment of the term of “servitization” has primarily been the focus of European Union [EU] based academia and EU OEM Board Of Directors [BOD] suites. In the last 2-3 years, EU-based OEMs have been touting the term in their US-based operations. Also a limited group of US-based academics and management consultants have been discussing the model as well. As of today, few US-based BOD, or investors are familiar with the term, but it is my belief that will be changing in the near term. Note that the terminology employed for the US-based business model may be different than that of the EU-based “servitization”; currently US-based firms employ terms such as “subscription” and “Product-as-a-Service [PaaS]” that encompass many of the elements of “servitization”.
In one perspective, the revenues generated from servitization simply shifts transactional-based revenues to that of the contract. For example, a Preventive Maintenance [PM] task is scheduled every 600 hours employing $1,000 of parts; this will be done either by the maintainer/owner purchasing $1,000 of parts in a transaction or having the parts bundled in the contract’s pricing of the fixed-fee per hour of operation. At this point there is little incentive for the seller to embrace servitization; it appears to be a zero-sum game.
The “magic sauce” of the seller of a servitization offering encompasses 4 major areas.
- Higher Profitability
There is a powerful incentive to reduce costs incurred to deliver an outcome-based fixed-fee solution during the life of the contract
- Contracted Recurring Revenues
The investor community is “excited” about such a recurring revenue business model; they reward the enterprise with highly favorable valuations that can exceed the Price/Earnings [P/E] ratios of their peers by 25%-50%.
- “Stickiness” of Relationships
Engaged in a long-term relationship with buyer, providing opportunities for future renewal and up-selling/cross-selling revenue opportunities.
- Optimized Performance of Machine Models; Customer Success
In order to meet outcome performance assurances, the seller will provide the buyer with continuous improvements in the capabilities, employability and deliverability of the machine.
Below are some of the factors that may hinder the embracement of servitization by the Commercial Machine community.
- The difficulty in changing organizational cultures of actors.
- The potential risks of large multi-year losses for seller.
- Challenges of sellers in educating the investor community of the new business model on the income statement and balance sheet.
In conclusion, it is not if the “servitization” business model will be embraced by the Commercial Machine community, but when. It will be difficult journey, of 10-25 years, but when early adapters demonstrate the financial and relationship benefits, the rest of the community will follow suit.
Would you like to learn how to effectively implement a “Servitization” business model in your company? Schedule a FREE Consultation TODAY!