“Servitization”; A B2B Business Model That Will Be Embraced by the Machine Community in the Coming Decades

This blog post was written by Ron Giuntini, president of Giunitini & Company, a consulting firm focused primarily on the Configuration and Pricing of Quotes [CPQ] engaged in B2B Aftermarket agreements. Ron is also the founder of G35 Software, a prototype proprietary CPQ software tool.

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:

  1. 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.
  2. 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.
  3. 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).
  4. 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.
  5. 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.
  6. 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.
  7. 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.
  8. Contract renewal is aggressively pursued; it is a major end-game of the business model.
  9. A supplemental fee schedule is established; for solutions delivered that are not supported in the contract.
  10. Guidance for the price and configuration for quotes of the pre-landed contract is overseen by one entity.
  11. Higher profitability for seller; typically 25-150% higher than that of a product.
  12. “Stickiness” of buyer-seller relationships; continuous contact for years.
  13. Higher sales commissions for account managers; multi-year worth of booked sales.
  14. Optimized budgeting for buyer; converts CapEx to OpEx and reduces # of transactions.
  15. 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.

  1. 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
  2. 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%.
  3. “Stickiness” of Relationships
    Engaged in a long-term relationship with buyer, providing opportunities for future renewal and up-selling/cross-selling revenue opportunities.
  4. 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.

  1. The difficulty in changing organizational cultures of actors.
  2. The potential risks of large multi-year losses for seller.
  3. 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.

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The Secret to Selling More Service Contracts

This article first appeared in Field Service News on May 28, 2018

Field service executives often face challenges when it comes to generating additional service revenue for their companies.

They often face resistance from customers as evidenced by low contract attachment rates. The natural tendency is to blame the price as the reasons why customers aren’t purchasing more services contracts.

After all, this is the feedback they received from their sales teams and from the customers.

Being logical and rational business people, field service executives try to solve the problem by lowering the price, after all, if the customer says that the price is too high, it must be the reason why they are not buying, right?

To quote, the popular song by George and Ira Gershwin, “It ain’t necessarily so!”. While price may be a factor in the purchase decision, seldom is price the only reason why customers don’t purchase service contracts.

In market research studies that I have conducted for clients in a wide array of technology service markets, I have found that price is often low on the list of criteria that end-users consider when selecting and evaluating service providers. Criteria such as quality of service, knowledge and skill of service personnel, breadth of service offering, and vendor’s knowledge of their business are perceived by customers to have higher importance than price alone.

The truth is “your price is too high” will always be an objection that customers provide when they cannot justify the value of a service contract.

This is because they have no way of logically defending the value of the service being purchased. Stated another way; they are not able to differentiate the benefits of service contracts from time and materials service. The problem is that Field Service Organizations (FSOs) often attempt to sell service contracts without providing justification about why a service contract is better than simply paying for service on a time and materials basis.

A common saying among sales professionals is that customers buy emotionally and then defend their purchases logically. All too often, FSOs provide little emotional reason why a customer should purchase as service contract as opposed to T & M and even less logical supporting evidence about why a service contract is more valuable.

To achieve high attachment rates, FSOs must be able to articulate the value of their service offerings to customers as well as to their own salespeople. The value proposition must impact customers’ emotionally by addressing their fears, worries, doubts, and concerns about the impact of service or the lack thereof on their operations.

For example, fear of excessive equipment downtime, lost revenue, low machine utilization levels, or the possibility of quality defects. Of course, the FSO needs to provide logical supporting evidence why their service offering will eliminate these issues.

FSOs achieve this results by articulating, either through a sales conversation or marketing collateral, what’s included in a service contract that is not included in time & materials. This requires they do an effective job in defining the coverage, entitlements and resources available to the customer through a service contract.

They must be able to answer the customer primary question “What’s in it for me?”. If the only difference between a service contract and time & materials is that the customer can prepay for service, then there is no emotional value or logical contrast. However, if the service contract provides a preferred level of service (e.g., 4-hour response time, 99.9% uptime guarantee, 7 by 24-hour coverage, parts, etc.) or preferred price structure then the customer is presented with some real value and contrast.

Ultimately, FSOs must be able to help customers defend their purchase of service contracts. They do this by offering more value in a service contract than the customer could possibly receive through time and materials services.

Fundamentally, FSOs can deliver better service to customers under contract.

This is because the contacts provide data about the installed base and service demand requirements. As a result, FSOS can anticipate service events and be more effective at planning and allocating service resources. This, in turn, makes it possible for FSOs to provide a guaranteed level of service to their customers.

Honesty is always the best policy especially when it is supported by a guarantee and exceptional service!

Do you have any comments or questions?  Let us know by posting below !!