To be commercially successful, manufacturers adopting servitization need to carefully translate strategic intent into a robust revenue model. Dr. Peter Colman and Xi Bing Ang provide a guiding framework.
According to Simon-Kucher’s last Global Pricing Study, 66% of surveyed companies were contemplating changing their revenue model. The importance of investing sufficient time and effort to fully think through such changes cannot be overstated.
Segmenting the market
Despite the general excitement around servitization, it is rare for a manufacturer to shift its business entirely to a servitized model. Consider the civil aerospace sector – one of the earliest adopters of servitization is Rolls-Royce. According to the firm’s annual report, last year, services contributed 53% of revenue, with the rest still coming from equipment sales.
You can read Dr. Peter Colman and Xi Bing Ang’s companion piece, offering advice on how to successfully define servitization pricing strategies, here.
Manufacturers need to understand which specific segments would value a servitized model. Depending on the industry, different segmentation dimensions may be pertinent. For example, a leading lift manufacturer segments its market by customer type, selling lifts as capital equipment to building developers, while offering 10- or 20-year lease contracts to building tenants for the use of lifts.
In another case, a major truck tyre manufacturer only servitized its newest innovation, switching the price from ‘per tyre’ to ‘per kilometre’, overcoming its customers’ psychological barriers to paying much higher prices, even though they were much longer-lasting tyres. We have also seen other industrial machinery manufacturers that servitize only in some geographies and not others, due to market dynamics such as buying behaviours or credit risk.
Managing parallel revenue models brings with it significant complexity. For example, it is critical to consider the price interrelationship between the two models to avoid inconsistencies that an experienced procurement professional can exploit.
Creating the servitized offering
When designing the servitized offering, companies should avoid the common mistake of over-bundling, i.e. including the exhaustive suite of its services in an “everything-for-everyone” package. It is generally more advisable to construct a multi-tiered set of offerings (e.g. a “Gold-Silver-Bronze”- type structure) to target distinct customer segments with differing needs, willingness-to-pay and cost-to-serve.
For example, a leading global rail transport supplier offers tiered maintenance service bundles to rail system operators, from spare parts supply and preventive maintenance agreements, to full turnkey contracts where it takes on end-to-end responsibility for keeping the customer’s rolling stock operational.
In another example, an industrial equipment manufacturer offered two versions of its servitized model: one where the customer paid a fixed monthly fee for use of the equipment as well as assured supply of required consumables, and another where the consumables were sold separately – the second offering being more suitable for customers whose consumable consumption was unpredictable, fluctuating significantly from month to month.
Selecting the price metric
The price metric is the reference base unit on which the total fee charged to a customer is calculated. The key is to choose a metric that allows the provider to extract a commensurate share of value delivered to a customer, and to do so in a reliable and future-proof way.
An example of a price metric that has become an industry standard is ‘pay per print’ in the office copier market. Careful consideration of this metric is critical. As a cautionary example, one logistics company began charging for delivering flat screen TVs using a price metric of ‘per TV transported’. In the following years, the size of flat screen TVs increased dramatically, leading to a rapid explosion in cost for the logistics company with no corresponding increase in revenue.
Developing the price formula
A price formula describes how a customer’s total fee would vary at different levels of the selected price metric. This can range from a fully fixed rate, e.g. one where total price is flat regardless of usage levels, such as the earlier example of leasing contracts for lifts, to a more variable one, e.g. a tiered rate function where the customer pays a different per unit rate as usage increases from one band to the next.
Choosing the right price formula involves evaluating how it can be used to steer customer behaviour and analysing the likely margins in each situation. It is critical that manufacturers conduct stress tests prior to commercial launch through financial simulations to ensure the targeted revenue outcomes are possible.
Defining contract terms
Finally, companies should remember to consider contract terms when crafting any new revenue model. These can have a material impact on profitability and risk, and should not be an afterthought. For example, it is usually good practice to be able to offer multiple contract durations, e.g. five-, 10-year, or longer contracts.
This allows the sales team some room to negotiate and an additional lever to use in customer negotiations. Other terms that should have clear commercial policies include payment terms, break clauses and annual contractual price escalators.
Lasting change
In any fundamental business shift, significant amounts of analytical resources and management attention are typically spent on the development or enhancement of a company’s products and services. To maximise the likelihood of commercial success, a commensurate amount of both must also be dedicated to crafting the revenue model.
Constructing a compelling revenue model for servitization is a complex undertaking that requires careful consideration of all the elements described. It is also a process that needs to take place in conjunction with, rather than at the end of, the development of any new offering.
