4 December 2012

The Servitization of Manufacturing: Where Does Value Lie and When Is Value Realised?

One way of conceptualizing the servitization of manufacturing is to think about the two questions: (i) where does value lie, and (ii) when is value realised. In traditional manufacturing environments the value lies in products & parts – the physical assets – and value is realised at the point of sale – when the customer pays for the product. Many manufacturing businesses, particularly those with long life cycle products, have recognized that value can also be realized throughout the life of product, especially when products need repair and overhaul. Such firms have a strong focus on the aftermarket and capture significant value through the sales of spares and repairs.

An alternative perspective is to think about value lying in “solutions” rather than “products & parts”. This paradigm puts the emphasis on the outcomes the customer wants, rather than the physical product. The old Theodore Levitt quote “customers don’t want quarter inch drills, they want quarter inch holes” illustrates the point. Many customers don’t want to own the physical products that many manufacturers provide, instead they just want the end result – or the outcome – that the product delivers. When manufacturing firms switch to an outcome focus they often contract for capability, guaranteeing uptime and/or availability of their equipment through life. Rolls-Royce, in its aero-engine business, now contracts for Power by Hour, selling the thrust the engines deliver rather than the engines themselves. A significant advantage of contracting for capability is that the incentives of the customers and the original equipment manufacturers are aligned. In an aftermarket focused model, it is actually in the original equipment manufacturers interest for their equipment to break down, as they realise value when they repair their products and provide spare parts. When contracting for capability or outcomes, however, the original equipment manufacturer only gets paid when their equipment is working, so it is in the original equipment manufacturer’s interest to maximize equipment reliability, something that customers also care about.

One of the challenges of contracting for capability is the issue of risk. If original equipment manufacturers take responsibility for the outcomes their products deliver, effectively guaranteeing results for their customers, they inevitably take on significant risk. The original equipment manufacturer is now responsible for delivering outcomes, not just the product. Some servitizing manufacturers have decided that the risk involved in outcome based contracting is too great and some customers have decided they are not willing to cede control over the outcomes, so they are unwilling to enter into contracting for capability. In such situations there is an alternative approach to offering services - selling knowledge and insight – recognizing that value lies in the solution the original equipment manufacturer offers. Think here of manufacturers that also offer design and development or installation advice. Think of those that have moved into training and consultancy services. They no longer simply sell products. They also sell knowledge and/or insight. Figure 1 brings these four perspectives on servitization together into a single representation, which illustrates the strategic choices manufacturers can consider when exploring how to servitize. These choices are not mutually exclusive. Manufacturers can decide both to be aftermarket and advisory focused, although clearly the different positions require different organizational capabilities.

Figure 1: Conceptualising the Servitization of Manufacturing

Andy Neely
Director, Cambridge Service Alliance

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