Strategy & Change

Achieving Profitable Growth: Services Business Model Innovation in a Product-Centric Environment

IBM Global Business Services

IntroductionConfronted by lower product sales prospects, increased margin pressures and customer demands for free service support, many firms are entering the service business. Yet most of these firms will be unable to scale their service operations to develop a viable stand-alone services capability. In the rare cases where they are successful in establishing a services business it will often fail to deliver the expected profit margins.

However, when properly planned and executed, a products to services business transformation generates impressive results. Our experience with several companies in various different industries over the past nine years shows that new service businesses:

Generate 15%-40% in incremental revenue;•

Provide in-depth customer relationships that bring in product “pull-through” sales;•

Generate unique insights into product usage;•

Lower sales costs by 5%-15%, and•

Contribute 10%-25% to the bottom line• 1.

From Products to Services: Key ChallengesThere are many difficulties that beset the general manager who is moving from leading a product business to leading a product and services business. Being aware of these challenges and addressing them in the planning phase is critical. Key challenges include:

Inability to Detach Services Resources from Product Support Roles: Customers who are used to getting services for free resist paying separately for them - even when the manufacturer launches an independent services business. This causes significant internal friction between the product sales team and the nascent services organization. The product sales team keeps asking for dedicated services personnel to support product sales, but the services group wants to keep key talent to help sell and deliver services independently. Often, such conflicts reach a stage where product and services groups each want their own separate services personnel who are dedicated to their respective needs.

Misaligned Go-to-Market Model to Sell Services: Many firms task their historically product-oriented sales teams with selling services alongside products. Since product sales transactions typically generate much higher revenues than services transactions, and the primary sales metric is revenue, it is understandable that services sales receive only limited focus. Yet, expectations are for services to achieve double-digit growth rates and capture new markets. This fundamental disconnect is the primary reason why many firms are not able to scale a services business.

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Uncompetitive Services Pricing: Manufacturers’ services are often unable to compete against pure-play service providers who offer similar services - typically at 15%-20% lower cost1. This causes the services group to stay in a defensive mode, offering only a product-centric services portfolio with minimal value-add. The product-turned-services company has now ceded fertile ground to competitors and has missed out on opportunities to sell those services whereby they could influence their customers’ down-stream purchasing decisions.

Organizational Paralysis Due to Perceived Channel Conflict: Many manufacturers’ channel partners offer value-added services. As such when the manufacturer decides to enter the services business it is quite normal for the product sales team to anticipate that the newly created services offerings will create channel conflict and not fully support it.

The Inability to Adopt a Different Business Model (Services- versus Product-Centric Business Model): Many of the challenges identified above occur in a corporate environment with a strong product-centric legacy. At its core, services require a different business model, as illustrated in Table 1. In addition a services business model requires different selling skills, the ability to develop and articulate a different Value Proposition (see Table 1), often to a different buying audience, with different buying triggers and cycles, and with different pricing

The challenge of embracing this new business model is compounded by managers having to launch this new services business model while protecting and minimizing any impact to their traditional product revenue stream.

Table 1: Product versus Services Business Model Differences

Product Business Model Services Business Model

Value Proposition Unique value offered: Speeds, feeds, •technologyQuality product backed by the firm’s brand•Target segment: Typically targeted at healthy •companies

Unique value offered: Business acumen, industry or •functional experience and specialized skills that enhance a client’s competitive positionMeasurable reduction in cost or improvement in key •metricsTarget segment: Companies with “problems”•

Operating Model First make, then sell•Manufacturer bears product development risk•Sales skills: Technology, product-centric•Hardware and software sales transactions•Delivery means ship and install•Employees: Existing (legacy) employees•

First sell, then make•Customers share risk•Sales skills: Establishing long-term client relationships •through collaborationDelivery means months or years of working with client •every dayEmployees: External hires as well as existing employees•

Financial Model Source of value: Innovation and development•Key Metrics: Market-share, COGS•Profit lever: Economies of scale in •Manufacturing

Source of value: Talent, customer insight•Key metrics: Rates and utilization•Profit lever: Asset reuse, economies of knowledge•

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Addressing Products to Services Business ChallengesA general manager can utilize several tactics to overcome some of the key challenges identified. These include:

Consolidating All Services Under a Single Profit and Loss Statement (P&L): In one case study, we observed a manufacturer giving away free pre- and post-sale services... at a cost of 20% of sales1. By simply launching a separate services group and chartering this services group to manage itself as a free-standing business, dramatic cost savings were achieved. The newly created services group rigorously accounted for free services given to the product sales group. Additionally, this new services group minimized free service give-aways for non-strategic accounts. By taking these steps, they cut their sales operations cost by as much as 20%1 . This simple move brought organizational discipline around free services – using them when and where they were most needed, unlocking services’ potential to pursue revenue generating opportunities, and bringing greater transparency to sales support costs. See Figure 1.

Figure 1: Traditional versus Revenue Generating Services Organizational Structure

Traditional Services Structure Services as an Independent P&L

Establishing Consistent Services Pricing Discipline: Since many services businesses are not historically accountable for true P&L, and are often subordinate to a product group, they do not have established processes for pricing. We have observed that even long after services groups have been established, pricing for various offerings is often inconsistent across any given segment, and is often dictated by the product sales team. While the product sales team does need to have pricing flexibility in order continue to win product business in the market-place, pricing policy and discipline is needed. This prevents a ‘death spiral’ towards free (value-less) services as negotiations continue to result in deeper and deeper discounts.

Corp

ProductA

Services

ProductB

Services

ProductC

Services

ProductA

ProductB

ProductC

Services

Corp

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Providing an Independent Sales Force to Grow Services: Selling services requires a consultative sales approach that is often very different from a product selling approach that relies more on technology and feature/function discussions. Typically, transaction sizes of these two different types of sale are also quite different – with product sales transactions being much larger. This dynamic naturally causes product sales reps to give away services – a smaller dollar transaction – in order to earn the larger product business. For this reason we recommend that manufacturers who are focused on growing their services business should provide their services group with its own sales force. In our observations it is also best for this new sales force to be independent of product sales and closely aligned with the services delivery team.

Gradually Unbundling Services by Targeting Different Customer Segments: A common objection raised by the product sales teams is that if you unbundle services for strategic accounts, you will lose competitiveness on future product bids. To address this concern, services teams need to gradually unbundle services - first by focusing on new customers and then by offering a new value proposition to existing customers. In essence, you perfect the new value proposition and pricing model on new customers. Once a truly value-add service is created, you can then go back to existing customers and offer them something for which they are truly willing to pay. This is an important point – service unbundling simply isn’t charging your existing customers for something that they used to get for free. It is about refining the value proposition and getting customers to recognize the value in a service they may not have acknowledged in the past. See Figure 2.

Another important point is that even in industries where a manufacturer has an existing customer base where it would be easy to cultivate new service opportunities, we still recommend the path of evolution in Figure 2 since it is better to establish the new services’ value proposition with non-strategic customers before coming back to the core strategic customers.

Figure 2: Evolution of Services Target Segment

Long-Term Near-to-Mid -Term

NE

WC

UR

RE

NT

NEWCURRENT

ValueProposition

Customer

Suggested New Path

Traditional Path

Today Transitory

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It is typical of services sales teams to follow product sales teams and build on existing product relationships at an account. Most services groups in a product-centric firm generate over 75% of their revenue from the same clients that buy their products1. There are two common issues that arise with this approach. First, the product buyer is often not the same as services buyer. Second, the customer has leverage with the manufacturer during product negotiations. The customer often asks the manufacturer to lower their services price in order to earn the larger product business. We recommend that companies develop a services specific market segmentation model to identify new services opportunities. With this targeted segmentation, manufacturers can more easily create and offer a unique value proposition to new groups of customers, (or at the very least, they can offer their existing value proposition to new groups of customers). This helps manufacturers avoid the negotiation ‘leverage trap’, minimizes internal conflict between the product and services sales teams, and causes less disruption to existing business.

Creating a Unique Value Proposition for Channel Partners: Often, channel partners create a more serviceable product by installing optional third-party modules. An example of this would be a remote monitoring service (software and call center support) added to a ‘big-ticket’ medical device. This kind of monitoring service gives the customer (e.g. hospital or large clinic) knowledge of equipment issues, needed repairs, or even training or product usage tips. Manufacturers are best positioned to create this kind of serviceable product because of their deep product knowledge. Additionally, manufacturers have a cost advantage in this process since it is usually most cost effective to install such optional modules at the factory. Lastly certain services, such as remote diagnostics, can be monitored by the manufacturer and branded under the manufacturer’s name more effectively. This lowers overall product and service price, gives the manufacturer more flexibility in capturing additional value from customers in terms of additional post-sales services. In return, channel partners can market and push customers to sign up for such services and then deliver those services in the field, sharing value with the manufacturer.

Another way that manufacturers can create value for the channel is by capturing product usage information via remote monitoring services. With so many products able to transmit usage data to manufacturers (internet connected TVs, medical imaging devices, office equipment, manufacturing systems, etc.), this data gives manufacturers the ability to create new services based on unique customer usage insight. Given channel partners’ scope of activity and expertise, it often makes sense for manufacturers to share this insight and partner with the channel to deliver innovative new services to customers. For instance, product usage data can lead to new services that help customers troubleshoot, optimize, customize or train on a particular product. Due to the breadth of these services manufacturers would typically need channel partner help to deliver them.

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Developing Services Processes which are Distinct From Product Processes: Key metrics for mature product businesses are revenue, market share, and COGS while key metrics for service businesses are revenue growth, signings, and utilization. This fundamental difference in top-level metrics means that different processes must be emphasized. Manufacturing is an asset intensive business with a focus on research, manufacturing operations and the supply chain while service delivery is a knowledge and resource intensive business with an emphasis on customer insight, knowledge management and resource management.

Executing on the Products to Services TransformationOnce key challenges are addressed with tactics like those mentioned above, there must be a focus on aligning the organization for execution of the new services business. Key execution priorities include:

Ensuring Strategic Alignment: Companies need to understand the compelling business and emotional needs to create a services division – beyond the CEO’s request. Typically, there is a strong desire for a services business, but it’s not clear the underlying reason as to why. Is it to help sell more products (a ‘pull-through’ rationale), improve the customer experience, create a stand-alone services business or improve overall transaction size? Many times it takes a business crisis, or ”burning-platform” for senior management to think through these issues, articulate the rationale for services, and financially commit to launching the new services business.

Seeking Efficiencies from Maintenance Operations: One of the biggest challenges facing senior management tasked with growing a new services business is where to get funding -especially for the additional head-count needed to sell services. At a corporate level, there is usually a process for reviewing services business plans and then providing a level of seed-funding. Yet one overlooked place for new services venture funding is in the existing services operations. These existing after-sales services operations often contain inefficient processes that have not been closely examined during the past decade. By eliminating inefficiencies and streamlining processes, modest funding can be generated for a new services venture. To do this, a few common levers should be considered. These include entitlement minimization, parts inventory reduction, enabling ‘first time fixes’, a closed loop quality feedback, returns minimization, moving after-sales services out of the product groups, and forming a global shared service, and global process standardization.

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As an example of how such savings can provide real funding for growth, see Table 2 for hypothetical illustration.

Table 2: Optimizing Maintenance Operation to Fund Value Added Services Growth

Description Value

Revenue $1,000,000,0000Maintenance Services Revenue $100,000,000Maintenance Services Cost (%) 40%Maintenance Services Cost $40,000,000Typical Improvement Achieved 10%-15%Cost Saving Achieved $4,000,000-$4,500,000

Revenue Plan for Value Added Service-Year 1 $100,000,000Quota Per Sales Person $5,000,000Services FTEs Needed 20Burdened Labor Rate for Sales FTEs $200,000Amount Need to Fund Sales FTEs $4,000,000

The hypothetical case above illustrates how optimizing traditional maintenance services could provide most of the funding needed to support the new Services sales resources.

Selecting a Services Business Model to Focus On: There are five different types of services business models: product-centric, professional service, outsourcing, information-based and financial services2. Each one is a fundamentally different type of business and with a unique set of sales, delivery, and management skills, and back-end support required to run them. One of the common mistakes that service managers make when they launch services is that they try to focus on more than two services models at a time. We recommend that management carefully select which services business model they want to adopt and ensure it receives the required support and attention.

Developing Unique Value Propositions: One reason why value propositions do not resonate with customers is that many managers – while having deep knowledge of what customers want - are too product-centric in terms of their customer thinking. In order to assess the true value proposition of new services, manufacturers must unlearn their product-oriented view of customers and relearn how products and services, as a whole, are utilized by various customer segments.

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Partnering with Ecosystem Players (Including Competitors) to Offer a Robust Services Portfolio and Minimize Risk: While many firms have outsourced parts of their manufacturing or supply chain operations, these same firms are reluctant to do so for their services operations. Few firms effectively offer their services through channel partners, yet it is quite possible – and sometimes more profitable - to offer services under their own (the manufacturer’s) brand, yet sell and deliver the services through channel partners. Another, often overlooked, area of services growth opportunity, yet one fraught with conflict, is forming services alliances with other manufacturers. In essence, this expands the addressable market by offering services for competitors of the manufacturers’ own product group.

Lessons Learned

Ensure Leadership Commitment: Providing needed attention to nurture and scale a new services business does not happen unless the CEO commits to providing key resources and sufficient investment. If a services business is to succeed in a product-centric environment, it must have more than senior management attention, it must have their enthusiasm. Building a services business is about inspiring the key leaders that they are creating the future of the company, even when their day-to-day assignments in a product-centric environment are overwhelming. In addition to an inspiring vision, there needs to be a career path for services, and the fledgling services business must be seeded with proven “stars” in key leadership roles to demonstrate leadership commitment and attract further talent.

Cultivate Services Culture: To develop a new services business, there needs to be a culture that promotes service excellence. In many situations the services culture is distinctly different from the existing product culture, and building blocks need to be put in place to create a strong services culture. This can be accomplished by implementing services performance metrics and incentives to sell services, bringing in outsiders to develop and cultivate services processes, and if required, keeping the new services group at ‘arms- length’ from the product group to let it mature.

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Evolve Organization and Skills: While there is no one right answer for the type of organizational model that will foster services growth, it is our observation that in order for services to grow it needs to be managed at arms-length, at least initially, from the product group. This organization needs the freedom to evolve with the market. Second, since services require unique skills, management needs to develop a staffing plan and career path for the services profession. This includes mixing skilled insiders with recruitment of experienced external hires, as well as articulating career options for these newly minted service professionals.

Focus on Customer Insight and the Entire Service Value Chain: While most firms have a well established product development process, services offering development is far more ad-hoc. Part of the reason for this is the low barrier to launching a new services offering. This often leads to too many offerings, unprofitable offerings, lack of sales focus on services, and confusion in the marketplace. In addition, many offerings are capability-based offerings, which is to say that the services group offers services because they have the right skills and tools already in place. While this is not bad by itself, the first test of a viable services offering should be identifying the sweet spot of customer demand and customers’ willingness to pay, as well as the services groups’ ‘adjacencies’ in terms of capabilities that might also be marketable. Pricing, market positioning, sales training and offering ‘retirement’ (as the market evolves) are all critical steps in service offering development, and require the same type of discipline as the marketing management process for products3.

Services Management System• Develop strong executive leadership • Organize customer-facing solutions unit • Refocus products unit • Develop services brand

Market Assessment• Assess demand• Test competitiveness• Identify new opporunities

Service• Develop scalable service delivery• Assess cost of service delivery• Develop pricing strategy

Marketing & Sales• Assess value of services• Transition customers• Assess and prioritize multiple customer requests• Establish long-term value relationship• Deploy services support team

Service Execution• Train service delivery teams• Develop infrastructure• Foster knowledge creation and sharing

Service Assessment• Monitor service performance measures• Assess quality assurance processes• Benchmark services against competitors• Provide input to market assessment

Figure 3: Services Value Chain

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Conclusions When managed properly, new services businesses can deliver solid economic value to the top and bottom line. In order to capture this value, managers must look at services through a very different lens, understanding that this is a fundamentally different business model than their existing product business. We recommend managing the entire Services Value Chain to realize the full benefits of creating independent services revenue stream, increased product pull-through, and deeper customer relationships.

About the AuthorAnees Gopalani, an IBM Global Business Services Associate Partner, is the Services and Solutions Leader for the Strategy & Change practice. He consults to Fortune 500 companies in the electronics and general manufacturing industries on growth strategies and business transformation. Anees can be reached at anees@us.ibm.com

References1 IBM Analysis; multiple clients, 2001-2009

2 Majewski, Bridgette and Srinivas, Singu, “The Services Challenge: Operationalizng Your Services Strategy”, IBM Business Consulting Services Executive Brief, 2003.

3 Gopalani, Anees and Bagchi, Sugato, “Products to Services Transition: Challenges and Capabilities in the Services Value Chain”, www.ibm.com/research, 2001