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How do you put a value on Servitization?

Servitization is a hot topic, particularly in manufacturing. The consensus of opinion seems to be that it’s an opportunity to add more value for customers while driving topline growth simultaneously. We talk about the benefits of positive growth, building new revenue streams and improving productivity, but how do you measure these gains? Quantifying the value of adopting a Servitization model can be tricky, and I haven’t seen much, if any, supporting data. To better understand the tangible benefits of this business model, IFS recently partnered with Noventum to produce The Service Business Growth Model, benchmarking the financial performance of 120 B2B industrial manufacturers with considerable service revenues. We looked at the growth and profit potential after manufacturing companies invested in developing new industrial services and analyzed the investment strategies of the fastest-growing and most profitable manufacturers.

I’ve picked out just a few findings from the study, which I thought were particularly interesting and worth exploring in more detail:

1. Companies that provide full-service contracts, customer business-related services, and product-related services saw productivity and profitability increase.

When manufacturers grow their service business and continue developing their capabilities, customer business-related services become the majority (53%) of their total service revenue. This leads to more profitable growth, with best-in-class providers of proactive services reporting gross margins of almost 60% and displaying productivity levels 27% higher than organizations with a reactive/preventive strategy. There’s also a positive trend if you look at the predictability of financial results, with up to 65% recurring revenues from service contracts reported by proactive service providers.

At IFS, we’ve seen this firsthand with many of our own customers. When Smart Care, America’s largest independent commercial kitchen equipment service and maintenance organization, transformed its service operation, they set a goal of 80% for technician utilization. They’re achieving around 86%, which surprised some of their executives, who thought 80% utilization was a theoretical limit! This improved productivity has also driven up their profitability. Another great example is Spencer Technologies, a retail technology provider that expanded its services with reverse logistics and repairs. This expansion has allowed them to win new contracts and increase revenue.

2. Service transformation can make things look financially worse – at first.

While moving from a reactive to a predictive model, manufacturers saw a modest increase in recurring revenue but also experienced a decline in gross margin. But why? One reason might be that organizations with strong product service backgrounds have practices that are difficult to change. Pricing is a good example – they often use cost-plus rather than value-based pricing and reduce maintenance charges during negotiations to win business. And this sort of strategy cannibalizes service revenue. The way forward is to implement a Servitization pricing model based on added value and outcomes, such as higher availability or improved performance levels from serviced machinery. And ideally, whatever that value-add or outcome happens to be, it should be something the customer is willing to pay a premium for.

One of last year’s IFS Change for Good Winners, Climate For Life (CFL) Holding , adopted such an approach. They began exploring the ‘climate as a service’ proposition around 7 years ago and, at that time, were the first to do so. They now provide customers with an energy-neutral, comfortable indoor climate, including plenty of hot water, for a fixed fee for 25 years. Another interesting example, although not manufacturing related, is Cubic Transportation Systems, a leading integrator of payment and information solutions and related services for intelligent travel applications. They embarked on an outcomes-based service journey with their customer, Transport for London (TfL), where the number one criteria is system uptime, rather than traditional break/fix metrics. But other companies have been doing this for years. In fact, Rolls Royce will soon celebrate the 60th anniversary of its ‘Power-by-the-Hour’ approach to engine maintenance management.

In summary, by moving to a Servitization model, the expectations of the manufacturer and the customer will be totally aligned, potentially for the very first time! Additionally, as everyone will be focused on delivering the desired outcome, it will be an opportunity to enter into genuine partnerships with customers. Manufacturers can stop competing on a product-versus-product basis, and winning business will be determined by who delivers the best outcome efficiently and effectively.

Please get in touch with me if you’re interested in finding out more. Alternatively, you can download the Service Business Growth Model or watch the on-demand webinar Servitization: Benchmark against the best to grow business.

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