While many companies continue to pursue their traditional Business Models, others fear theirs are under attack from technological disruption. Professor Andy Neely from the University of Cambridge is a thought leader in servitization. He explains the impact companies are facing and how to change their approaches.

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Many manufacturing companies are moving from selling products to selling services. What’s the driver?

AN: There are three different reasons. Some for economic reasons, some strategic and some for environmental reasons.

The economic reasons are that we can’t compete on cost in manufacturing in developed economies, so we must innovate and change the business model, the installed base in many countries. So, there are good economic reasons for servitising.

Strategically, customers demand it, they say “we have power – we would like to contract with you on a different basis.”

Governments often do this. You’ll see it increasingly in healthcare, where governments want to buy the healthcare outcomes we want as a society rather than just buying access to pharmaceuticals. Strategically, you might also servitise to encourage customer loyalty. If the value from your product comes from the sale of spare parts and consumables of life – you want the customer to stay with you.

We have power – we would like to contract with you on a different basis.

Environmental issues reflect changing notions of ownership. For example, in the automotive industry. Business models like Uber and Zipcars allow you to share cars, and even if you have a first car – your second car might be one you use occasionally. So rather than owning the asset, you can buy the right to use someone else’s asset for a short period of time, which creates less damage to the environment.

In your current research, how are you working with organisations to help them transition from a product and activity-based model to a more outcome-focused service model?

I sit on the Institute of Manufacturing (IOM) and one of our research areas is looking at this transformation of the manufacturing business models – call it servitization. I’ve been working very closely with BAE Systems, Caterpillar, IBM, Pearson and a number of large organisations from quite different sectors, all of which are thinking about either “how do I change my business model?” or “how do we help our customers change their business models and move towards outcomes and services?”

The Cambridge Service Alliance has spent the last six years specifically looking at this transformation challenge across all sorts of different industries.

How do we help our customers change their business models and move towards outcomes and services?

Do firms have the skills needed to move from their product model to a service model?

Making the transition can be incredibly difficult, both for the firms and sometimes for the customers. We often talk about the notion of readiness. Readiness is both your own organisation’s readiness and your customer’s readiness to accept that you might change the way you might interact with them.

Large asset manufacturing companies have for years been used to making big, complex pieces of equipment and selling machine tools. In a recent study in Germany, the data suggests that the sales reps used to give away the service contracts partly to secure the sale of the machine tool. The firm celebrated the sale of the machine tool, even though the lifetime value of the service contract was worth as least as much, if not more, than the tool itself.

In lots of engineering companies, the physical asset is what people have cared about for years, so the challenge is breaking that mindset and saying ‘the asset matters, but what is as just as important is the long-term support contract’. That mindset shift is difficult for firms to make, especially when their entire metric system and bonus packages are based around the short-term win.

In some cases, it’s the customers who are not ready to do this. They might always have purchased trains but now they’re being offered a train availability contract of a train per day. They’ll ask what capability the firm has to offer that service. So sometimes the customers are nervous about changing a system that they know and adequately now, to one where the OEM might provide more of the service. How do we persuade our customers to buy solutions from us before we have proved their value?

What are the biggest challenges facing companies when they want to make this leap from products to services?

Firstly, it’s changing the mindsets and culture inside the organisation so that people value services and not just products.

The second biggest challenge is transforming the internal workings, systems, procedures and organisational design. Functional silos and structures put barriers in place that stop the company from focusing on creating and delivering value. Who buys services and solutions? Procurement is typically not structured that way. It normally thinks in products and categories, yet services and solutions often cross multiple products and categories.

The metrics the company uses might also prove problematic. For example, changes could be made in the design process to make it easier to develop a better through-life product. However, it might increase the build cost. Given that the design team and manufacturing team are measured on keeping manufacturing costs down and direct product manufacture cost, not product lifecycle costs, it is likely that they won’t make some of those investments.

Are companies’ hierarchical organisational structures the primary barrier to this transition?

AN: A lot of companies have systems that were set up for one way of operating, and when you try to change the business model, the system holds you back. A good example is CAPEX and OPEX. There was an example in the mining and quarry industry where one of the asset providers was moving to a model where they said “Rather than just sell you machines, we will use the data from the machines to optimise production at the quarry, and we will sell you a fixed cost-per-tonne of mineral extracted from the ground.” It made perfect sense, but it caused problems because the contract cost-per-tonne was an OPEX cost, a monthly payment, whereas investment in original equipment was bought under CAPEX.

CAPEX in the customer organisation was a central HQ decision, OPEX was a local decision. So the consequence of moving to the quarry optimisation service was that the CAPEX budget went down – so less central investment – but the local OPEX budget went up. Because the budget had already been set, the local managers were resistant to this new model. Even though it was better for the organisation, they didn’t want to blow the operating expenditure budget. Systems and structures within an organisation often make it more difficult to innovate the business model.

What advice would you give to businesses now, about where the future is headed and what actions are needed in the short term?

Things are changing rapidly around digital technologies and this is creating some really significant opportunities for rethinking business models. The Internet of Things will allow us to capture more data than ever before, creating new insights into customer values. It allows companies to get closer to the end consumer, and understand the outcome that your customer’s customer is looking for.

The firms that are going to win in the long term are those focused on how we help our customer’s customer do their job, and building the business model around that.