product provider to customer value provider: escaping the services … · 2003-12-18 · product...

IBM Institute for Business Value

Product Provider to Customer Value Provider: Escaping the services maze

Lured by attractive economics, many manufacturing firms have attempted to establish complementary services businesses, only to find themselves trapped far short of the profitable growth that they originally imagined. Recent analysis at the IBM Institute for Business Value suggests that services success depends on a firm’s positioning itself as an indispensable part of its customer’s value-creation process— not simply by providing a valued service, but by helping the customer create more value overall.

By Dan Greenberg

Product Provider to Customer Value Provider

1 Product Provider to Customer Value Provider IBM Institute for Business Value

Introduction

Product makers face an escalating challenge. In today’s marketplace, maintaining any type of competitive advantage is increasingly difficult. Global expansion—while it may offer new markets—invites intense competition. After all, in a global economy, there is only one low-cost provider, one brand leader and one “world’s largest;” regional leaders may soon trail global competitors. Advantages from innovative product and process design fade quickly when information on leading manufacturing practices is easily accessible and secrets can be revealed through reverse engineering. Driven by rising customer expectations, manufacturers flood the market with new products and features, only to find the market saturated quickly and their customers overloaded with “innovation.”

The numbers demonstrate what many manufacturing executives already know: lack of growth is a serious problem. More than two-thirds of the U.S. industrial companies in the IndustryWeek 1000 have underperformed the S&P 500 for the past 5 years, and 69 percent of the top U.S. publicly traded industrial companies have a stock value that is lower today than it was 5 years ago.1

When growth slows, companies try tactics that have worked in the past: focusing their portfolio on their strongest products, cutting costs through process improvement or using successful platforms to expand into adjacent markets. But when traditional growth tactics reach the point of diminishing returns, firms frequently turn to services for much-needed revenue improvement and a healthier bottom line.

The economics certainly seem superior—a recurring revenue stream, less fixed capital and higher margins. A services business can build on the firm’s products, brand image and existing customer base, while simultaneously attracting new customers. It sounds like an ideal path to enhanced profitability. Unfortunately, the transition from a product-centric company to a services-oriented one is not straight, even, or easy. For many firms, it’s more like a maze.

Contents

1 Introduction

2 The maze

4 Solving the maze

9 Preparing for the trek

12 Exit the maze, enter the race

12 About the author

13 References



The maze

Although many manufacturers have entered the fray—attempting to increase shareholder value through new services offerings—few have emerged with successful services businesses. In some situations, mistakes in strategy creation and business execution have actually led to value destruction. Those who fail to make the transition from a product to a services business typically stumble into one or more blind alleys:

The dead end—a poor value proposition

As with products, a strong customer value proposition is critical when developing a new services offering. Yet, some businesses fail to accurately assess the value that their customers place on a particular service. Although the services businesses are fundamentally different, a company might still be relying on product-centric information. Whether it lacks insights about customer preferences, misunderstands basic requirements or underestimates expectations about services, the services business usually has the same result: it fails to meet its goals.

When a company’s vision of the future is distorted—sometimes clouded by prior success—leaders can misinterpret or, worse, ignore important trends, invalidating their company’s core value proposition. For example, companies that produce film and photographic equipment foresaw the game-changing potential of digital imaging, with its plethora of associated services opportunities, long before any significant demand emerged. Yet, some firms ignored the signs until it was too late. Despite a large commercial customer base that relied heavily on quickly capturing, storing and distributing images, Polaroid was slow to act on new digital services opportunities, failed to move beyond its core business and eventually, in 2001, filed for bankruptcy.2

A manufacturer who

specialized in custom-built

motors was caught off guard

by the industry migration

toward less-expensive,

standardized motors. Their

customer base evaporated

as clients realized the

performance differential

offered by a tailor-designed

motor was not worth the

price premium for

customization services.

The endless loop—an easy-to-duplicate offering

Truly unique services are difficult to imagine and even more challenging to deliver. But, when barriers to entry are low, an organization can be drawn into a tit-for-tat spiral with competitors. One firm adds a services offering; the competitor responds in kind. The firm adds another service; their competitor matches it. Companies in the endless loop run faster and faster, creating broader and broader offerings, without achieving their desired growth or margins.

Warranties are a typical first move toward services. But, how long does it take for the competition to create or enhance a warranty? Next, many companies offer installation or maintenance services for their core products; soon everyone does the same. Service offerings across entire industries become commodities because market players have not been able to design and deliver truly differentiated services.

Competitive pressures have

forced automakers to

continually extend standard

warranties — with some

manufacturers now offering

ten-year terms that include

normal maintenance, too.



Squeezed in a corner—bundling products and services

Each quarter, the pressure mounts. To meet revenue numbers, businesses frequently make trade-offs, sacrificing margins in one area to close a large, multifaceted sale. Unfortunately, when a manufacturing company discounts a bundled solution, the “cut” occurs in the most profitable areas—typically the new services. And, because services usually comprise a smaller part of the overall bundle, the impact is disproportional; a 5 percent discount on the whole could mean 20 percent less profit for the services business. Before long, services margins sink toward product profit levels, and the business is left wondering where those attractive—and much-anticipated—services profit margins went.

Bundling services with products has another consequence. Services may be discounted or given away to make “the big sale” for the product business. Discounting or giving away services, though, sets a margin-threatening precedent with individual customers—and, eventually, the marketplace. Similar to the endless spiral described previously, competitors are compelled to match pricing actions, shrinking services margins across entire industries. Once customers expect a service to be discounted or free, a firm is forced to invent new, full-priced offerings to help offset lost profit. As those new services are bundled into “solutions” and succumb to “bundled discount” pressure, the debilitating cycle continues.

Individual private branch

exchange (PBX) makers

initially bundled warranty and

installation services with

equipment purchases as a

way to “differentiate” their

products. Soon, most providers

offered similar services.

Rampant discounting followed,

and the industry’s services

margins shriveled.

Becoming sidetracked— losing product focus

When launching a services business, it is natural for manufacturing companies to concentrate on making the new business a success. However, in the frenzy and excitement of launching a new services line of business, an organization may focus management attention and business incentives on the “new model” and ignore the remainder of the business. The results can be detrimental to both old and new businesses. Services are typically related in some way to the manufacturer’s product—either directly or through brand association; product quality or customer service issues reflect poorly on all areas of the business.

Pre-1980, a significant portion

of Xerox’s profits came from

leasing and servicing its

copiers. Few incentives

existed to drive improved

product quality. Though highly

profitable, maintenance

revenues evaporated as

competitors took share with

more-reliable products. Overcoming the Minotaur —making a complete transformation

Like the character from Greek mythology, Theseus, who had to overcome a mythical monster to escape the labyrinth, manufacturing companies face their own “Minotaurs” in the transition from products to services. Firms often view entry into a services market as just another growth initiative, severely underestimating the degree of organizational change required. They attempt to sell services as they’ve always sold products, add new responsibilities to existing roles, maintain current organizational structures and manage the business using existing metrics and incentives. This seldom works. Required capabilities and skills are frequently missing. The business constantly runs into obstacles because the organization is still operating in traditional, product-centric ways.



Even when organizations do recognize necessary changes, completing a transformation of this magnitude is a challenge. Rigorous change management is essential. Whether they become discouraged or distracted by other, more pressing priorities, some organizations simply never complete the job, and a strong services business never materializes.

Figure 1. The traditional line of negotation.

Source: IBM Institute for Business Value analysis, after Introduction to Negotiation, Professor Mary P. Rowe, MIT Sloan School of Management, 1999, used by permission.

Value customer captures

“Zero-sum” game

Conquer

Appease

Competition drives margins down

Valu

e m

anuf

actu

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aptu

res

An automotive parts

manufacturer decided to

offer inventory-management

services. Although demand

was high, the firm could not

deliver reliably. Prematurely

launching their services

offering —without requisite

processes, skills and

technology support —

cost the company several

key customers.

Solving the maze

Despite a few impressive turnaround stories, most manufacturing firms have struggled to succeed in the services realm. Strategy design flaws and poor execution are prevalent, leaving many businesses trapped in a seemingly inescapable maze. Research at the IBM Institute for Business Value suggests a more-navigable route—one where companies design strategies differently and prepare their organizations properly for a services-oriented transformation.

When designing a services strategy, businesses naturally gravitate toward service offerings that increase “wallet share” with existing customers. Frequently, this puts the customer and the supplier at odds, forcing a tug-of-war along traditional lines of negotiation (see Figure 1). It’s a zero-sum game: every dollar the manufacturer wins is a dollar lost to the customer.



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However, to develop a more compelling proposition, product makers should consider a different objective. Instead of inventing services aimed at gaining a greater share of customer spending, suppliers should look for ways to help customers create more business value. Rather than pursue the now popular role of “solutions” provider—packaging traditional products with a range of new services—product providers should reinvent themselves as Customer Value Providers (CVPs). With this new CVP mindset, traditional zero-sum negotiation disappears; both parties can win (see Figure 2). When the customer realizes significantly more value, the supplier improves its competitive position and shares in the windfall it helped create.

Figure 2. Unlocking new value creates more for all.

Source: IBM Institute for Business Value analysis, after Introduction to Negotiation, Professor Mary P. Rowe, MIT Sloan School of Management, 1999, used by permission.

Value customer captures

“Zero-sum” game

Conquer

Appease

Valu

e m

anuf

actu

rer c

aptu

res

Total possible value



Down-chainUp-chain In-chain

Financing and infrastructure

When a manufacturer becomes a CVP, the ultimate goal should be to create a defensible new market position. IBM Institute for Business Value analysis suggests that the odds of success are higher when suppliers can ingrain themselves—as deeply as possible— in their customers’ value-creation process. As a supplier’s coverage expands further throughout the customer’s value chain and their knowledge of the customer’s business deepens, they become more and more difficult to replace. To move into that coveted position, companies should look for opportunities in all directions: up-chain, down-chain, in-chain and throughout the “gold-chain” (see Figure 3).

Gold-chain

Figure 3. Opportunities to embed yourself in your customers’ value chain.

Source: IBM Institute for Business Value Analysis.

Up-chain

Some forms of up-chain integration, such as vendor-managed inventory and electronic data interchange (EDI) order capability, have become extremely common. In many industries, customers expect suppliers to offer these services and consider them a basic prerequisite to supplier qualification. Although offering these services no longer differentiates a manufacturer in the traditional sense, companies that embraced these practices early did gain a distinct advantage: they carved out a toehold in each customer’s value chain and raised switching costs for those customers. Even services that no longer provide general marketplace differentiation can yield individual customer differentiation if a business presses its positional advantage and makes itself increasingly indispensable to individual customers.

Collaborative product design may be the new frontier for up-chain integration. Companies as diverse as industrial lubricant producers and circuit board manufacturers are now assisting their customers with design of the final product. These suppliers gain in-depth knowledge of the customer’s business, thereby creating ties that are difficult to break. With design services in particular, companies should keep two strategic design points mind: design fees should be kept separate— instead of bundling them with manufacturing charges—to help protect against margin erosion; and the value for the customer obtained from collaborative design must be clear and compelling enough to differentiate it from standard fare.

Research and Development Procurement Manufacturing Marketing and sales

Distribution and logistics



In-chain

Asset management is emerging as a new category of in-chain services for manufacturers who produce capital goods. Technology that wasn’t available or practical ten years ago now enables additional information gathering and remote problem diagnosis. For example, a manufacturer of mining equipment has equipped its products for remote maintenance—benefiting customers that formerly faced the cost and downtime of lowering mechanics into the mines or pulling the machinery out of the mines for routine maintenance and repair. John Deere now offers “Ag Management Solutions,” where the company’s consultants provide agricultural advice to farmers based on insights derived from tractor-mounted devices that collect data on field condition and productivity in segments as small as ten inches.

In-chain integration opportunities are available to suppliers of both direct and indirect goods as well. Automotive component suppliers have broadened their role, preassembling and deliver-ing entire subsystems to OEM assembly lines. Technology makers now provide outsourcing services for entire processes—both business and technical— that involve their products.

For decades, manufacturers have recognized the importance of having their products “designed in” as part of their customers’ end products: switching costs are high. As a CVP, being designed in as an integral part of the value-creation process is equally important. Thus, there is a natural tie to up-chain, for-fee design services… and a strong incentive to discount them. Companies must balance the customer value created (and captured) through up-chain, for-pay design services with the customer value created (and captured) by being an active in-chain participant. This balance is difficult and, as will be discussed later, the right choice is the one that puts the supplier on a path to increase barriers to competition.

Down-chain

Down-chain ideas are more difficult to envision because of the tendency to think of suppliers as up-chain or in-chain relative to the customer’s value production. But, creativity can pay off. For example, one company that produces custom-designed packaging realized that it could increase the efficiency of its customer’s downstream value chain. Rather than ship the special cartons it produces to the consumer packaged goods manufacturer, the packaging producer could receive the product itself, package it and distribute the goods directly to retailers. With no need to transport bulky containers or maintain a stockpile of empty packaging, production costs go down, and both businesses profit. Over time, other opportunities for the packaging producer will begin to appear: designing additional packaging, managing distribution channels or handling channel negotiations, just to name a few. As its sphere of influence grows, the packaging producer becomes more indispensable and more immune to replacement.



Gold-chain

Interesting ideas for integrating into the customer’s value chain often appear when suppliers pay attention to “the gold.” In addition to offering their engines for short-term lease, long-term lease and sale, General Electric Aircraft Engines (GEAE) provides a Power-by-the-Hour program, where they charge not for the engine itself, but for actual usage. This approach converts a major fixed cost for airlines into a variable expense. It also reduces the pressure to accurately determine up front how many spare engines to purchase. Unused engines are expensive, as is a plane grounded for lack of a spare; purchasing decisions are risky. For those who prefer to own the engines, GEAE also offers “spares” insurance, guaranteeing that a replacement can be delivered to any airport within 24 hours.

Along with their gold-chain offerings, GEAE also works in-chain, servicing all makes of engines, not just their own. GEAE thus obtains comprehensive maintenance contracts with major airlines and has access to accurate data on both the maintenance costs and residual value of their competitors’ engines. Collectively, these programs allow GEAE to optimize product designs and pricing structures based on solid data, and to solidify a role in its customers’ value chains by creating real value for its customers.

An effective CVP strategy …

• Presses your advantage—Take one aspect of your business where you currently outshine the competition and parlay that edge into a credible starting point for a services business.

• Reflects a strong knowledge of your customer’s business—To find a unique way to add value to your customer’s business, you must first develop a deep appreciation of their business goals and critical challenges.

• Aligns with critical customer goals—Although it’s common practice to design a strategy around your objectives, an effective CVP strategy concentrates first and foremost on helping customers achieve their key goals.

• Increases barriers to competition—Unique services are the long-term goal, but establishing high barriers-to-entry must be a critical design point for your CVP strategy. Broad and deep positioning in the customer’s value chain can help elevate switching costs.

• Is designed with “continuation” in mind—Finding an ideal initial entry point into services may not be feasible. Therefore, it’s critical to devise a multiphase plan, a map of the maze ( just as Theseus created with his ball of twine), that extends obvious first steps into a progression toward the ultimate destination: a defensible market position that creates substantial new value for your customers… and high margins for you.



Preparing for the trek

A CVP strategy is not simply a new growth strategy. It’s not like introducing another “product” or expanding into an adjacent geographic market. Successfully becoming a CVP involves major, enterprise-wide transformation and demands executive-level commitment, a clear vision … and adequate resources.

Moving to a significantly different business model is virtually impossible without modifying some basic underpinnings of the business. And, although a transformation from product provider to Customer Value Provider is worthy of more discussion than can be included in this paper, Figure 4 offers a glimpse into the type of change involved.

Manufacturers — while concerned with meeting customer requirements — are naturally organized and focused on the development and manufacturing of products. In CVP companies, customer value is the product. Therefore, these businesses are overwhelmingly customer-facing. Their organizational structures, employee attitudes and operational metrics all reflect this focus. Services business startups are fast-paced and risky, and the services staff must operate in an environment that differs greatly from the inwardly facing focus of the traditional product business.

For a fledgling services business to gain its footing, it needs to operate as a separate organization with its own income statement, an independent management structure and sufficient autonomy to avoid being unduly influenced by the larger product organization. Without this independence, the temptation to bundle, discount and thereby crush the nascent services business will be overwhelming.

Marketing strategies and channels will probably be different for a CVP. Firms may need to reallocate investments to help reposition their brand. Balancing the needs of distinct businesses with the need to appear as a single, cohesive company to the customer will inevitably be a challenge. Sales coverage and deal structure can become more complicated. New types of contracts are required, with associated changes in creation, risk assessment, negotiation and administration processes.

Different business models demand different ways of measuring success. And, even when the actual measure is the same, the results are not always comparable. Take gross margin, for example. The cost of goods sold is usually far less in a services business where salaries—one of the largest expenses—may fall below the line. As a result, there may be many percentage points of difference in gross margin between the services and product lines of business, with no clear indication of which business was more successful.

In services businesses, capital generally means people, not factories. Improving your return on these “assets” requires different types of investments, including:

• Establishing better knowledge-management practices

• Creating “social networks” where individuals can locate experts and accelerate responsiveness

• Developing new methods for recruiting and retaining customer-facing employees

• Building missing skills and adopting new training approaches that rely more on mentoring and learning through apprenticeships

• Placing proven managers who have built and led services businesses, not simply businesses, in leadership roles.

For a product maker, expanding into a CVP role often exposes gaps in the company’s application portfolio. A manufacturer probably lacks a full suite of customer-facing applications. And, even though many functions are conceptually the same between product and services businesses, specific application requirements are usually quite different. The technology for operating a call center for a services business is different from applications used to provide product support; software designed to schedule manufacturing and supply operations simply won’t handle dispatching services personnel. To compete effectively, product makers need to rethink and refine their technology infrastructure to meet the unique needs of their new services businesses.

Figure 4. Product Provider-to-Customer Value Provider transformations involve significant change.

Corporate culture

Organization design

Go-to-market approach

Metrics

Return on “assets”

Technology infrastructure



Figure 5. Strategically planned and executed, transformation from providing products to providing

customer value can yield significant rewards.

As demonstrated by companies such as General Electric and IBM, CVP businesses can be key contributors to sustained long-term growth (see Figure 5). However, given the inherent risk of converting an established enterprise to a completely different business model and mode of operation, most manufacturers are understandably apprehensive. How do you know where to start—or whether a Customer Value Provider role is actually a smart move for your company? Here are some steps to help guide your thinking:

Evaluate your current position

• What do you consider your strongest market advantage? A distinguishing process or technology? Your scale or scope? Unique relationships with customers?

• Can your advantage in the product market give you an advantage over current providers of the services that you’re creating?

• Have you leveraged your existing advantages to their fullest before seriously considering a services play?

• Where does your product fit in the customer’s value chain? Is it considered a capital or direct purchase?

• How critical are your products to your customer’s value-creation process? Does their production stop if you don’t deliver? What portion of their value is attributable to your product?

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Examine your customer’s value chain

• Are they struggling with cost control in a particular area?

• Where are they losing business opportunities?

• Can you pinpoint critical business processes where improved asset utilization could dispro-portionately impact value?

• Can you reduce their risk or help shield against downturns in their business cycle?

Compare your strengths to customer’s weaknesses

• What can you do sooner, cheaper, quicker or better?

• Where can your unique capabilities be leveraged in new ways to help the customer create more value?

Analyze emerging opportunities

• Can you fully gauge the value of your services to your customers? Do they understand this value?

• Is the change in value produced substantial enough that the customer would be willing to share a portion of the gain with you?

• After evaluating standard criteria such as market potential, competitive strength and overall risk, does the opportunity present an attractive and achievable payback profile?

Chart your path

• How can you break down the transformation to a CVP into realistic steps?

• What capabilities are required at each point? What do they cost to develop and maintain? How can you continue to be profitable at each step of the transition?

• Is your overall portfolio of initiatives balanced between long- and short-term changes and high- and low-risk moves?

• How frequently should you reevaluate and adjust your plans?

• What is the best route? Is there a critical path? Can you better optimize interim returns by adjusting the sequence?

• Most importantly, have you constructed a series of linked initiatives that truly elevate the value created for the customer and continuously improve your competitive position?



Exit the maze, enter the race

Although services businesses are certainly not a panacea for the constraints manufacturers are currently experiencing, they can contribute to growth—if designed and operated strategically by a true CVP. Yet, starting a new business venture is never easy. And, in the manufacturing sector, designing and executing a viable services strategy can be particularly challenging. As a leading computer manufacturer that has transformed itself, IBM understands the daunting nature of the task—and why it is so critically important. Our Strategy & Change consultants would welcome the opportunity to discuss both the challenges and rewards a CVP strategy might afford. To learn more about Product Provider-to-Customer Value Provider transformations from the research conducted at the IBM Institute for Business Value, or to explore how we can assist you with your emerging business design, please contact us at [email protected]. Additional resources for business executives are available at our Web site:

ibm.com/services/strategy

About the author

Dan Greenberg co-leads the Industrial Sector team at the IBM Institute for Business Value. Dan can be contacted at [email protected].

The IBM Institute for Business Value develops fact-based strategic insights for senior business executives around critical industry-specific and cross-industry issues. Clients in the Institute’s member programs—the Business Value Alliance and the Institute for Knowledge-based Organizations—benefit from access to in-depth consulting studies, a community of peers and dialogue with IBM strategic advisors. These programs help executives realize business value in an environment of rapid, technology-enabled competitive change. You may contact the authors or send an e-mail to [email protected] for more information on these programs.



Contributors

• Marc Chapman, Managing Principal, Strategy and Change Practice, IBM Global Services.

• Drea Lewis, Consultant, Strategy and Change Practice, IBM Global Services.

• Jerry Longyear, Executive Consultant, Strategy and Change Practice, IBM Global Services.

• Singu Srinivas, Principal, Strategy and Change Practice, IBM Global Services.

• John Zuk, Principal, Strategy and Change Practice, IBM Global Services.

References1 IBM Institute for Business Value Analysis.

2 Deutsch, Claudia H. “For Polaroid, the Bad News Seems to Be the Only News.” The New York Times. October 4, 2001.

© Copyright IBM Corporation 2002

IBM Global Services Route 100 Somers, NY 10589 U.S.A.

Produced in the United States of America 05-02 All Rights Reserved

IBM and the IBM logo are registered trademarks of International Business Machines Corporation in the United States, other countries, or both.

Other company, product and service names may be trademarks or service marks of others.

References in this publication to IBM products and services do not imply that IBM intends to make them available in all countries in which IBM operates.

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product provider to customer value provider: escaping the services … · 2003-12-18 · product...

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