50 Years of Growth, Innovation and Leadership

Manufacturing Leadership Journal

James E. Heppelmann

www.frost.com

Transforming the Relationship Between Products and Services

JOURNAL

Frost & Sullivan

CONTENTS

Many Forces of Transformation ............................................................................................ 3

Smart, Connected Products: The New Value Delivery Platform ...................................... 4

Enter “Servitization” ............................................................................................................. 6

A Few Manufacturers are Already Leading the Way ......................................................... 7

Five Steps to Becoming a Servitized Business .................................................................... 7

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Effiiciently making great products has been the hallmark of manufacturers’ competitive advantage during the past 50 years. This strategy has led manufacturers to prioritize activities that maximize returns at the moment of sale. In recent years, however, leverage from such production-centric strategies has begun to diminish, in part because they have become commonplace.

With a new century upon us, manufacturers are thinking about new sources of competitive advantage. A few companies are lighting the way to a brave new future in which manufacturers reprioritize activities to maximize returns across the entire useful life of the product. This thinking looks past the single sales transaction, creating multiple opportunities for an exchange of value, and simultaneously transforming the relationship between manufacturer and customer.

Under these new business models, the line between products and services is blurring, with products being reconceived as “things bundled with services” or, in many cases, things delivered and consumed as a service. For manufacturers, this means a rethinking of nearly everything, from how products are conceived, designed, and sourced to how they are produced, sold, and serviced. We’re at the early stages of a fundamental transformation, marking what could be one of the most significant business model disruptions since the Industrial Revolution.

MANY FORCES OF TRANSFORMATION

The manufacturing world understands this point all too well. We recently commissioned Oxford Economics, a global forecasting and quantitative analysis firm, to survey 300 manufacturing executives worldwide about their views of the future. Nearly 70% said they expect their companies to undergo significant business process transformation over the next three years. Why? These executives think they’re nearing a point of diminishing returns with their focus on improving manufacturing operations, with more than half saying they believe they’ve already wrung out almost all the potential savings from effiiciencies in their production processes.

In a natural response, manufacturers are looking to technology for new sources of competitive advantage. To better meet fragmenting customer demand, for example, manufacturers are harnessing digital technologies that can help them to improve global collaboration and expand regionalized manufacturing approaches into globalized design-build-service anywhere strategies. They are also employing digital product models to simulate and validate a myriad product configurations and ensure that customers’ demands can be produced at scale and complex supply chains are tracked to ensure regulatory compliance is consistently maintained.

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Figure 1: 68 percent of manufacturers agree or strongly agree that their firm will undergo significant business process transformation to prepare for future market demands in the next three years.

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Digital models don’t just reduce the constraints of geography, however. They can also reduce the constraints of time. The same visualizations of parts and assemblies that engineers rely on when designing a product also help service technicians when they maintain and fix the machines in future years. Service techs can watch computer-generated videos of sophisticated testing and repair sequences using data that was generated by the engineers who designed the original product to accelerate service calls.

Adding 3D printers and digital data to the service cycle will revolutionize the process even further. Perhaps in the future, manufacturers will be able to equip service vans with their own 3D printers. When a technician discovers a broken part, he will be able to just make a new one without heading back to the parts warehouse. Manufacturers will be able to leverage their proprietary engineering data to control servicing and slash parts inventories.

SMART, CONNECTED PRODUCTS: THE NEW VALUE DELIVERY PLATFORM

While some of these forces have been at work for a while, the rapid rise of smart, connected products is dramatically accelerating the pace of change. Products today have evolved from purely mechanical devices to fully integrated systems of hardware and software, increasingly embedded with sensors that are reshaping how machines interact with humans, with other machines, and with manufacturers. This is good for manufacturers and their customers.

For example, auto-industry supplier Continental AG, based in Hanover, Germany, now makes windshield-wiper systems with rain-sensors and software that control how rapidly the wipers sweep across the windshield. But Continental also lets car makers connect the sensors to vehicle-control systems that tell the car to roll up the passenger windows when rain starts—a win for consumers.

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An analogous win for manufacturers is being generated by what I call the “digital umbilical cord,” a persistent electronic connection to products that feeds volumes of performance and related data back to the manufacturer. An obvious application of this concept applies to the after-sales service period. Under this scenario, the manufacturer always knows about the status of the product. Smart, connected products have the ability to help perform self-diagnostics and capture service information. Manufacturers understand how products are being used, how best to maintain them, and how best to deliver value over the course of the products’ useful lives.

What we’re starting to see now is that new customer demands are also reshaping age-old business models. When customers buy something, they don’t just want the assurance it will either be fixed or replaced if it breaks. They want the manufacturer to have skin in the game. They’re signing contracts specifying that they will pay by the hour of operation or the amount of work done by the product. They aren’t simply paying up front for the product itself.

Look at Trane, a maker of HVAC systems that is part of Ingersoll-Rand Corp. An air conditioner is a pretty basic manufactured product—fans, compressors, and sheet-metal connected to a thermostat that tells it when to turn on. But Trane’s newest HVAC systems also contain extensive digital sensor systems that are connected to its Intelligent Services Center. The center monitors buildings 24-hours a day, seven days a week, watching for systems failures or warning signs of trouble. It’s a smart, connected product, to be sure.

Using proprietary analytics and subject matter expertise, Trane is fundamentally shifting its business model to offer optimized building operations as an ongoing business service to its customers. Trane Intelligent Services resolves 30% of HVAC problems remotely without sending a service truck. Some 40% of problems are diagnosed in 30 minutes or less. This allows Trane and its customers to reduce costs.

ENTER “SERVITIZATION”

Academics have coined a term for this business transformation. They call it: “Servitization.” The Servitization Cognoscenti will have its second-annual academic conference in November in Granada, Spain. For manufacturers, Servitization is “a services led competitive strategy” in which “revenue generation is directly linked to asset availability, reliability and performance,” according to Tim Baines and Howard Lightfoot in Made to Serve, one of the seminal books on the subject.

It’s a fundamental business model shift in which products evolve to be integrated bundles of services capable of delivering new value continuously through the customer experience lifecycle. The idea is already moving from the halls of academia to corporate boardrooms. Oxford Economics, for example, found that more than 70% of manufacturing executives believe their firms will offer performance-based service contracts, a form of Servitization, within three years.

Oxford Economics also found that aerospace and medical device companies are among the leaders in the move to Servitization. Many aerospace firms were inspired by the widely-cited example of Rolls Royce. The jet-turbine maker sells a service-based offering called TotalCare.

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Plane buyers contract for the hours in which the engine is available for use rather than buying jet engines. Rolls Royce takes responsibility for making sure the engines are in perfect operating condition.

Servitization as a concept isn’t a completely new phenomenon. How we consume goods has already shifted in some industries including music, entertainment, and even software. As the Rolls Royce example suggests, there’s no reason to think this same shift—from ownership to consumption on demand—can’t happen in complex manufactured goods. For manufacturers, after-sales replacement parts became a high-margin business. But customers who don’t like unplanned expenditures countered by pushing for product warranties and service contracts. In the high-tech world, software companies now get much of their revenue from maintenance contracts, which include commitments to upgrade and enhance the software.

Again, turning to Oxford Economics, more than two-thirds of manufacturers expect to use service as a differentiator by 2015, with more than half of them planning to establish a service profit center. And 77% said improving services is a key factor for competitiveness. European manufacturing executives, dealing with the region’s weak economic recovery, were particularly enthused. Among European manufacturers, 82% said they will enhance services as a way to differentiate their products, compared to about two-thirds in the U.S. and Asia.

Figure 2: By 2015, 71 percent of all manufacturers will use service as a key way to differentiate their products.

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Ironically, one of the enabling technologies for this transformation is one that’s been with us for a while: The digital modeling tools mentioned earlier that help engineers design the product in the first place. When blueprints were on paper and repair records were handwritten, tracking the lifecycles of products was difficult. But today, manufacturers have completely accurate digital designs and histories of products. Those can easily be shared across a global value chain, and they can be used to enable the service lifecycle.

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A FEW MANUFACTURERS ARE ALREADY LEADING THE WAY

Visionary manufacturing companies already are changing their business models to embrace selling bundles of services, sometimes by subscription, tied to the use of their products. Most manufacturers will probably transition to a hybrid model, in which they continue to make direct sales but get a growing percentage of their revenue from services. Ultimately these models could simply replace transactional product sales. And this impacts everything.

Manufacturers need to think early in the product development process about services they want to deliver. For example, John Deere’s WorkSight technology connects its loaders and shovels to monitoring dashboards, so company managers see where an entire fleet of mining vehicles is at any time day or night. Diagnostic data flows wirelessly to a technician who may show up at a worksite with a replacement part before a driver has even noticed a problem. The information demonstrates how a more sophisticated product—one that is designed to be smart and connected—can drive more value to the customer. John Deere is moving from being a product-based manufacturer to a solutions-based partner for its customers.

Schneider Electric is one of the world’s largest manufacturers of electrical power distribution equipment and industrial controls. In 2011, it introduced the first of a series of software-based services called StruxureWare that it provides to customers to help them monitor and operate their buildings, from data centers to offices. The company takes an integrated approach to building management that can reduce energy use by 30%, reduce capital expenditures and operating expenditures, and improve overall business performance. Schneider connects monitoring and operating of lighting, HVAC, IT, and security into a single system to greatly improve efficiency. For example, shutting off lights on a hot summer day reduces the air-conditioning load.

FIVE STEPS TO BECOMING A SERVITIZED BUSINESS

Sounds like the future just got a lot more interesting. But getting there just got a lot harder. A good place to start on your journey to new service-based sources of competitive advantage is to assess how prepared you are for such a significant business transformation.

Here are five significant areas where manufacturing companies have to change the way they look at their business models:

Service is a center for generating revenue. Traditionally, many manufacturing companies have looked at services as a cost center. Services are a route to creating an ongoing relationship with customers who will pay an annual fee. Companies need to start thinking about making investments in personnel and systems that will make services something that customers want to pay for.

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Service is key to the brand. Once a customer has bought a product, the service experience becomes the brand. Poor service directly impacts the company’s reputation, particularly in this world of online reviews. But good service can turn into cross-selling opportunities. At some companies, investments in service start rising once marketing is identified as a key stakeholder.

Spare parts actually represent a cost rather than a revenue driver. In most manufacturing companies, selling spare parts for repair of vehicles and appliances is a source of high margin sales. But if the customer has paid for a service contract, every part that needs to be replaced reduces the value of that contract.

Product lifecycle doesn’t determine customer lifecycle. Services can decouple the life of the product and the life of the customer relationship. A car lease with a warranty can roll over into a new car lease three years later, long before the car reaches obsolescence. Servitization expert Tim Baines notes that, when the Xerox Corporation takes over a company’s document production center, it can switch printers and copiers in and out as appropriate for the volume of documents being produced. End of product life no longer matters. If a more cost-effective printer is developed, Xerox will automatically install it, and Xerox will get some of the benefits of the improved efficiency of the new product.

Services require engineering and capital investment as well as personnel. Product engineers are reluctant to design for serviceability if it means higher costs. But when a company is responsible for uptime, adding costs to a product before the sale may reduce costs down the road. For instance, building in diagnostics and connectivity between a product and a service center may mean a repairman brings the right part and doesn’t need a second trip. Spending money on multi-lingual, interactive field-service videos may reduce the need for costly training classes.

In the new world, the customer relationship will be characterized by an ongoing delivery of value – exchanged over a platform in the form of a smart, connected product – rather than a simple transfer of ownership of a thing. The risk of ownership, which has historically been transferred at the point of sale from manufacturer to customer, will remain with the manufacturer itself.

The pursuit of this new source of competitive advantage could be complex. Manufacturers will need to fundamentally rethink how they design, build, and service their products. But for those that get it right, the future represents a huge opportunity to transform the way products are created and serviced, and the way value is exchanged between manufacturers and their customers.

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James (Jim) Heppelmann is the President and CEO of PTC and is responsible for driving PTC’s global business strategy and operations. Previous to his appointment as CEO, Mr. Heppelmann served as PTC’s president and chief operating officer, responsible for managing the company’s operating business units. He also serves on PTC’s Board of Directors. Mr. Heppelmann previously served as executive vice president, software products, and chief product officer at PTC with responsibility for overall product direction.

Mr. Heppelmann has worked in the information technology industry since 1985 and has extensive experience developing and deploying large-scale product development systems within the manufacturing marketplace. Prior to joining PTC, Mr. Heppelmann was co-founder and chief technical officer of Windchill Technology, a Minnesota-based company acquired by PTC in 1998. Before co-founding Windchill Technology, Mr. Heppelmann served as chief technical officer at Metaphase Technology. Mr. Heppelmann had worked at Control Data Corporation (now known as Syntegra) for seven years until the company formed Metaphase in 1992.

Mr. Heppelmann serves as a member of the national FIRST (For Inspiration and Recognition of Science and Technology) executive advisory board, and is a member of the Dean’s advisory board at the University of Minnesota College of Science & Engineering. Mr. Heppelmann attended the University of Minnesota, where he earned a bachelor’s degree in mechanical engineering with an emphasis on computer-aided design.

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