Servicization: Managing Mission Critical Products As Services That Generate Customer Value

Servicization: Managing Mission Critical Products As Services That Generate Customer Value Morris A. Cohen The Wharton School, University of Pennsylvania Vinayak Deshpande Purdue University Geert-Jan van Houtum Eindhoven University of Technology SCTL, Costa Rica July 2009

Theme: Products as Services and Services as Products Servicization = converting a tangible product into a service associated with the value generated by the customer through product utilization throughout the after sales period

Supporting the customer’s after sales experience provides an opportunity for sustainable competitive advantage 80% of cost determined in design Customer Value Creation Design Post Sales (Support) Satisfaction determined post sales through product use Produce/Fulfill Product Life Cycle

After-sales service market • Industries: Aircraft, semiconductor, automobile, defense, medical devices, oil and gas,... • After-sales services represents: 26% of total revenue, 46% of total profits (Sources: AMR Research, Aberdeen Group - 2002, Deloitte - 2007) • Commercial & military aircraft: Customers: airlines, military, other institutions CONTRACTS Repair and maintenance Prime Supplier 1 Supplier 2 Supplier ... Supplier 3 Supplier n Avionic system Landing gear Mechanical Engine

Yet, the potential to capture additional service business is enormous After-sales service market After-sales spare parts market 40% Served 70% Served 30% of installed base not being served 60% of installed base not being served And, the “non-captive” market represents a much larger opportunity

Servicization Benefits • Higher profitability due to higher margins • Lower risk revenue stream over the entire product life-cycle (captive consumers) • Source of differentiation from competition • Deeper understanding of customer’s technologies, processes and plans – knowledge that rivals can’t easily aquire • Alignment of incentives for sustainability and environmental impact (e.g. painting automobiles)

Servicization in Practice • Extensively used in the chemical industry, emergence of Chemical Management Services • Performance Based Logistics (PBL) contracts used in the military • IBM redefining itself as a one-stop provider of services such as systems integration, hardware and software expertise, etc. • Xerox positioning itself as “The Document Company” by selling “document management services” • CAT logistics offers its capabilities in service parts management and logistics to other customers • Airproducts and Chemicals delivers gas to INTEL fabs

Main Issue 1: How should “servicization” of products be managed?

Issue: How should service contracts/relationships be structured? • Examples: • “Power by the hour” contracts pay engine manufacturers based on flight hours flown • “Product availability” contracts used in the aerospace and semi-conductor industries • “Downtime” penalty contracts used by Intel with its equipment manufacturers • Flight “On-time” performance used as a popular metric of service in the airline industry

Performance-based Aligned Incentives Service Provider Buyer Value of Services through Products Wants to increase Wants to increase T&M vs Performance-Based Support Time & material Conflicting Incentives Buyer Supplier Material Products Wants to increase Wants to decrease TIME & MATERIAL CONTRACTS: Payment based on resources consumed in the service PERFORMANCE-BASED CONTRACTS: Payment based on flying hours generated by the service

Main challenges: Management of resources Optimization of service supply chain (parts, repair, support) Outsourcing and asset ownership Design value (performance) based customer-supplier relationships Measures of performance Allocation of risk and risk premium Rationing over mutliple customer segments Pricing (product vs. support service) Contract terms

Main Issue 2: Delivery of Services

Issue: Customer differentiation “80-20 Service rule: 80% of profits come from 20% of customers” “ At a utility company, the top 300 customers are served by six reps while the bottom 30,000 are handled by one rep” “First Union codes its customers as green or red. Green customers are profitable while reds are the money losers” “Starwood Sheraton provides their best service to platinum customers” Armed with data, companies are learning that it makes financial sense to segment customers. Question: How should the service network be structured when customers have differing service level requirements and different willingness to pay for service?

Classical Examples of Service Differentiation Example 1: Yield management in the airline industry -Common inventory of seats sold under multiple fare classes Example 2: Hotels and car rental companies - Multiple customer classes based on the price/service preferences

Supply Chain Example: Third Party Logistics 3PL Provider ………….. Customer 1 95% Fillrate Customer 2 90% Fillrate Customer n 98% Fillrate

Resource Strategies for multiple customer classes 95% 95% and 85% 95% 85% K 1. Separate Resources 2. Completely pooled resources 3. Pooled resources with differentiation

Question Should the resources for serving different classes of customers be pooled or separated, or should hybrid strategies like rationing be used to manage differentiated service requirements?

Main issue 3: Impact of Service on the Design of Manufactured Products

Vanderlande Industries • Main office: Netherlands • Yearly revenues: 600 M€ • Products: • Baggage handling systems (London Heathrow T5, Amsterdam, Hong Kong, Paris, Munich, …) • Parcel and Postal (UPS, DHL Leipzig, …) • Automated solutions for warehouses • Services: from basic services to full service, generates 15% of the revenues and grows with 20% per year

Proj. Man. Costs Project Costs Engineering Costs Sales Charges Acquisition Costs Equipment Costs Init. Spare Parts Costs TCO Site Works Costs of Capital Maintenance Costs Labour Costs Direct Labour Costs RMR Costs Indirect Labour Costs Operating Costs Helpdesk Costs Downtime Costs Spare Parts Costs Total Cost of Ownership (TCO)

TCO calculations for one specific system • Used life span: 20 years • Downtime Costs = • 50% of TCO ! • Looking at TCO is very relevant!

Major issue • Possibilities to decrease TCO: • More reliable components, use of remote monitoring and diagnostics, building in redundancy, modular design, more preventive maintenance, … • Main questions: • How is a product’s design affected by its TCO? • Important factor: Presence/absence of service contracts • Should firms build different products for customers with different service and cost requirements? • OEM’s have to serve innovative and conservative customers

Thought Experiment & Questions for discussion • Think of a product that is sold primarily as a material product, not a service. Identify the value provided by the product and question whether it can be sold as a service. Brainstorm the following questions for the “servicization” of this product. • How should the service contract/relationship be structured to align incentives? • How should the service supply chain be structured for managing differentiated service requirements? • How is the product design affected by “servicization” and TCO?

Servicization: Managing Mission Critical Products As Services That Generate Customer Value