Why should companies start selling products as services

26. 03. 2020

What can manufacturers do to become more like Netflix and make more profit?

Servitization is a paradigm shift in how companies sell their products. It guides manufacturers away from the traditional direct sales towards business models that are common for services.

Here is a simple example. Imagine a company that produces industrial milling (CNC) machines and decides to servitize its business model. They could, for instance, shift away from one single payment towards a subscription model that gives customers more flexibility and is cheaper in the short term.

Rolls Royce among pioneers

Rolls Royce is a poster child for successful servitization. Instead of selling their aero engines, the British manufacturing giant now contracts with many of its customers for the “power-by-the-hour” model. Rolls Royce also provides all the necessary support (maintenance and repairs) and makes sure that the engines are always operational. This means that the customer only pays when the engine is working. Since any downtime is bad for both sides – Rolls Royces doesn’t get paid and the customer can’t fly -, the interests of both companies are much more aligned.

There are other ways for how companies can servitize their business. After-sales services, such as maintaining, cleaning, and recycling, are most common. Take General Electric, for example. The American industrial giant does not only sell medical equipment they also install and maintain them. Other companies decided not to sell their products but rather the know-how that is required to develop these products. Qualcomm, a smartphone chipmaker, makes the most money from patents and other licensing agreements. Alstom, a French industrial conglomerate, on the other hand, offers services that prioritize performance for its clients. If something goes wrong and the trains break down, Alstom incurs penalties – the company has the incentive to provide the best possible product and maintenance to avoid failures.

The Auto industry is also increasingly adopting servitized models. Mercedes, for example, has recently rolled out a subscription-based service that allows users to rent a new car literally every day. Customers, currently only in the U.S., don’t have any obligations aside from paying a monthly fee between 1095 and 2995 dollars. Other car brands (BMW, Cadillac, Volvo) are introducing similar “Netflix-Esque” solutions.

Services bring in more profit

There is a good reason why companies are increasingly servitizing their businesses. Globalization has pushed margins so far down that companies are not able to compete on price alone. So, they started to bundle services and products, delivering additional value for the customer. It’s also much easier to servitize products today because new technologies make subscriptions, revenue-sharing and other models possible. These technologies include big data, mobile platforms, advanced sensors and robots, computer cloud, virtual reality, and 3D printing.

The incentive for servitization is clear. Companies that expand or combine their product offering with services are up to three times more likely to make a profit, according to an enterprise software company IFS. Analysts at McKinsey have come to a similar conclusion – an average EBIT margin on services is 25 percent while product yield only 10 percent. Service-generated revenue is also more stable and less affected by market dynamics.

It’s true, however, that the big corporations are usually more successful at servitization. »They have the money and know-how to experiment with different business models. Small companies, on the other hand, sometimes don't even think of all the other possibilities they have to sell the product. It's, therefore, very important that these companies get support and help,« says Borut Potočnik one of the Things+ mentors guiding participant companies at the Technology Park in Ljubljana.