Most of the software-intensive systems companies that I work with are in the process of converting from pure product businesses to product + service or pure services businesses. This is a huge change for any company and means changes at several levels and all functions of the company.
Over the last months, I have been trying to understand what this means for companies and why it is happening. If we start with the implications, it is clear that the first major chance is the relationship with the customer. This relationship changes from a transactional relationship, where the customer only interacts with the company when he or she needs a new instance of the product, to a continuous one where the customer and the product deployed at the customer constantly or frequently interact with the company. This is a consequence of the normal service delivery because identifying when the deployed product starts to exhibit issues and fixing it before the customer even notices a problem obviously results in a higher quality of service.
The second change is that continuous deployment of software to products out in the field now has an associated business case. Deploying new software may extend the economic life of products at customers, reducing the cost of delivering the service as the physical product needs to be replaced less frequently. Alternatively, if the service fee is dependent on performance, new software releases can improve performance and in that way increase revenue.
The third major change is financial. Product companies typically get paid at the time of product delivery and that creates a cash flow where expenses for manufacturing and to some extent R&D are aligned with the revenue generated from product sales. In a services business, however, you’re asked to deliver the product in order to start the service delivery, but the recouping of those expenses occurs over a much longer period of time and fundamentally changes the cash flow. In fact, you are financing the product for your customer. Of course, with proper pricing, a services business can be very profitable, but not getting paid for the initial investment is inherent in the shift.
Fourth, everything in the company runs at a higher heartbeat and shifts from waterfall-style to continuous processes. Of course, this is the case in the service monetization where monthly service fees are typical and in software where frequent deployments are increasingly the norm, but even for the physical parts of the products we often see that companies start to provide a constant stream of improvements and cost measures. There is no real incentive anymore to create a big hoopla around a new product model or type and consequently companies are less inclined to accumulate an extensive set of improvements only available to the new product as a mechanism to drive upgrade and replacement decisions.
Of course, there are many other implications of the transition to a services company, but those go beyond the scope of this post. The next question is why companies are moving from product to services businesses. The answer to that question lies in the ownership of the customer relationship. For decades, B2B and B2C customers have moved from CAPEX to OPEX. Owning expensive items has a high risk associated with it when you don’t know how long you will need the item. In addition, quality issues become very binary. If you own one car, it is very unfortunate when it breaks and it leaves you with an unpredictable cost at unexpected times. A leasing company owns thousands of cars and they can calculate and manage their risk because they know that a certain percentage of cars will experience issues. It become a manageable cost of doing business. In addition, especially younger generations have shifted their behavior from ownership to access and are much more open to the sharing economy.
As customers increasingly want access rather than ownership, they automatically turn to services rather than products. And once you use a service, do you really care about the product that is used to deliver a service? When ordering an Uber, do you think about what car the driver will have? Or do you only care about getting from A to B quickly and efficiently? This means that the traditional differentiators of product companies, such as brand, reliability, lifetime cost, etc., are no longer relevant. As a customer, whether the service provider uses a cheap, crappy product to deliver the service or an expensive, reliable product does not really matter to me as I only pay for the service. This means that service providers have all the incentive to treat product companies as cost-driven suppliers. As a product company, the only way you can make a living in an industry moving to services is by being the cheapest. All your differentiation is irrelevant as it never makes in the RFQ.
The only way for product companies to survive in such a business context is by owning the customer relationship. And that, in turn, means not just providing the customer with a product, but to manage the entire set of tasks that the customer wants to outsource. Which then turns the product company into a services provider. And as a services provider, the company needs to orchestrate its ecosystem. If your product needs to be installed at the customer, you are now responsible for getting it installed, meaning that you need to orchestrate the selection of the installer, ensuring that the installer does a good job and financing the installation. If your product needs regular maintenance, similarly you will be on the hook for ensuring that this happens, either by your own people or by partners.
Although other societal shifts are involved, for many product companies it is the emergence and increasing importance of software and connectivity are the root causes of a fundamental shift from products to services in a wide variety of industries. These technologies drive a continuous rather than transactional customer engagement and allow for servitization in areas where it was impossible or prohibitively expensive to do so earlier. I am calling the end of product companies as the only way a product company can survive in an industry that has shifted to services is by being the cheapest. And that’s no fun way to run a company. So, instead product companies are forced to forward integrate in their value network and take ownership of the relationship with the end-customer (B2B or B2C). And that requires them to become service companies.
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