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Manufacturers consider the product as a service trend

Manufacturers are starting to embrace the product as a service trend -- but correctly pricing the service component could be a steep challenge.

According to a recent IDC report, by 2018, 40% of top 100 discrete manufacturers and 20% of top 100 process manufacturers...

will provide product-as-a-service platforms. The report's authors say that "leading manufacturers have seen the potential that after-sales service revenues hold, with some generating up to 50% of their profits from after-sales sources. As manufacturers apply service innovation to their efforts, the product becomes a platform to deliver business outcomes and tangible value."

Let's look at how this trend might affect manufacturers and their IT departments. There is a service element in most products, particularly in durables where manufacturers are expected to deliver manuals, call-in support, self-service support, field maintenance and more. In addition, today's hard goods increasingly come equipped with embedded computers and the requisite software that must be supported and perhaps updated from time to time. Even consumable products can contain a service element -- think of Butterball's turkey talk-line or the various games and contests that are part of the after-sale "service" for soft drinks, food products and more.

More products now are bundled with a continuing service element (a product as a service) that, although optional, diminishes the product's long-term value if not taken. For example, when you buy a General Motors car, you get a subscription to OnStar for a limited length of time. After that, you pay a monthly or annual fee to keep the service. And most cars today come with satellite radio, which, after the initial few months, only works if you pay a monthly fee.

How realistic is product as a service for manufacturers?

In these examples, the service is not a majority of the product value. But consider two table radios. One is AM/FM and sells for $25. The other is AM/FM plus satellite and sells for $45. The customer pays considerably more for the satellite link but does not receive the extra value without subscribing to the service.

Another example is ink jet printers: The retail price is likely to be little more than (or maybe even less than) the cost to produce and distribute the printer. The manufacturer makes its profit on the ink cartridges you must buy year after year. That's why printer manufacturers fight so hard against third-party cartridge producers. This is the King Gillette business model: Give away the razor and make money on the blades. Arguably, the digitization of physical products is not much different from these examples. Services and subscriptions are replacing cartridges and razor blades as a portion of the customer value that is delivered and paid for over time, after an initial purchase.

For the manufacturer, the service is quite a different part of the business. Making printers and making ink cartridges are both manufacturing processes for physical products sold through retail outlets. Making radios and delivering digital content are very different activities. Making cars and developing and delivering software updates (as Tesla just announced for improvements to the existing fleet of cars to relieve "range anxiety") are very different businesses.

Manufacturers that are including more digital content in products have to beef up (or sub-contract) their programming capabilities and either price the support and update requirements into the product's initial price, or try to sell the buyer a continuing service agreement at a recurring cost. This will be harder to do in some markets than in others. Selling a $30,000 car and then asking for $20 per month for OnStar or $10 per month for Sirius Radio might be seen as an annoyance or perhaps a benefit, if the customer is "sold" properly upfront. Do you think Tesla's customers would object to paying, say, $1,900 a year for software updates? That's about what an ERP software company would charge for a support contract on a $10,000 ERP package. What's the difference? For a Tesla, software is perceived to be a minor part of the product. Charging $1,900 per year for mechanical maintenance might be acceptable. But that amount of money (or any amount, for that matter) for software maintenance would likely be resented. If mandatory, it would probably spur protests and lawsuits.

Pricing product service components will be challenging

As everyday products become more digital -- that's where the Internet of Things is taking us -- this dilemma will become more widespread. Producers of all manner of mechanical products that were previously just that (physical or mechanical) will be selling and servicing software and perhaps delivering digital services besides. How they will be paid for these additional services is a major issue that each individual marketplace will have to decide.

Manufacturers of physical products that see opportunity (or challenge) in this direction must redirect and enhance the IT side of the business, establishing a resource dedicated to direct product and customer support. This is no longer a part-time task for the internal IT department. Outsourcing a major portion of the internal system tasks to a cloud provider is a good way to free up existing IT resources and reassign them to product and customer support.

Product marketing and design must be very alert to evolving service and information content of competitor products and watch for opportunities to extend the informational content of its own products ahead of the competition. This major trend affects virtually all industries and products. Companies that lead their industry will enjoy tremendous success while laggards will very quickly fall behind.

There is danger in leading an industry, of course, and one of the biggest challenges will be how to turn these product as a service improvements into profits. There is no universal solution; each market will view pricing changes or the introduction of subscription or continuing payments differently. As always, the key is to establish value (in the customer's mind) and price accordingly. Customers will gladly pay for value but will not pay more than what the product or service is worth to them. Manufacturers of physical goods have to change their thinking to realize, and communicate, the value of their product's service component.

Next Steps

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This was last published in March 2015

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Does offering product as a service options make sense for your organization?
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This is the very right move. A concept of a product as a combination of services was assumed more than 5 years ago (e.g. in "Ladder to SOE", service-oriented enterprise). I have no doubt that the challenge of pricing separate services will be solved sooner rather than later.
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Indeed a very right move
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