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Why service innovation is different, and why that matters

Service companies comprise 75 percent of economic activity in developed countries.  But companies are often seen as less innovative with service provision than with product design, manufacture and sales. But is this really the case or we are just misunderstanding the process of innovation in services?  We recently did some research to find out.

The focus was put on four providers of complex relational services, such as performance-based contracts that guarantee product availability. The research has shown that the conception of the product orientated innovation process  (company innovates- company sells – customer uses) doesn’t hold in the relational services, where the customer’s involvement in co-creating the service is accentuated. That means that the new services development is simultaneous to their production and use, thus making the customer a co-creator of the service. Firms that prepare properly for these two characteristics – simultaneity and co-creation – before engaging in relational service provision are likely to be more successful.

The service contract is designed, contracted for and then delivered by the service provider on the basis of the outcome that the customer wants. The service is innovative when the service provider offers a new outcome- an outcome he never provided before. The innovation actually takes place through interaction of the service provider and the client, making them co-creators of the service through the delivery.

Risk and reward in service innovation have a different nature as well. Although the service provider may invest in the infrastructure necessary to provide the new service, through payment of service fees the client effectively co-finances the innovation process.  As customer signs a long-term contract, the service provider avoids the market risk. But the service provider must address the risks inherent in delivering a novel service, whether these are higher service costs, contract penalties, loss of profits, or a dented reputation.

Problems with initial service delivery might cause the company to withdraw from the innovation. This actually disables it to understand the lessons from the initial innovation and reap the benefits that accrue over time through additional services to existing and new clients. The potential benefits for the service provider include: first-mover advantage, enabling the firm to leverage its learning by using it to secure further contracts with existing or new clients; cross leveraging innovation infrastructure investments and learning across other service contracts; and using the initial service innovation as a catalyst for other types of innovation –both services and products.

Firms that wish to be good service innovators need to have cross-functional teams and company-wide incentives to innovate, in other words an organizational-wide entrepreneurial culture should be encouraged throughout the company. This stresses how crucial adopting a long-term approach to innovative services is. The client and the service provider have to have a long-lasting, mutually trusting relationship in order to capture the full benefits of the innovation. They have to be well acquainted with one another in order to overcome the initial problems.

Ivanka Visnjic,
Research Lead, Cambridge Service Alliance

Social media and the new way of networking

Online profiles on social networking platforms such as LinkedIn and Facebook have powerfully altered the way we network and build relationships with colleagues and work partners.  Paradoxically, the intensification of competitive pressures in business resulting from the information age is accompanied by an opposite phenomenon, of distributing help more willingly to connect people to a wider group than ever before.

It is not new that people from the same circles help each other out, be it to find a job or share access to new opportunities.  Now, as social circles expand to their widest through social networks, the definition of “friends” is also influencing who we are willing to help, in the expectation of a returned favour later on in life.  Every new encounter is perceived as a potential resource for a future time, and comes with positive expectations.  

People who belong to the same network are most likely to be competing for the same job or the same promotion at some stage in life or another.  Yet the members of a common online social network are inclined to think of themselves as “friends” or connections that they want to help out.  In the academic jargon of social networks, online contacts serve as “brokers”, people who may introduce or refer one another to a contact or for a position.  Sometimes, this happens between people who may never have met each other in person.  A few connections in common or a few keywords may be enough.

Online profiles expose our social networks to everyone.  The effect is partly to show how well-connected we are, a well-recognised measure of “strength” or social capital in the business world (Kilduff et al., 2011, Inkpen & Tsang, 2005).  But the collateral is that sharing our network to friends and colleagues, opens up the same resource to them.  Is the power of social media to have instituted a silent etiquette, of never to refuse an introduction?

Meantime, in the physical world, shrinking developed economies mean increasing competition for every single job position.  In investment banks, 2000 applications get narrowed down to 30 new hires.  In less structured professional environments such as entrepreneurship and business, fewer and fewer new technologies or new ideas ever turn into profit.  Competition wipes out small and large companies every day, products become obsolete ever faster, and entire industries disappear overnight.  So, is online social “brokerage” leading to a more efficient matching of human resources and work, or is it enabling the identification and selection of the very best and very few for the over-subscribed opportunities?

Beyond Servitization: What's Next?

The Installed Base: How Well Do You Understand the Opportunity?

Successfully Implementing a Service Business Model in a Manufacturing Firm

1. a skill set capable of extending the relationship with the broad client base;
2. the capability to develop sophisticated service offerings that provide better coverage of customers’ needs; and
3. the ability to offer all the services efficiently.

Challenges and Issues of Engineering Asset Management

1. Effective decision making. Improving decision making across the organisation, through better use of longer term financial, and non-financial, metrics to deliver value for all involved in managing assets.
2. Organisational changes. Organisations must evolve to enable better decision making and share knowledge and skills, breaking down silos and boundaries resulting from functional specialism and multiple cost centres.
3. Data capture, sharing and standards. Improving the quality and availability of the information available for decision making.
4. Predictive analytics. New information technologies are available to improve Asset Management, but several barriers prevent their effective use.

'Tech is destroying the line between Manufacturing and Services' Fortune Article - Response from Andy Neely

Saul Kaplan’s article Tech is destroying the line between manufacturing and services makes interesting reading, but it rather misses the point. He says: “It’s hard to tell the difference between a manufacturer and a service provider and the distinction is limiting.” But the key consideration here is not whether you are a manufacturer or a service provider. It’s about how you create and capture value. Manufacturing firms across the world are embracing this challenge - innovating their business models towards services, powered by the latest technologies. They are doing it by focusing on four key issues:

1. Innovating the value proposition by concentrating on the outcomes customers actually want. The old Theodore Levitt quote encapsulates this well – customers don’t want ¼ inch drills, they want ¼ holes.
2. Innovating the value delivery system. Focusing on what they should do themselves, what they should ask others to do, who they should partner with and how they should pool capabilities to deliver outcomes.
3.  Managing inherent risks. Taking responsibility for outcomes involves risk which must be recognised, accepted and carefully managed.
4.  Taking account of the ecosystem – that is all the organisations able to influence the service provider’s ability to create and appropriate value. For example, by managing the ecosystem Apple retains far more of the sales price of its products than its competitors do.

Why servitise: Alternative rationales

I have often thought about the reasons why firms servitize (sell services as well as products). Usually I categorise these under three broad headings - economic, strategic and environmental. The economic reasons for servitization include:

1. The challenge of competing on cost - in many developed countries firms find it difficult, if not impossible, to compete on cost alone. The reality is that their underlying costs bases are too high in comparison to lower cost economies and so they have to compete through innovation and differentiation - services valued by customers are one route of differentiation.

2. The installed base argument - in capital goods industries, where products have long-life cycles, the installed base can be significant. In 2010, for example, Boeing had 19,410 commercial planes in operation and delivered 462 new planes, giving a ratio of 42 operational planes for every new plane delivered. Providing service and support for the installed base is a significant market opportunity.

3. Stability of revenues - particularly important in recent years, in many capital goods industries product revenues can be lumpy. Significant revenue is gained when products are sold and delivered, but this doesn't happen every day. Ongoing service and support revenues provide a more stable income stream, smoothing the effect of lumpy product sale revenues.

In strategic terms there are four key reasons for servitization.

1. Locking in customers - a traditional business model that has been used for years. Products are sold at or slightly above cost, money is made on the provision of spares and consumables. Think razors and razor blades; printers and ink cartridges.

2. Locking out competitors - especially important in industries with a high installed base. As demand for high margin service and support grows, new entrants are attracted to the services market. many original equipment manufacturers make strategic moves to partner with their customers and in doing so seek to lock out potential new entrants to the services market.

3. Increasing differentiation - some customers value the stability that service and support contracts offer. A fixed price can mean predictable maintenance costs and a transfer of risk from the customer to the service provider. These benefits provide a differentiation advantage to original equipment manufacturers.

4. Customer demand - the final strategic reason I often talk about is customer demand, in the sense that customers demand that their providers offer service based contracts. In public procurement, particularly the defence sector, this is becoming an increasingly important trend. Government Departments are asking to contract for capability, by the right to use the assets (ships, ground vehicles and planes), rather than taking ownership of the assets.

A final, and potentially increasingly important, rationale for servitization is the environmental rationale. Here the idea is to question whether transfer of asset ownership is neccessary. Think of car sharing schemes, such as StreetCar and ZipCar, or DVD sharing schemes, such as Netflicks. Do consumers really need to take physical ownership of assets or can we share access to them, thereby reducing the environmental impact of production.

While these three rationales have stood the test of time, the reasons for this blog is I came across a new strategic rationale at a recent conference - the idea of service as a pre-sale opportunity. Volvo Cars run an active programme with their dealers where they seek to persuade them that every service encounter is also an opportunity to build customer loyalty and hence secure a repeat purchase - hence service as a pre-sale. The data that Volvo presented are illuminating. They clearly show that, at least for Volvo Cars, repeat business is a function both of product quality and service quality. How many of your service staff see service as a pre-sale opportunity?

Andy Neely

Director, Cambridge Service Alliance

Five predictions for the future of services

The Servitization of Manufacturing: Where Does Value Lie and When Is Value Realised?

One way of conceptualizing the servitization of manufacturing is to think about the two questions: (i) where does value lie, and (ii) when is value realised. In traditional manufacturing environments the value lies in products & parts – the physical assets – and value is realised at the point of sale – when the customer pays for the product. Many manufacturing businesses, particularly those with long life cycle products, have recognized that value can also be realized throughout the life of product, especially when products need repair and overhaul. Such firms have a strong focus on the aftermarket and capture significant value through the sales of spares and repairs.

An alternative perspective is to think about value lying in “solutions” rather than “products & parts”. This paradigm puts the emphasis on the outcomes the customer wants, rather than the physical product. The old Theodore Levhgitt quote “customers don’t want quarter inch drills, they want quarter inch holes” illustrates the point. Many customers don’t want to own the physical products that many manufacturers provide, instead they just want the end result – or the outcome – that the product delivers. When manufacturing firms switch to an outcome focus they often contract for capability, guaranteeing uptime and/or availability of their equipment through life. Rolls-Royce, in its aero-engine business, now contracts for Power by Hour, selling the thrust the engines deliver rather than the engines themselves. A significant advantage of contracting for capability is that the incentives of the customers and the original equipment manufacturers are aligned. In an aftermarket focused model, it is actually in the original equipment manufacturers interest for their equipment to break down, as they realise value when they repair their products and provide spare parts. When contracting for capability or outcomes, however, the original equipment manufacturer only gets paid when their equipment is working, so it is in the original equipment manufacturer’s interest to maximize equipment reliability, something that customers also care about.

One of the challenges of contracting for capability is the issue of risk. If original equipment manufacturers take responsibility for the outcomes their products deliver, effectively guaranteeing results for their customers, they inevitably take on significant risk. The original equipment manufacturer is now responsible for delivering outcomes, not just the product. Some servitizing manufacturers have decided that the risk involved in outcome based contracting is too great and some customers have decided they are not willing to cede control over the outcomes, so they are unwilling to enter into contracting for capability. In such situations there is an alternative approach to offering services - selling knowledge and insight – recognizing that value lies in the solution the original equipment manufacturer offers. Think here of manufacturers that also offer design and development or installation advice. Think of those that have moved into training and consultancy services. They no longer simply sell products. They also sell knowledge and/or insight. Figure 1 brings these four perspectives on servitization together into a single representation, which illustrates the strategic choices manufacturers can consider when exploring how to servitize. These choices are not mutually exclusive. Manufacturers can decide both to be aftermarket and advisory focused, although clearly the different positions require different organizational capabilities.

Figure 1: Conceptualising the Servitization of Manufacturing

Andy Neely

Director, Cambridge Service Alliance

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Beyond Co-Creation: Think About Co-Evolution

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Innovation Festivals: A Source of Ideas

How Companies Learn Your Secrets: The Power and Pitfalls of Analytics

Is Servitization for You?

Andy Neely, Director Cambridge Service Alliance

There’s much talk of the servitization of manufacturing – supplementing products with services. The most recent data suggests that some 70% of economic activity lies in the service sector. Yet this figure ignores the significant proportion of service within the traditional manufacturing sector. Capital intense manufacturing firms, like BAE Systems and Rolls Royce, now generate over 50% of their revenues from service and support. Others, such as the oil majors have vertically integrated, offering downstream retail services, as well as upstream extraction operations. The shift to services seems inexorable and pervades many walks of life, but is it for you?

In answering this question there are some basic issues to consider. The first is quite simply are you selling a product that people want or need to own? Some products are consumed during use – think of food or fireworks. Your customer has to take ownership of these products, as they are used during the consumption process and have no resale value after they have been used. Other products are aspirational – products that customers don't need to own, but that they choose to own because of the value the product confers. We don’t need expensive cars to take us from A to B, or expensive watches to tell the time, but some people choose to spend their money on these luxury purchases because of the status ownership of the product confers.

Clearly there is scope to offer services associated with both consumed products and aspirational products. Restaurants are service and they use food as an input. Suppliers can offer to automatically restock restaurant supplies, an inventory management service, associated with food stocks. Some businesses choose to rent or lease aspirational products – luxury cars and even designer watches. In fact it is almost impossible to define a product that cannot be accompanied by a service. The question is where does the value lie. And can the service be delivered efficiently enough to generate a decent return.

For more detail on the shift to services see the Cambridge Service Alliance report – The Servitization of Manufacturing: Further Evidence