Tim Baines, Professor of Operations Strategy at Aston Business School and Executive Director of the Advanced Services Group, makes his third appearance on the podcast sharing with Sarah insights into one of the most-discussed aspects of servitization: how to create revenue.
Sarah Nicastro: Welcome to The Future of Field Service Podcast. I’m your host, Sarah Nicastro. Today we’re going to be talking about the business model blueprint for Servitization success. I am excited to welcome back to the podcast for a third time, Professor Tim Baines, who teaches operations strategy at Aston Business School and is the executive director of the Advanced Services Group. Tim, welcome back to The Future of Field Service Podcast.
Tim Baines: Thank you, Sarah. I’m pleased to be here.
Sarah Nicastro: We won’t go into details but we had to work very, very hard to bring you this episode today. So, thanks to Tim for hanging in there with us, and I’m excited for today’s conversation. I think the biggest question that comes up for me, when I’m talking with folks about the journey to Servitization is how do we monetize it? What are the revenue models? How do we use it to increase revenue? So that is a part of what we’re going to be talking about with Tim today.
Sarah Nicastro: Tim was first on the podcast last year, talking about the forces behind Servitization and what that journey looks like for companies, so if you haven’t listened to that episode, it’s definitely worth revisiting. And in December we tackled some Servitization predictions for 2021 and some of the things that Tim expects to see this year. So today we are going to add on to our nice stretch of podcasts, by talking about business models and revenue models and how to make Servitization work for your business.
Sarah Nicastro: So Tim, to start, can we talk about how does Servitization represent a business model innovation?
Tim Baines: Thank you, Sarah. So the whole conversation about Servitization drags in this idea of the innovation of the business model of the firm. The innovation of the business model of the manufacturing firm. And as you know, this whole conversation is about moving from a world where the business model is largely about the design and the production of a product, and the transactional sale of that product, to a world where the business model is ultimately about ensuring the outcomes, the business outcomes for the customer. And for our business model, as a provider, as a manufacturer, to be based on receiving value, on the capture of value, as our customer consumes the service that we actually offer.
Tim Baines: So the conversation about Servitization naturally leads into conversation about business models. And when we look at business models, look at the business model framework. It’s largely recognized as having four elements to it. One element is about the offering, what you put out there, what you give to the customer, the service, or the product, or the product and service. One element is about how you deliver that, so the systems, the technologies, the people. And the third element, and really the focus for our conversation upon revenue models, the third element is about this value capture.
Tim Baines: And I’ll just mention for the moment, the fourth element is about the broader competitive landscape and our competencies to compete in that. Before, now I’m moving back to this third element and saying, okay, the processes of value capture, how we get value out of delivering the product or the products and service to our customer, is where we naturally go when we think about revenue models.
Tim Baines: And of course, if you think about an organization putting a service into a customer, they’re going to receive value in a number of ways. Some of those ways are going to be very direct, ways in which we can monetize and other ways are going to be less direct. The learning that we get, for example, of working with a customer. That learning flowing back to us.
Tim Baines: But of course, when we talk about revenue models, we’re talking really about that way in which we capture direct funding, how we get value, monetary value, out of our offering to the customer. And what becomes interesting, you can look at this area of revenue models and you can reflect upon it and think about the different revenue models which are actually out there. And there is, of course, the traditional revenue model that you associate with a product sale, that the manufacturer gets reimbursed directly and perhaps immediately, and perhaps in full for the sale of a product, right away across to these subscription type models, where we’re paying for, on perhaps a monthly basis, for actually the provision of a product or a service.
Tim Baines: And ultimately when you get to the business, the revenue models that we’re really interested in, which are associated with these more advanced services, these revenue models consist of a combination of different factors. They consist of a pay-per-use component but they also consist of a lower banding, where every month we will receive some revenue, no matter how much our customer uses our product or service and an upper banding, which is basically a point over which we’re saying to the customer, you can’t use our products and service any further because we need to have access to that to do some services with. So maintenance work.
Tim Baines: So I hope that’s made sense, Sarah. There’s an awful lot in this topic of revenue models and it starts with the business model and it starts with the fact that we are undergoing a move to different types of business models. And the revenue model innovation is a really important component of that move to these business models, which are based more around service, rather than the transactional sale of the product.
Tim Baines: So I’ll stop there for the moment and just see whether my explanation resonates with what you were seeing, Sarah, what you’re being asked when you speak to people.
Sarah Nicastro: Yeah. Tim, that explanation actually had me thinking about our first conversation and talking about some of the forces behind Servitization, Right? And so if you follow me for a moment, what I’m thinking about is the conversation is often led with revenue model, right?
Sarah Nicastro: So I don’t have a lot of organizations leading the conversation with me and talking about the more holistic view of business model. They’re pretty focused on the revenue model. And what it made me think about is that that’s because ultimately that revenue model aspect of the business model is what’s going to yield the payoff to them, right? So it’s kind of, they’re naturally focused there because they’re most concerned with, if we’re going to invest time and resources on this journey, what’s the payoff to us? Does that make sense?
Tim Baines: It absolutely does. And I see that also.
Sarah Nicastro: Yeah. And it made me think about the conversation in the context of some of the external and internal forces around Servitization, right? So it’s, to me, the focus on the revenue aspect only, is sort of an internal focus, where the business model focus is looking at it more holistically, with both, what’s the ultimate pay-off to the company, in terms of revenue but also how are we going to deliver value to the customers, that they are in essence, willing to pay for? Does that make sense?
Tim Baines: It does Sarah. And I think there’s three threads of conversation which intertwine. When we look at this area of Servitization, if we’re not careful, we can just see them as one thing that’s happening, revenue models. But of course, as you’ve just pointed out, you have A, the way in which the customer actually pays us, but B, how that rolls up to be the business case for the organization, the compelling financial argument for us to move forward with services. But also C, what that means in terms of our relationships with other financial organizations or the financial innovations, or the ways in which we might explore, to actually fund some of our own activities. And that third area is in itself, a whole area of conversation, which can take a deep dive into and can be fully immersive.
Tim Baines: But the first two points, I very much agree with it, when we speak to practitioners, we see the same thing. They are interested in, how is somebody going to pay me? How is that going to affect me? Am I going to receive a lump sum or am I going to receive monthly payments? What’s it going to look like?
Tim Baines: And then secondly, how do I put together a compelling financial case to the business, which is an argument for us to either move into Servitization, to move forward with Servitization, to expand our Servitization activity. Those are those two levels.
Sarah Nicastro: Yeah. That makes sense. So you talked about one of the components of the revenue model being the value capture process. So can you talk a little bit about some of the different ways of capturing value?
Tim Baines: So, and this is where I understand this language here can seem a little bit, almost like conceptual and difficult to grasp for a practitioner. But this is the language that the scholars who are working on, on business model innovation, those scholars tend to use. And one of the challenges people like you and I have, Sarah, is to take this somewhat academic conceptual language and translate it into practical terms. And value capture is one of these academic terms.
Tim Baines: But when we bring it right the way down and say, “Well, what are we really talking about, the level of a manufacturing firm,” we can simply say, the important bit for us is how do our customers pay us? How do customers pay us? Now, one of the challenges is that manufacturing firms, of course, are very familiar with the idea that our customers pay us when they buy a product. And of course, as we move into these services, which are more sophisticated, these more advanced, these outcome-based services, the way in which our customers pay us tends to change.
Tim Baines: So we’re here as a manufacturing firm. We are made aware that when you look at the more sophisticated outcome-based contracts, customers tend to pay for that service as they consume it. And that can give a lot of concerns to the manufacturer because you take the example of a high value asset. Let’s say it’s a machine tool. Let’s say it’s a million dollar machine tool. The old world is that the manufacturer makes the machine tool, sells the machine tool, gets a million dollars for it and with that million dollars, has the funds then, to reinvest in the materials, pay for the workforce, et cetera, this sets about making the next machine tool.
Tim Baines: But of course, when we moved to these services and you hear people like myself, advocating it’s going to be a pay-per-use, the manufacturer’s sitting there and saying, “Right, I’m not going to get a million dollars. I might get more than a million dollars. I might get $2 million. But it’s going to take me five years to get that $2 million.”
Sarah Nicastro: Right.
Tim Baines: “Or three years or two years to get that $2 million.” We’re going to get more money back because ultimately I’m going to provide more services to go with the product. But I’m going to be getting back over a longer period of time and I’m not going to get it back as a lump sum. I’m going to get it back as a month by month payment. And that gives the manufacturer these alarm bells. And the manufacturer says, “I can’t do this. How am I going to pay for all these raw materials that I’ve just consumed, in providing this machine tool. If all I’m going to get back as a monthly installment, which over two or three years, is going to build up towards this 2 million pounds, but from day one, I’m just going to get a small fraction of that back, how can I afford to do that?”
Tim Baines: Now there’s an explanation of how you can do it, but I’ll just pause for a second Sarah and say, does that resonate? Is that the type of conversation that people have come to you with?
Sarah Nicastro: Yes. That absolutely makes sense. And I think the implications of that level of change within a company are something that is just not simple, right? I mean, it’s something that takes a lot of change management in thinking but also work to put into practice and sort out what that means and how to evolve into that type of model.
Tim Baines: And it’s a topic which, when people first started looking at these more sophisticated services, these more sophisticated business model and there were outsiders to it. And they looked at these and said, “This is really concerning.” And I always remember some of the very early research papers, that I read about Roll-Royce. And you would see the statement that says, Rolls-Royce no longer sell jet engines, they sell power by the hour. And of course, people took that literally and they said, “Oh, so they’re not selling the gas turbine?”
Tim Baines: The answer is, they absolutely are selling the gas turbine, whether it’s Rolls-Royce with a gas turbine, where there is a company like Alstom, or GE. Sorry, Alstom with a train system. Whether it’s Caterpillar with a big quarry truck, the asset is being sold. So I think that’s the first part of the message back to the manufacturer, exploring the Servitization space. They will still sell the asset.
Tim Baines: So back to our machine tool example. I will still sell the machine tool. And I will sell it and I will get that lump sum payment for the machine tool. It’s just that the customer isn’t necessarily buying the machine tool. And that’s what people get confused with. With these more advanced services, I’m still selling the asset. I’m just not selling it to the customer.
Tim Baines: I’m selling it to a finance organization, which becomes an intermediary in this model. And remember, a couple moments ago, I spoke about the three strands. This is part of the third strand, which we could perhaps talk about in more detail at a separate time. But if you look at these organizations, whether it’s Caterpillar or whether it’s Rolls-Royce, whether it’s GE, they all have a financial institution, a captive financial institution. So a financial function with inside their organization, which is taking on, when the product is made, when the machine tool is made, in effect, internally, they are buying that asset from the manufacturing part of the organization and putting it into the finance part of the organization.
Tim Baines: And now there’s other businesses out there, which are much smaller than people, like Rolls or GE, who are using external banks to do the same thing. So it hasn’t got to be a captive bank, but external bank. Well, that’s what happens, is the asset is being sold.
Tim Baines: So the manufacturer actually, going back to our fictitious example of the machine tool manufacturer, what’s actually happening, is here I am. I am selling my machine. I made my machine tool. I’m going to sell it. I’m going to sell it to the bank and it’s going to go to the bank. So I’m getting a million dollars right away for the transactional sale. And then I’ve got a guaranteed income then, for the next two, three, four, five years, whatever the contract length is, of another million pounds, another million dollars for those services, which I’m going to provide for.
Tim Baines: And this is where this conversation then, about the revenue model and the compelling case for services get so intertwined because all of a sudden I’ve now got an income into my business of 2 million pounds, whereas previously, I would have only got a million pounds or two million dollars, where previously I’d only got a million dollars.
Tim Baines: Now that’s a very compelling argument to move forward to Servitization. But the argument doesn’t exist unless you get underneath the surface of it and start to tease out what the revenue model looks like in the way that you’re doing. In the way that you’re speaking to me about.
Sarah Nicastro: So Tim, can you walk us through, what are some of the established and emergent revenue models for advanced services?
Tim Baines: Okay. So understand the baseline. So the baseline is the traditional transactional sale of the product. I’ve made the product. I’m selling it to you, as the customer, and you’re paying me directly one single installment for receiving that product.
Tim Baines: So moving away from that, what you tend to hear people talk about more and more is a subscription. A pay-per-use. And notionally, a subscription model is a model we’re familiar with. It’s the model that you might have on a mobile phone or with a gym membership, is each month, I will have a monthly payment.
Tim Baines: Now, based in the context of what we just spoke about a few moments ago, about the fact that I will still be having my transactional sale of the product to the finance house, which will give me a lump sum back inside my organization, to go and finance my manufacturing system, the customer just experiences their subscription charge. So as a provider, I am getting both a lump sum repaid and I’m also getting a subscription from the customer. The customer themselves is paying a subscription and that subscription comprises of two components. Part of it is going back to me, the manufacturer for my services and part of it is going back to the finance, as to pay for the loan, which they’ve taken on, in effect, has been taken on the machine. So the customer sees a subscription charge.
Tim Baines: Now, when you look at subscription charges, that is, a lot of people are looking at the moment in time at Servitization and seeing it as being a move to subscription charging for a combination of a product and a service. Now it’s more sophisticated than that, of course, when you start to look at more complex machinery because the power by the hour model on a gas turbine isn’t simply a subscription. It comprises of three components.
Tim Baines: It comprises of a baseline, which says that, look, even if the asset isn’t being used, you will still pay me every month, a base fee. And by contrast, it comprises of an upper fee, that says, “Look, we don’t expect you to ever pay more than this top level because we don’t expect you to use the asset more than so many hours in a week, so many weeks in the year, type of thing because there’s a maximum utilization we would expect this asset to actually have. And it might only be 85% because above that, we need to have access to the equipment to maintain the equipment.
Tim Baines: So you’ve got a lower band, a higher band and between the two, you’ve got a variable. And the variable will be based perhaps on the number of hours used or the outcome, the number of products produced, et cetera.
Tim Baines: So some practical examples. If you look at, we’ve talked about Rolls-Royce, in terms of power by the hour, the idea that the gas turbine thrust, that’s an airline operating company buys from Rolls-Royce, is based upon the number of hours that that machine is running for them.
Tim Baines: If you go into food production, you go in the world of food production and you think about the idea of pay per pack. If you imagine a production line and the production line is producing potato crisps. And then you’ve got each item going through the machine, in effect it incurs a kind of a revenue flow back to the manufacturer of the machine. A pay per pack. And you have that happening with companies like Domino and companies like Ishida, and companies like Tetra Pak. Or people like that who are playing around with these ideas about pay per pack.
Tim Baines: And then you’ve got this idea of pay per good pack. And if you imagine in food production, you’ve got a difference between paying per item produced and paying per good item produced. And that’s a different form of revenue model. And they’re all bundle ups, Sarah. So you’ve got all these different revenue models, components of a revenue model.
Tim Baines: And one of the challenges when you’re thinking about an advanced service offering, is to put together that construct of that revenue model so it works for the customer. So you’ve got these different components, as I’ve just talked through. So it’s a revenue model, which comprises of those and works for the customer. And it’s on the base of the revenue model that the justification, the business case, can then be put in place. And then we go from there.
Tim Baines: So I’m sorry, Sarah. There’s an awful lot in the revenue model conversation and I’m mindful that I’ve spoken at length about it. But is it helping to clarify or am I just adding more fog to an already quite foggy topic?
Sarah Nicastro: No, I think it’s definitely helpful. And I think, there are certainly areas where we could really dig in and that gives us an opportunity to have you back at some point and do that. But this is good.
Sarah Nicastro: I do want to ask a couple more questions. The next is around what do you think the future trends are for these revenue models for Servitization? How do you see this kind of evolving?
Tim Baines: Okay. So I see, what I feel I’ve witnessed over the past few years is people becoming much more aware of a subscription charging approach. So the customer paying a subscription. And you can think about it in terms of if you stream music, you pay a subscription.
Tim Baines: Now the subscription charge is simply a fee, which gives you an availability. And somebody like myself, who lives in a place where my mobile phone reception is poor, still pays the same, if you like, subscription fee that somebody who’s living in the center of town would pay. I’m not paying a fee based upon me fully experiencing the outcome that I want. I’m paying a fee which is giving me access. I’m not paying a fee which is based upon the successful receipt of me receiving an outcome. Now, of course, there are, if I look at the contracts, there are terms and conditions about my mobile phone should work under these conditions, et cetera, et cetera, and I can get a refund if I don’t get it.
Tim Baines: But without going into the depths of the contract, I think the trend will ultimately go towards charging for outcome. Charging for successful delivery of outcome. And go back to my point, a moment ago, imagine a piece of production machinery inside a food processing plant. And let’s say that piece of production machinery is a bottling machine. And at the moment in time, we might talk about moving to a world where the manufacturer, the production machinery is being paid on the basis of the number of bottles which are being filled.
Tim Baines: Actually, the customer doesn’t receive income based upon the number of the bottles. We receive income based upon the number of bottles which have been fully filled. Have been filled in a way that the contents remain sterile, let’s say, et cetera. Paid per good fill. Okay.
Tim Baines: And that’s part of that evolution. So that’s where I think it’ll go to, Sarah. I think most businesses are quite a way off that yet. They’re really in the world of even this idea about moving to a subscription-based approach and partnering with a financial institution, to enable that subscription-based approach. That’s where the bulk of business is, just to exploring that.
Sarah Nicastro: I agree. And I was going to point out, one of the things I see companies doing is almost tiptoeing toward subscription but not being fully comfortable with it yet. Meaning some companies I see are still trying to keep the two worlds separate, in the sense of selling the asset, but then trying to offer service on subscription after the fact. And I think that I see how you could feel as though you’re kind of testing the waters in that approach but I think ultimately, what you’ve talked about today makes far more sense and is a truer representation of actual Servitization, If you understand what I mean. Does that make sense?
Tim Baines: I think Sarah… Go ahead. Sorry.
Sarah Nicastro: No go ahead.
Tim Baines: No, I was just going to add something in, which was, I think this move to subscription is a very valuable component of the Servitization journey but it isn’t the Servitization journey in itself. And I think it’s important to recognize that a customer can still buy a product on what feels like a subscription basis. I know Goodyear will sell a tire to a customer on the basis of a monthly payment of the number of miles or kilometers that tire has gone.
Sarah Nicastro: Right.
Tim Baines: Now that’s still a traditional product sale. It’s just really been paid for in installments. So the shift to subscription doesn’t explain the whole Servitization journey. And it’s important to recognize that because we have come across situations where, because the subscription model is difficult for the manufacturing organization to grasp, the whole Servitization initiative gets derailed. Of course, Servitization is fundamentally innovation in the customer value proposition.
Sarah Nicastro: Right.
Tim Baines: Doing more and more for our customers and of which a pay-per-use subscription model makes absolute sense. But the subscription model itself doesn’t explain the Servitization. It’s a component.
Sarah Nicastro: Right.
Tim Baines: It isn’t the journey itself.
Sarah Nicastro: That makes perfect sense. So last question for you today, Tim. What you just said, I think is an important distinction. The Servitization journey is really one that is representative of evolving your customer value proposition. Determining how you monetize that and what the revenue model looks like is one component of that journey. It does seem to be one of the biggest struggles for a lot of people, or at least if not the biggest struggle, something on which they’re putting the most emphasis. So for someone listening, that is struggling a bit with this conceptually, what’s your best advice or synopsis for how to, as best they can, simplify and make progress in this area?
Tim Baines: I think I would suggest three steps, really. Sarah. I think the first step has to be, to be clear in your mind, exactly what this model actually looks like. And we’ve talked about it in the sense of this idea that what the customer receives is different than necessarily what the manufacturer offers. And that happens because in the loop now, where we’ve got this financial organization, whether it’s incumbent in the manufacturer or it’s independent to the manufacturer, being part of the equation. So being clear in your own mind about what is the structure of the financial flows, I think is my first step.
Tim Baines: And I’m not suggesting anybody goes into huge amounts of detail, but just sits down and sketches it out and says, “Yeah, okay. I understand what the customer’s going to get and pay for. I understand what it is that I’m going to produce now. I’m going to receive funds. And I understand that if there is a financial organization in the loop, what they are going to get. What’s their slice of the operation?
Tim Baines: I think my second piece of advice would be that I know that this is going… For an organization to invest in this, it’s got to have this business case. But of course, the structure of that business case is both dependent upon this revenue model and also the stages of maturity of the Servitization journey. Because if we’re at the stage earlier on and going back to our roadmap, where we’re just exploring the ideas, then the business case is simply asking for permission to explore the idea further, whereas if we’re much further down the road, the business case is about much more strategic investment.
Tim Baines: So I think my second point is really be clear about the basic business case that you need to form, on the basis of the revenue model. So understanding how detailed you need to go, in figuring out the revenue model, really is determined by what’s the business case you have to create at this stage of the game? So if the business case is to just get permission to do some experimentation, then at this stage of the game, the revenue model only has to be fleshed out as what it might look like with one particular customer, whereas if we’re looking for permission to make a big investment, then the revenue model has to be fleshed out in much more detail with multiple customers.
Tim Baines: So I think that’s the second point is be clear about almost like the stage that you’re actually at in your Servitization journey and particularly, therefore, what does the business case need to comprise of?
Tim Baines: And then the third piece of advice is, if at all possible, come up with just a prototype and just experiment with one very safe organization that you can use to mutually learn from the experience. Just pilot, to try it. And through that piloting and trying, then both organizations will develop their knowledge and their insights of what this can actually look like. And then that’s the platform to move further forward.
Tim Baines: And so you’ve got these three components really, that are coming out of it. And the first one would be clear about what that structure could look like, think about where I am, in terms of a business case and the sophistication of a business case I need to produce. And thirdly, just think about a very basic pilot at this stage.
Sarah Nicastro: Excellent. Very good. Very good advice, Tim. And we’re out of time for today but I could ask you so many more questions. So we’d love to have you back again soon and continue the conversation. As you said, there’s plenty of areas here to dig into but thank you so much for joining us again and sharing your perspective. We really appreciate it.
Tim Baines: Now, Sarah, thank you. I’ve enjoyed the conversation today and yes. Thanks for your tenacity in ensuring I actually get to speak to you today. So thank you. Take care and I hope to speak to you again in the near future.
Sarah Nicastro: You can find more by visiting us at www.futureoffieldservice.com and you can also find us on LinkedIn as well as Twitter – @TheFutureofFS. The Future of Field Service podcast is published in partnership with IFS – you can learn more about IFS Service Management by visiting www.ifs.com. As always, thank you for listening.