Product Companies Becoming Profitable Services Providers

August 21, 2009

In these times of rising costs and dwindling profits, many companies are shifting away from a sole focus on products. In order to drive continued growth and differentiate themselves in an increasingly saturated marketplace, companies are increasingly offering services (or  'integrated solutions') to customers.   

Consider IBM, for instance. Twenty years ago, the company was a struggling computer manufacturer. In the mid-nineties, Big Blue repositioned itself as a provider of information technology services and transitioned from selling computer equipment to selling solutions specific to their customers' IT challenges. This transition not only revitalized IBM's business but also provided a successful model for other product-dominant companies to emulate, something that many have done.

And with good reason, says Professor Stephen Brown, executive director of the W. P. Carey School's Center for Services Leadership. Services account for 80 percent of the U.S. GDP and similarly high percentages in the GDPs of other developed nations. The trend is also apparent in developing economies. Services accounted for 34 percent of China's GDP a few years ago. Today, the number is 40 percent and growing.

New avenue of growth 

According to Brown, there are a number of reasons why shifting to services has proved a successful strategy for manufacturers and other product-dominant companies seeking new avenues of growth. One is the relatively low capital expenditure such a shift requires. Another is the recurring flow of revenue that services often provide.

"Service offerings frequently have a higher profit margin than products and they can also gain a larger share of the customer's wallet -- instead of just getting income from the customer for a product, manufacturers can also supplement that income with service income," he said recently in Shanghai at the "Creating Value Through Service" symposium organized by W. P. Carey's Center for Services Leadership and the Center of Service Marketing and Management at Shanghai's Fudan University.

Brown cited two examples: GE's jet engine business, which sells the engines nearly at cost but bundles them with highly profitable, multi-year service contracts, and retailer PetSmart, whose pet grooming, training, boarding, and other services account for a relatively small percent of the company's revenue but a major chunk of its profits.

Services also provide an opportunity for differentiation. While some manufacturers -- Apple and Hummer come to mind -- rely solely on iconic products for a differential competitive advantage, marketers of more utilitarian items, construction cranes for instance, need help when it comes to staving off the competition. Enter services, which according to Brown "are typically less visible and more difficult for competitors to copy."

Getting personal with customers 

Nowhere is this truer than in the automotive industry, where the most visible competition does not involve the cars themselves but the services that come bundled with them -- warranties, rebates, financing options. "This is a car commercial but it's not about cars, it's about the people who buy them," begins one of the ads in Hyundai's most recent marketing campaign that touts a service that allows car buyers to return a new car with no adverse consequences to their credit rating if they lose their income. The message is clear. People can buy a car from any manufacturer, but only Hyundai sells them peace of mind.

The Hyundai campaign points to possibly the most compelling reason for focusing on services, which, according to Brown, is that it lets manufacturers get closer to their customers and really understand what they want. And increasingly, it seems, what they want are services.

Financial necessity precipitated IBM's move into services, but it succeeded because "the insights they got from talking to their customers were the revelation that transformed their business," said Brown.

A cultural shift 

And while the advantages of such a transformation are obvious, achieving it can be tricky. "Product companies must commit to and build a much stronger relationship with their customers and be proactive in creating customized solutions for them. Such a massive culture change can only occur if it is promoted and continually enforced by senior leadership in the organization," he said.

Making the requisite cultural change often requires huge organizational adjustments, such as creating a specific business unit that deals with service and reports directly to the CEO. In his talk at the Shanghai symposium, Mark Wheeler, VP of Global Services for Abbott Diagnostics, warned that "trying to hide the service group under another part of the organization, whether it be operations or R&D, is certainly a recipe for failure."

Many of the companies that fail do so "because they haven't recognized how massive the change is and they've only been looking to make incremental or marginal adjustments to their organization," said Brown.

But even if a company reorganizes and repositions itself, it still has to figure out what services to offer.

Base service offerings on expertise 

In her talk at the Shanghai symposium, Michelle Kam, Director of the Institute for Business Value at IBM, outlined three major areas in which product companies can develop services.

1. Product-related, value-added services

This is by far the simplest area, and is often a manufacturer's entry point into services. "These are services that derive from an understanding of the customers' key concerns throughout the product acquisition and ownership lifecycle," said Kam. Services of this type include the navigation and telematics services offered by car manufacturers and Apple's new One to One service, which pairs new Mac owners with Apple experts who help them set up their computers.

2. Non-product-related services

Imagine that thanks to the requirements of its own business, a big manufacturer has developed a particularly strong competence in HR and has excess or easily expandable operational capability in HR. Its customers may not have a strong HR department and prefer to use it as a third-party provider. Chinese electronics giant Haier, for example, has developed real operational strengths in logistics management and now offers logistics management services to its customers.

3. Service-led solutions

This is the most advanced service area and requires a total remaking of a product firm's business model and organization. By working closely with their customers, companies uncover and address their customers' real needs and help them to identify needs of which they weren't even aware. To deliver this type of service, "you must think like your customers and work in their best interest, even if it's not always your own," said Kam. IBM has become famous for its so-called "product-agnosticism," recommending competitors' products to its customers when necessary.

In all three areas, companies must create services that reflect their expertise, and "build on the reputation of their products and on their existing customer base, where they already have a reputation and value," said Brown, "not go off and create some new service that doesn't have any relationship to what they've been doing for perhaps decades."

The caveats 

All these suggestions come with some important caveats.

First, as Brown pointed out, "Running a successful service business is not the same as running a successful product business." Companies moving into the solutions business must strike a balance between offering completely standardized services, which can prove inflexible in the face of customer needs, and creating completely customized services, which can be financially draining.

Second, that the transition doesn't happen overnight -- a company won't close up for the night a manufacturer and open its doors the next day with a service focus.

Brown's final piece of advice: "Don't try to do everything at once." 

Bottom Line:

  • Product-dominant companies are turning increasingly to offering services because they are relatively inexpensive to implement, they can provide recurring revenue, and they serve as effective differentiators in an increasingly crowded marketplace.
  • There are three types of services that a manufacturer can credibly offer: services based on its products (e.g., maintenance, support, and training), services based on its operational strengths (e.g., inventory management, IT, and HR), and services that leverage both products and operational strengths to solve specific customer problems.
  • Recognize that running a successful service business is not the same as running a successful product business, and that the transition will not happen overnight.