Overcoming the Challenges in Migrating from Products to Services: Facing the Enemy Within

September 09, 2009

Twenty years ago, Abbott revolutionized the medical diagnostic equipment market with a series of groundbreaking innovations. The products they manufactured -- machines that automated blood testing and disease screening in medical laboratories-- were much more advanced than anything else on the market and profits soared. The real innovation, however, was that for one price, Abbott's customers got everything they needed. The equipment came bundled with installation, training, and maintenance services. Abbott's competitors scrambled to follow suit.

Fast forward to the present. Abbott's diagnostic machines have grown in complexity and cost while profit margins have shrunk steadily, and the competition, initially blindsided by Abbott's first-mover advantage, has now fully caught up.

"We changed the marketplace twenty years ago; now it's time for us to change it back again because our profits are not sustainable," said Mark Wheeler, vice president of Global Services at Abbott Diagnostics. He spoke in Shanghai at the "Creating Value Through Service" symposium jointly organized by the W. P. Carey School's Center for Services Leadership and the Center of Service Marketing and Management at Shanghai's Fudan University. "We need new sources of revenue to help get those profits back up, and services are an obvious way for us to drive that profit."

But wait, doesn't that mean telling customers that they'll have to pay for something that they've always gotten for free? Surely they'll resist.

Why customers pay for service

Surprisingly, that's not the case. According to Wheeler, the major resistance manufacturers face when monetizing their service offerings comes from within their own organizations.

To understand why, we first need to understand why customers are willing to pay for services, even when they previously received them free. The key, says Wheeler, is recognizing the value services provide to customers.

"Value does not mean price," cautioned Wheeler. In his talk at the Shanghai symposium, University of Miami Professor of Marketing A. Parasuraman explained that "the value customers perceive a company is providing them derives from three different components: the quality of the service (the quality of the interaction the customer has with the company), the quality of the product, and its price." In a market where product quality and price are constant among competitors, the only differentiating factor is the service.

"If customers are being served in the way that they expect to be served, those customers will be much more satisfied and will buy much more product from you," said Wheeler.

Charging for services allows customers to recognize that the value of what they're receiving resides in the service. Tiered service plans give them choice as well as clarity around exactly what they can expect to receive, something Wheeler says many of his customers weren't getting before. Finally, customers find the ability to switch between different levels of service reassuring. "They like the inherent flexibility of knowing that they can add on something in the future that they don't need now," he said.

An important corollary is that a company can only charge for a service that its customers perceive has value. This means that companies have to talk to their customers and find out what it is they value. They have to improve their existing services so that the customers understand that they're paying for that added value. That may involve structuring their services more clearly or it may involve enhancing the services themselves. "The process strengthens relationships with the customers and may stimulate the creation of new services as well," said Prof. Stephen Brown, executive director of the Center for Services Leadership at the W. P. Carey School, in his talk.

In either case, charging for services involves an organizational shift away from what Brown calls the logic of manufacturing--how to make things, how to cut costs, how to increase efficiency--towards a logic focused on addressing customers' needs. Unsurprisingly, the product-dominant firms themselves prove most resistant to this shift.

"A service logic focuses on how to help customers solve their problems. This requires a deep and intimate understanding of customers beyond what most product-dominant companies have ever even considered," said Brown.

Executives who understand customer needs nonetheless excuse their resistance by claiming that customers don't understand the underlying complexity of their business. "I've heard things like, 'Of course we know what our customers want, but our customers are wrong,'" said Parasuraman.

Tips for overcoming internal resistance

The real obstacle, though, is the product-dominant firm's sales force. "They've been motivated and incentivized for a long time to sell products and they've used services to strengthen their value propositions to customers," explained Brown. In addition to eliminating salespeople's traditional deal sweeteners, selling services is typically much more time intensive than selling products and often requires talking to different, and often more senior, people within the customer's organization.

Wheeler, Brown, and Parasuraman all agree that even in a manufacturing organization committed to a service focus, only one-third of the sales force will be able to sell the new services. Of the remaining two-thirds, one will struggle and eventually learn while the final third will be incapable of selling services and require reshuffling or replacement.

Using his own company as an example, Wheeler offers some pointers to help other manufacturers overcome resistance to services.

1. Go after the quick wins.

Getting salespeople to see that customers will not immediately switch over to a competitor's products when they're charged for previously free services is half the battle. Abbott found that 20 percent of its customers accounted for 80 percent of its service costs, which led to the creation of tiered service plans. The highly serviced customers were thrilled that paying entitled them to higher priority service. Their enthusiasm refuted many of the salespeople's objections and got them excited about higher sales volumes and commissions.

2. Service to the promise that you've made your customers.

"That means not just delivering the maximum that you've promised but also not delivering in areas where you've promised less or customers have paid for less," said Wheeler.

3. Create an infrastructure to support service sales.

Selling services requires new sales training, hiring policies, incentives, and performance assessments. Salespeople have to become experts in their customers' businesses and need to be properly supported. Selling services also requires new invoicing and billing procedures, systems for managing the implementation of services, as well as financial structures and strategies for dealing with service revenues.

Despite these challenges, numerous product dominant firms have begun providing and selling services successfully. Mindsets change. "Imagine telling our parents thirty years ago that we'd be paying for water," said Wheeler. Provided customers can see the value in a service, they will not object to paying a fair price for it, and if we believe Wheeler, they might even thank you for the privilege.

Bottom Line:

  • By charging for services, product-oriented companies ensure that customers understand the value of what they're receiving. Getting customers to see the value may require manufacturers to restructure their service offerings and/or educate their customers.
  • Manufacturers' organizations represent a much bigger obstacle to charging for services than the customers who are accustomed to receiving them for free. Obstinate sales forces need to be swayed with quick wins that refute their objections, new incentives, and proper organizational support.
  • Creating services that customers consider valuable requires a deeper understanding of customers than product firms traditionally have. Achieving that understanding ultimately calls for major organizational change.