For years, the manufacturing industry has been striving to increase the share of revenue it generates through services. As digitalization progresses, traditional services are increasingly being supplemented with digital services, often through the use of data and sensors, accelerating the shift from product-based to service-based business. However, companies still have to ask themselves, “Is this just a hobby, or do we actually want to earn money from our services?”
Maintenance through virtual reality (Bosch Rexroth), “smart” windshields that use sensors and performance management software to increase efficiency by 20 percent (GE) – there seems to be no limit to the possibilities of innovations in conventional industry. However, many companies keep having to find answers to the same old questions – regrettably, only once the innovation process has ended: What exactly am I offering – software, data provision, or services? How should I structure the offer? What is the right price model and what is the right price? Often, there are no comparable offers on the market, and particularly for software-based services, incurred costs don’t reflect the actual added value they provide. Cost-plus pricing is therefore out of the question.
We researched this topic in our most recent Global Pricing & Sales Study, which found that the objective behind 75 percent of digital innovations is to generate topline growth. However, less than a quarter of these initiatives have a noticeable impact on the topline result. What steps do companies have to take in order to earn money from their digital services?
One success story where the revenue model was completely restructured as part of the innovation process is Hitachi. By employing cutting-edge big data technology, Hitachi is managing to significantly reduce the breakdown rate of their trains, raising their performance level considerably. In order to monetize this added value properly, Hitachi concluded a deal with UK Rail Networks that was in keeping with their motto “Train as a service.” The trains themselves continue to be owned by Hitachi, while the British railway company only pays to use on-time trains. Having an effective price model, lower failure rates, and higher revenues from subscriptions creates a win-win situation.
To establish the best monetization approach for innovations, we recommend the following six steps, which can be used in numerous industries:
1. Value/customer value analysis: Analyze customer value/added value of the services or individual features (from the customer’s perspective) and quantify them.
2. Customer and service segmentation: Cluster your customer into homogeneous groups according to customer needs and willingness to pay – not all customers have the same service requirements or the same purchasing power.
3. Offer design: Define your future service offering (bundling, modular, etc.) based on the customer value specific to each customer segment. For digital services, the ability to enable add-on features has a significant influence on the design of the offer.
4. Price model: Select the most suitable price model in order to derive the best combination of customer loyalty and profitability in line with your overall strategy. With a greater focus on services, there is a shift away from traditional price-per-unit approaches toward continuous revenue streams, which can be achieved via subscription fees, pay per use, or other price metrics, etc. The basic idea is to base your approach on customer need and use “value sharing” (dividing added value between the company and the customer) to remove any doubts the customer may have about your service. The Hitachi example mentioned above is value sharing at its best.
5. Price differentiation and price level: Determine the right price level to suit the design of your offering (including the incremental difference between each option) differentiated according to customer segment. It is recommended to use quantified customer value as a basis to estimate the willingness to pay of each customer segment. By using a variety of methods (Simon-Kucher’s PriceStrat, Van Westendorp, Conjoint, etc.), a differentiated price level can be derived.
6. Market test: Validate your offer design and price model/level with a broad customer survey, so that your offering can be finalized.
To unleash the full potential of their innovative offerings, companies also need to ensure their sales teams are adequately trained. Only when the sales team truly understands the value of the offer to the customer (increased efficiency, longer maintenance cycles, shorter downtime, etc.) and is able to communicate the added value properly will the company be successful with their digital services. The transition from conventional product-selling to service-selling is a development that traditional industries can’t afford to overlook.
This article has first been published in German on industriemagazin.at in August 2018.