Digital Business Model Hoedown – Part II

In a recent post, we discussed various business models that digital solution vendors leverage when selling tech to industrials – we considered a spectrum along an axis that begins with old-school perpetual licenses (Full Price Up-front), then SaaS/XaaS models, then finally a few flavors of performance contracts (Value Share and Revenue Share). If this is a new topic for you, it might make sense to read the first post first.

Let’s now consider the same discussion from the perspective of an industrial equipment manufacturer. Equipment manufacturers are increasingly bringing connected machines to market with value-added digital services for their customers. These customers are end-user industrial operator customers who deploy the equipment into their internal operational environments. Let’s focus on how the equipment manufacturer charges its operator customers for the use of these digital services. There are parallels between how digital solution vendors and equipment manufacturers are monetizing their products & services.

Like the business model spectrum outlined above for digital solution vendors, we can consider a similar spectrum for equipment manufacturers: At one end of the spectrum, the most basic business model would be no business model – in this case, the manufacturer embeds digital capabilities simply as free competitive differentiators and does not charge for them in any way. Let’s call this model “Digital Freeware”. If sales increase due to these differentiated digital services, then that’s a win – but let’s not consider this direct revenue from the digital services.

We do see some equipment manufacturers giving away digital capabilities simply as Digital Freeware, but many manufacturers want to charge for them. Manufacturers may instead increase the price of the equipment (ie increase the initial purchase price, or capital expenditure) when including the digital services. Let’s call this model “Full Price Up-front” to align with the terms used in previous articles. This is perhaps analogous to the digital solution vendor charging a perpetual license, and again, this model is appealing to a range of industrial operator customers that want to pay for things up-front because that’s how their businesses (and books) work. But it’s the recurring revenue models at the other end of the spectrum that are getting equipment manufacturers really excited…

Digital technology offers equipment manufacturers the opportunity to fundamentally transform their businesses through recurring revenue – in this era, the diesel generator manufacturer hopes to garner a revenue multiple on par with Facebook. Many equipment manufacturers are ushering in digital services for which they charge a monthly fee, essentially a SaaS model, so let’s once again call this “XaaS”. These services include basic remote monitoring/visibility, remote control, machine health alerts, predictive maintenance, and other various operational analytics and process efficiency boosters. While this is very exciting stuff for equipment manufacturers, they often fail by introducing services that their customers don’t want to pay for – they forget that it’s essential to align new business/service models with customer needs and interests.

Taking recurring revenue to its limit… on the far end of the spectrum are full blown servitization / as-a-service models, where manufacturers give away equipment for no up-front cost and charge for its utilization. Prevailing industry terms for this are “Pay Per Use” and “Equipment-as-a-Service”. This is not an entirely a new model, and people often refer to a pioneering example in this field: “Power by the Hour”, whereby jet engine manufacturers provide engine maintenance & replacement services to airlines at fixed rates based on flight hours. This has been an industry standard for decades, the term specifically is trademarked by Rolls Royce, meanwhile GE, Pratt & Whitney, and others provide similar models. People talk about these models as though they will become prevalent in every industry. Spoiler: this will only become prevalent in a handful of industries, and not anytime soon in most of those industries. That said, we are seeing new examples of this in some industries through the use of digital technologies.

Some of the easiest examples to cite come from work with our client, relayr – we’ve worked closely with them for years and this is precisely what they do. This case study with Aluvation is a solid example of the concept – instead of selling aluminum treatment equipment to automotive OEMs, they install their heat treatment equipment in automotive factories and charge the auto OEMs for each car they treat (Heat-Treatment-as-a-Service). Another industry example I’ve followed for a few years is Kaeser Compressors, which sells Compressed-Air-as-a-Service instead of selling air compressors.

So why are equipment manufacturers trying to transition into these utilization-based business models? The basic premise is the following – the initial purchase (capital expenditure) for a machine represents a small fraction of the overall revenue potential for the machine over its lifecycle. Depending on whose research you read, this capital expenditure amounts to ~20% of the revenue potential. The remaining ~80% comes from the maintenance, repair, and ongoing support services that someone could provide to the operator. Transitioning to a utilization-based model helps the equipment manufacturer lock in the additional revenue from these after-market services (ensuring a separate 3rd party does not capture this revenue).

To summarize, we can look at business model innovation for equipment manufacturers along an axis that begins with not charging for digital capabilities (Digital Freeware), then increased up-front costs (Full Price Up-front), followed by recurring revenue schemes (XaaS), with the extreme being servitization / utilization-based business models (Pay Per Use). There are similarities between this spectrum for pure-play digital solution vendors and equipment manufacturers, although precious few on either side seem to have cracked the code.