Digital Business Model Hoedown

The cost of sensors has fallen, connectivity is ubiquitous, and machine learning tools are widely available… so why aren’t all industrial companies pushing forward with their digital agendas? Organizations have made progress on technology and solution architecture, but business model development and monetization schemes are still obstacles. For the scope of this discussion, let’s consider how pure-play digital solution vendors are selling to their industrial customers.

Digital solution vendors are the companies selling pure-play digital products (sensors, software, etc) into end-user operational environments (directly into factories, power plants, etc); or they are selling digital products to industrial equipment manufacturers, who in turn bundle and resell these digital products into end-user operations (ie an “OEM Model”). The business model question is tricky, and we see a wide range of approaches.

The traditional model is to sell hardware and/or perpetual software licenses, which are one-time purchases with no substantial recurring component – let’s call this model “Full Price Up-front”. This is what many industrial operators like to buy, since it aligns with the way they run their businesses: For example, a power plant operator knows how much a new turbine costs and then can predict its financial productivity and depreciation out over many years – many operators want to buy digital products that align with this financial operating model. The benefits of the purchase are understood by customers: They can determine the return on investment, and fully benefit from any additional productivity accrued.

Perpetual license structures are increasingly giving way to recurring revenue models, pioneered by enterprise IT vendors selling Software-as-a-Service (SaaS). While enterprise IT buyers have learned to budget around SaaS models, it’s a newer model for operators that want to buy and deploy digital solutions into industrial environments. Since the solutions discussed in this post often include hardware and services, let’s more accurately refer to this model as “X-as-a-Service” (XaaS) going forward. XaaS vendors charge on a recurring basis (monthly or annually) and pricing depends on one or more variables (users, feature sets, connected assets, data volume, etc). These models allow companies to defer some of the investment required in the Full Price Up-front model, reducing some friction in the buying process and allowing for more experimentation.

Beyond XaaS, vendors are getting more creative with their revenue models, and some now offer value-based pricing calculated against the performance of the digital solutions. We’ll call this model “Value Share”. For example, a maintenance analytics vendor may propose the following to a customer:

You can have my hardware and/or software solutions for no up-front cost and deploy it across the assets in your operating environments.

Over the next 2 years, we expect to see a 25% decrease in the cost of maintenance of these assets through the use of our solutions – and we want a 10% share of those savings.
This is an interesting model, but it is sometimes challenging to implement because digital solution vendors have to bear the risk and financing cost of the variable payments after deployment (especially challenging for startups, where a failed project could have serious cash flow implications). Furthermore, many industrial operators are too conservative to pursue this model despite what appear to be obvious benefits.

There is another type of performance contract better aligned with the go-to-market model of selling digital products through equipment manufacturers into end-user operations. This is where a digital solution vendor shares in the revenue generated by an equipment manufacturer who is reselling (ie white-labelling) the digital solution – let’s call this model “Revenue Share”. For example, suppose a digital solution vendor helps a manufacturer of turbines take a digital turbine to market. Instead of charging the turbine manufacturer Full Price Up-front, XaaS, or Value Share, the vendor may instead simply say:

I’ll give you my hardware and/or software solutions for no up-front cost, and you can embed them into the turbines you sell.

I want a 5% cut of the revenue you generate selling digitized turbines (or perhaps 5% of the associated digital services you’re selling alongside the turbines).

In this model, the digital solution vendor puts more skin in the game, and may become more than a technology partner (helping with sales & marketing). You might even consider this a joint venture.

To summarize, we can look at business model innovation for digital solution vendors along an axis that begins with old-school perpetual licenses (Full Price Up-front), then XaaS, then a few flavors of performance contracts (Value Share and Revenue Share).