Article
Manufacturers of industrial machinery and equipment have many reasons to pursue digital transformations. The potential to redefine how products are created, made, sold, and serviced is profound. Within plants and factories, new digital capabilities are increasingly at the heart of virtually every process and activity, leading to enormous gains in efficiency and productivity.
For industrial companies, however, the power of digital to change virtually every aspect of the business acquires an added dimension: the ability to support a shift from a product-centric business model to a solutions-centric model. By combining hardware, software, and services into a tightly integrated, tailored solution that meets a broader range of customer needs, companies can achieve higher margins and a number of related benefits.
This shift is already underway, and for good reason. As competition intensifies and hardware-driven innovation slows, maintaining profitable growth in a product-centric model is becoming increasingly difficult. A solutions model, however—particularly one with a strong digital/technology underpinning—can propel industrials past their competitors, boosting growth and creating stronger bonds with customers as you understand and meet more of their needs (see Figure 1).
Figure 1
But these potential gains are attracting new competitors that often enter the industrial space horizontally, leveraging their expertise in artificial intelligence (AI), software, cloud and web services, or other advantages. That creates a sense of urgency that should motivate the leaders of industrials to move aggressively to a solutions model, or risk missing a critical window. A focus on digital solutions can ensure that you make the right moves and achieve full value from this new, digitally powered revenue model.
The threat of complacency
Industrial leaders acknowledge that a solutions focus presents an opportunity to catalyze growth (not to mention the risk of competitive disruption), but most have been slow to act. There are two primary reasons. First, the pace of digital transformation―and the extent of the operational and organizational changes it has generated―can feel gradual, which creates a sense that there’s time to catch up. Second, most companies have made at least some digital/technology investments which, although often incremental, foster a misleading sense of momentum.
Yet, when you consider that fewer than 5% of industrials have successfully executed a technologically or digitally based transformation, it’s clear that many management teams are underestimating the difficulty of moving to a digitally driven solutions model. They may also be underestimating the potential; digital can not only prove transformative in reducing costs and improving core processes, but can—and often should―be a source of significant additional revenue. Industrials that put more effort into digital, in fact, are four times more likely to outperform the competition, while two out of three digital laggards perform worse than the competition.
Management teams underestimate the difficulty of moving to a digitally driven solutions model
As they pursue a digital transformation with the goal of moving toward a solutions-centric model, senior leaders should be prepared to address five strategic and operational challenges.
Key challenges:
- Changing life-cycle economics: Revenue streams will shift from one-off sales to recurring payments, so a company’s life-cycle economics will become more complex.
- Balance sheet transformation: Balance sheets are potentially transformed, as products that were once sold outright can now remain on the manufacturer’s balance sheet, e.g., through equipment-as-a-service (EaaS) models, which changes the manufacturer’s risk profile and financing requirements significantly.
- New operating model requirements: To successfully develop and sell solutions, rather than products, companies will need to rethink their operating models, removing organizational barriers that often hamper such transitions.
- Faster innovation cycles: Industrial products typically have multiyear innovation cycles, but solutions are often updated every 6 to 12 months, a much faster pace of development that many companies may struggle with.
- Ecosystem requirements: Solutions, by their very nature, integrate much more deeply into a customer’s processes, and may require an ecosystem of partners to facilitate deployment and interoperability.
Pilot projects can help industrials achieve a level of risk-free learning on some of those challenges. But creating a fully scaled solutions business is a multiyear journey that starts with strategic and competitive positioning and extends through the design of the tech stack, ownership of control points, curation of a partner ecosystem, enhancements to the operating model and talent pool, and the need to invest in and fund organic development and possible M&A moves.
The solution to solutions
That may sound daunting, but leaders of industrial companies have much to gain by embracing the solutions model, including competitive differentiation, faster growth, and increased margins and valuation. And, they may have little choice but to move forward, given that both their direct competitors and companies in adjacent spaces are all eying this promising opportunity.
Leaders and management teams, therefore, should address five priority actions now to help their companies gain a winning edge:
1. Assess the profit pool and potential competitors
Industry profit pools have experienced a paradigm shift, driven by two factors:
- Downward margin pressure on traditional products and services due to decreasing technological differentiation and increasing competition from low-cost players, enabled by at-scale globalized supply chains.
- Emergence of tech-enabled products and services that better meet customers’ needs and so command higher margins.
As a result, a small but growing profit pool for high-margin digital solutions is attracting many new players. As traditional market boundaries blur and barriers to entry become lower, suppliers and even customers become potential competitors.
2. Formulate a clear vision and ambition
As opposed to traditional market-entry strategies―where companies size the market, assume a certain attainable market share, and derive a business opportunity to go after—digital solutions businesses require a more strategic approach to setting a vision and ambition. This is a greenfield opportunity to create and monetize new markets, which requires companies to define their unique play and derive the resulting opportunity from that. The required investment will scale with the breadth of use cases and the extent of integration across whatever stack a company pursues in its solutions business. Given that most companies have scarce resources, they should pursue those solutions businesses where they have a clear strategic fit.
3. Define winning solutions for the right customer segments
To succeed in digital solutions, companies will need to define leadership differently. In hardware, winning is about product leadership, because a majority of a company’s cost is product cost. That puts a focus on scale, to drive down product costs and reinvest savings in better products. In a solutions model that includes software and services, high gross margins make product cost less of a concern. Instead, companies need to invest in customer acquisition and retention. They need to excel at customer segmentation, develop digital solutions for the customer segments they can win, and maximize customer value over the long term.
4. Create a development and delivery game plan
Once you’ve defined your segments and solutions, you’ll need to assemble them along the technology stack. This stack will include elements that don’t exist in your current portfolio, giving rise to make vs. acquire vs. partner decisions. Some solution elements will be control points with huge potential for monetization and will be handled firmly in-house, while other elements can be made better or cheaper by others. This requires an ecosystem mindset, rather than thinking in terms of a linear value chain with customers and suppliers. Similarly, companies will need to reevaluate operations from R&D to sales, because a solutions business entails much shorter development life cycles and a much more consultative selling model.
5. Manage solutions business along different metrics and risks
Entering the solutions space is complex and requires a clear financial roadmap and the right KPIs, which may change over time. Early on, for example, EBITDA margin isn’t as meaningful as customer unit contribution or customer churn. Risk is another critical consideration. Digital solutions businesses often have new business models (e.g., performance- or outcome-based payoffs) that create a risk profile for the business that needs to be professionally managed. And, while investors and shareholders are typically happy to hear about a company’s expansion into solutions, they may not understand the time and investment required to make it succeed. Be as clear as possible about the required investments and time frame required to see material returns.
We can help you address all these considerations, based on our experience in working with many industrials to leverage digital technologies and transform into solutions providers. We have a deep understanding of the business and technology issues, and how to effectively respond to opportunities and threats. At a time when a traditional focus on products is under increasing pressure, harnessing the power of digital to launch and scale new solutions businesses provides an unrivaled growth opportunity.