From manufacturing to providing services: How does it transform?

-Kanakprabha Jethani | Executive

(kanak@vinodkothari.com)

Background

Servitization is that foreign business term that does not find place in any dictionary but is in steps to becoming essence of many businesses. It is a transformation, from manufacturing to providing solutions, from being product-centred to being complete-solution centred. Essentially, it is a business model in which, manufacturer of a product also engages in provision of services relating to that product.

The concept of servitization arises from the traditional ideology of business of maintaining life-long relationship with customers. Cranfield University defines servitization as “the innovation of organisation’s capabilities and processes to better create mutual value through a shift from selling product to selling Product-Service Systems.”

For instance, a laptop manufacturing company, say A Co. manufactures and sells “laptops”, it is a manufacturing concern. However, when A Co. sells a “package” which includes a laptop along with provision for after-sale services, software to support operations on the laptop, anti-virus software, cloud-space for data storage etc. it is said to be servitization.

How does this model operate? How do the parties earn? Are there any existing models operating? What is their structure of operation?  Why does a manufacturer need to adopt this model? How will this be implemented? The following write-up answers all these questions and seeks to provide an all-round insight to the concept of servitization.

Structure of a servitization model

The concept of servitization has evolved answering the calls of the market that arose from phased transitions in customers approach to the products.

  • Initially, a product-oriented market was prevalent in which the manufacturer and seller had just a buy and sell relationship. They became strangers right after the sale.
  • This approach then shifted to product-oriented services, under which the manufacturer started providing additional services with respect to the product sold by it such as delivery, product installation, spare parts, updates and upgrades, warranty, maintenance etc.
  • With Rolls Royce making leaps into innovation, the concept of use-oriented services came into place. Under this companies offer product leasing, sharing, renting, and pooling services where the customer pays fee for using the product.

This concept is however different from leasing as leasing provides exclusive rights to use to the lessee. In this model, the product can be shared between two or more customers or the owner and the customer.

  • Later, the approach shifted to result-oriented services where the consideration for service provider is directly linked to the output generated by the customer.

Servitization model is a customer-oriented services model which combines features of all of the aforementioned approaches. This model serves the customers’ demand for real-time responses, effective self-service options, predictive maintenance etc.

An ideal servitization model involves an entire process from manufacturing of a product, its delivery, installation and training for its use to ongoing maintenance and consultancy relating to the product. It provides for an all-round cover of the product along with support services to the customer.

Money matters: How does the service-provider/manufacturer earn?

A typical servitization model of a manufacturer includes the following:

  • Sustainable production process
  • Supplier and customer interdependencies
  • Lifetime product maintenance
  • Repairs
  • Recycling of end product
  • Help desk
  • Customer specific support agreements

An ideal servitization relationship includes incentives for the supplier to reduce costs. It shares risks, financial risk especially, and it is based on achieving the highest performance possible. The optimal contract consists of a fixed payment or fixed price, cost-sharing and performance-based compensation.

Through servitization, the seller is bound to provide services to the buyer till the product exists. This bond is achieved by tying the supplier’s compensation to the output value of the equipment generated by the customer. This creates a lasting relationship between the seller and buyer. This is the transformation from earning profits to creating mutual value.

Economics of servitization

For a business, the essence of servitization lies in establishing long-term relationship with customers. This lengthened relationship results in maintenance of steady revenues which then results in greater profitability and customer retention. Further, streamlining the supply and services reduces the risk of quality deterioration. To sustain in the market, it is very necessary to provide value addition. The market wants innovation and new offerings every day and has offerors all around. For a business to stay, will have to provide more than just a product. Providing aftersales services and advanced services such as consultancy services and solutions enables a business to meet customers’ demand for complete solution packages and thus ensures sustainability.

Further, through servitization, manufacturers are exposed to a whole new set of issues faced during operation of their products. This provides them insights for future R&D and helps them bring innovation in their products and ensure continuous product improvement.

For a customer, the prime benefit that servitization brings out is that the customer has to pay only for the value derived from the product. The customer is saved from risk of unproductive expenditure. Further, the quality of product is maintained as the manufacturing entity only does further servicing of the product. Since, the customer has to pay for what is operational, it also ensures that the ‘operational time’ is productive as well. This urges the customer to undertake profitable operations only.

Risks in servitization

  • Financial risks: The transition from a manufacturing model to servitization model requires a complete shift in the operational basis of the entity. Also, the revenue generation model is completely changed by shifting the point of revenue generation from sale to outcome, which would result in elongation of operating cycle. Due to this, requirement of working capital is increased.
  • Operational risks: Manufacturers face operational issues like how to assess the use of asset, level of maintenance required, frequency of updations etc. Further, the transition requires a complete turnaround in the operating team and procedures which involves a very long downtime.
  • Partner risks: The concept of servitization is based on a generation of revenue when some other person is in operation. The return to manufacturer is directly linked with the operation or outcome of the customer. Thus, it poses a risk over the earning of the manufacturer.

Why does a business need to servitize?

For a business, where all competitors are trying to knock you down, survival is a lonely process. In order to stay, the business needs to keep the market interested. Following are certain factors which lead a business towards the direction of transformation:

  • Economic rationale: In a competitive market, it is not possible for firms to compete on basis of cost as they already operate on very low margins. In such a case, innovation is the key to stand out from the competitors. Further, stability of revenues is yet another driving force in this direction.
  • Strategic rationale: Through servitization, a business is able to retain its customers for a very long time. Lock-in customers and lock-out competitors is a clear implication of this. Moreover, customers are very much educated and aware in the present day market. They demand such models and a business that fulfils their demands, stays.
  • Environmental rationale: The world is moving towards sustainability. Responding to the current environmental changes, if a single entity is engaged during the entire lifecycle of the product, it would result in preservation of resources to a great extent. A business with such values and respect towards the environment always achieves a higher place in the eyes of the customer.

Global examples

The philosophy of “co-existence” has laid its nets in the business also. The concept of mutual-benefit has become the new definition of profitability and the world is responding to this change in the following manner:

  • Rolls Royce: This was the pioneering engine solution which changed the deal with customers from a transactional purchase of equipment towards a ten-year contractual relationship guaranteeing operational time of the engine. This model gave rise to the concept of ‘Performance-Based Logistics’ (PBL) which was initially introduced by Rolls Royce for jet engines. Later a similar model was proposed for the marine industry as well.
    Under this model, a fixed amount for flying per hour is charged. The customer are provided with accurate projections for maintenance cost and assurance for avoidance of breakdown costs.
  • Xerox’s print management: This model offers a bundle of services and copier to the customer. It provides a comprehensive set of capabilities which prevent malicious attacks, proliferation of malware and misuse of unauthorised access to printers etc. as well as services to help better manage documentation. The customer is charged based on the number of sheets of paper they have copied or printed.
  • MAN’s Financial Services: Offers comprehensive services around drivers’ behaviour and fuel efficiency in order to help customers operate more efficiently, with charging based on the distance trucks are driven.
    This was launched with the basic motive of reducing the cost of lease during off-seasons. It enabled the lessee to pay certain sum on each kilometre travelled by the leased truckthereby reducing the downtime costs.
  • Lumenstream: This Britain based start-up provides customers with fully maintained LED lighting with no upfront cost. In line with the proven fact that LED lights save upto 60% energy costs, the customer is charged based on share of energy savings achieved over a period of five years.
  • Small Robot Company: This company is transforming the process of farming through their Farming as a Service (FaaS) model. Under this model a series of robots (Tom, Dick and Harry) with ‘clever’ operating systems are linked to provide a full-fledged farming support. One of the robots monitors the crops, soil and weeds. The other two take care of all the feeding, seeding, and weeding. They record location of every crop and take care of each individual plant until it is entirely grown up.
    The farmer does not need to make any upfront payment for leasing the robot. Instead the farmer is charged on the basis of per-hectare subscription fee of robots working.
  • Philips: Philips provides LED lighting as a service to Amsterdam Schiphol airport through ‘Internet of Things’ (IoT) connectivity. Under the arrangement, Philips takes responsibility of the performance of the LED lamps. On the other hand, the airport is able to save 50% energy cost by using LED lights. A share of saved cost is paid as consideration to Philips.

How has the world responded to servitization?

Penetration of servitization model: Country-wise

Servitization has been a buzz in the recent times. Some countries have already made it the core model of their businesses while some are still struggling to get familiar with the concept itself. To understand how servitization has impacted and will continue to impact the world, it is first important to understand, how deep servitization has spread its roots in business models of various countries.

Following chart depicts that, out of certain number of entities, selected on random basis, what percentage of entities were practising servitization as on November 2013.

Source: University of Cambridge[1]

From the above figure it can be seen that USA has already embossed the concept of servitization in its ideology of business. A major chunk of the firms in USA covered by the research operate on servitization model. Seemingly, servitization model is in the steps of becoming the core model for majorly all businesses in USA. UK is following the footsteps of USA and has implemented servitization to some extent. Countries like Germany, India and France seem to be advancing in this field of innovation and some entities in these countries have initiated adopting servitization models. Russia seems to be resistant towards adoption of this innovation in its business models.

All that matters is growth

Benefits, growth, profits are the words that really matter in a business. Whether an innovation should be introduced or not? The answer lies in the benefits it gives. Businesses see benefits in growth and profitability. Increased sales, turnover, consumer base is what they look forward to.

Following figure shows how servitization has effected the turnover growth in various countries and what the forecasts are for the near future.

Source: European Commission report on servitization

From its inception till 2018-19, the initial stages of implementation of servitization have shown the very high levels of growth in turnover for countries like Germany, Italy and Netherlands where servitization has been implemented upto reasonable levels. A study in France by European Commission shows that with 70% of SMEs in France being servitized, rate of employment also grew by 30% and an average annual increase of around 10% in turnover in the country was also witnessed. By 2020-21, when servitisation would already have been implemented in major countries, the pace of growth would tend to slow down. However, there are still no signs of negative growth forecasts in any of the countries. Servitization is expected to increase turnovers of various countries by averagely 3-4% in the coming years.

Striking the balance

Seemingly, the structure of servitization-based models is altogether a risky exertion. The manufacturer is exposed to huge risks as the consideration is based on the output of the customer. This might, on one hand, result in blocking of funds in the initial stages. While on the other hand, the customer base of the manufacturer is strengthened. Earning of the manufacturer depends on operations of the customer which are substantially out of the control of the manufacturer. This creates a gap in the chain of flow of income for the manufacturer.

The servitization model requires integration of operations of manufacturer and the customer. It calls for a close connection between the both. The manufacturer shall not only communicate with the person procuring the product, but also with the person actually engaged in operation of the product. The necessity of rethinking internal and external processes is highly felt while transforming from a product-based to a customer-based structure. Introduction of new technology and human resources specializing the service industry has to be the primary step in the transformation process. Extensive use of data and analytics is an inseparable part of servitization industry.

In essence, manufacturer will have to implement servitization as one major programme, which would address everything, from production processes to client communication and revenue generation. A risk-return balance will have to be achieved so that continuous inflow of income for the manufacturer is ensured.

Way forward

While some countries have implemented it to a large extent, some are advancing, some struggling and some oblivious to it, servitization seems to have entered all territories. Various sectors also have reacted differently to servitization, but reasonable growth has been recognised in all of them by now. Flaws would pop-up with time and would be handled accordingly. The concept of servitization is based on the principle of value for all. It has the potential to serve productivity and profitability at all levels of a value chain. Like every other innovation, operational aspects obviously have certain glitches which one can understand only after continuous operation. An effective implementation of servitization models would require consistent updations and modifications to achieve a feasible structure suitable to specific needs of both, the manufacturer and the customer. It’s a slow pathway to growth: Innovation and consistency are the keys.

[1]https://cambridgeservicealliance.eng.cam.ac.uk/resources/Downloads/Monthly%20Papers/2013November_ServitizationinGermany.pdf

Safe in sandbox: India provides cocoon to fintech start-ups

-Kanakprabha Jethani

kanak@vinodkothari.com, finserv@vinodkothari.com

Published on April 22, 2019 | Updated as on August 26, 2019

Background

April 2019 marks the introduction of a structured proposal[1] on regulatory sandboxes (“Proposal”). ‘Sandboxes’ is a new term and has created a hustle in the market. What are these? What is the hustle all about? The following article gives a brief introduction to this new concept. With the rapidly evolving entities based on financial technology (Fintech) having innovative and complex technical model, the regulators have also been preparing themselves to respond and adapt with changing times. To harness such innovative business concepts, several developed countries and emerging economies have recognised the concept of ‘regulatory sandboxes’. Regulatory sandboxes or RS is a framework which allows an innovative startup involved in financial technologies to undergo live testing in a controlled environment where the regulator may or may not permit certain regulatory relaxations for the purpose of testing. The objective of proposing RS is to allow new and innovative projects to conduct live testing and enable learning by doing approach. The objective behind the framework is to facilitate development of potentially beneficial but risky innovations while ensuring the safety of end users and stability of the marketplace at large. Symbolically, RSs’ are a cocoon in which the startups stay for some time undergoing testing and growing simultaneously, and where it is determined whether they should be launched in the market. In furtherance to the recommendation of an inter-regulatory Working Group (WG) vide its Report on FinTech and Digital Banking1 , the Reserve Bank of India has released the draft ‘Enabling Framework for Regulatory Sandbox’ on April 18, 20192 . The final guidelines shall be released based on the comments of the stakeholders on the aforesaid draft.

Benefits and Limitations

Benefits:

  • Regulator can obtain a first-hand view of benefits and risks involved in the project and make future policies accordingly.
  • Product can be tested without an expensive launch and any shortcoming thereto can be rectified at initial stages.
  • Improvement in pace of innovation, financial inclusion and reach.
  • Firms working closely with RS’s garner a greater degree of legitimacy with investors and customers alike.

Limitations:

  • Applicant may tend to lose flexibility and time while undergoing testing.
  • Even after a successful testing, the applicant will require all the statutory approvals before its launch in the market.
  • They require time and skill of the regulator for assessing the complex innovation, which the regulator might not possess.
  • It demands additional manpower and resources on part of regulator so as to define RS plans and conduct proper assessment.

Emergence of concept of RS

The concept of RS emerged soon after the Global Financial Crisis (GFC) in 2007-08. It steadily gained prominence and in 2012, Project Catalyst introduced by US Consumer Financial Protection Bureau (CFPB) finally gave rise to the sandbox concept. In 2015, UK Government Office for Science exhibited the benefits of “close collaboration between regulator, institutions and FinTech companies from clinical environment or real people” through its FinTech Future report. In 2016, UK Financial Conduct Authority launched its regulatory sandbox. Emergence of RS in India In February 2018, RBI launched report of working group on FinTech and digital banking. It recommended Institute for Development and Research in Banking Technology (IDRBT) as the entity whose expertise could run RS in India in cooperation with RBI. After immense deliberations and research, RBI announced its detailed proposal on RS in April 2019. Some of the provisions of the proposal are described hereunder.

Who can apply?

A FinTech firm which fulfills criteria of a startup prescribed by the government can apply for an entry to RS. Few cohorts are to be run whereby there will be a limited number of entities in each cohort testing their products during a stipulated period. The RS must be based on thematic cohorts focusing on financial inclusion, payments and lending, digital KYC etc. Generally , 10-12 companies form part of each cohort which are selected by RBI through a selection process detailed in “Fit and Proper Criteria for Selection of Participants in RS”. Once approval is granted by RBI, the applicant becomes entity responsible for operating in RS. Focus of RBI while selecting the applicants for RS will be on following products/services or technologies:

Innovative Products/Services

  • Retail payments
  • Money transfer services
  • Marketplace lending
  • Digital KYC
  • Financial advisory services
  • Wealth management services
  • Digital identification services
  • Smart contracts
  • Financial inclusion products
  • Cyber security products Innovative Technology
  • Mobile technology applications (payments, digital identity, etc.)
  • Data Analytics
  • Application Program Interface (APIs) services
  • Applications under block chain technologies
  • Artificial Intelligence and Machine Learning applications

Who cannot apply?

Following product/services/technology shall not be considered for entry in RS:

  • Credit registry
  • Credit information
  • Crypto currency/Crypto assets services
  • Trading/investing/settling in crypto assets
  • Initial Coin Offerings, etc.
  • Chain marketing services
  • Any product/services which have been banned by the regulators/Government of India

For how long does a company stay in the cocoon?

A cohort generally operates for a period of 6 months. However, the period can be extended on application of the entity. Also, RBI may, at its discretion discontinue testing of certain entities which fails to achieve its intended purpose. RS operates in following stages:

S.No. Stage Time period Purpose
1 Preliminary screening 4 weeks The applicant is made aware of objectives and principles of RS.
2 Test design 3 weeks FinTech Unit finalises the test design of the entity.
3 Application assessment 3 weeks Vetting of test design and modification.
4 Testing 12 weeks Monitoring and generation of evidence to assess the testing.
5 Evaluation 4 weeks Viability of the project is confirmed by RBI

 

An alternative to RS

An alternative approach used in developing countries is known as the “test and learn” approach. It is a custom-made solution created by negotiations and dialogue between regulator and innovator for testing the innovation. M-PESA in Kenya emerged after the ‘test-and-learn’ approach was applied in 2005. The basic difference between RS and test-and-learn approach is that a RS is more transparent, standardized and published process. Also, various private, proprietary or industry led sandboxes are being operated in various countries on a commercial or non-commercial basis. They conduct testing and experimentation off the market and without involvement of any regulator. Asean Financial Innovation Network (AFIN) is an example of industry led sandbox.

Globalization in RS

A noteworthy RS in the Global context has been the UK’s Financial Conduct Authority (FCA) which has accepted 89 firms since its launch in 2016. It was one of the early propagators to lead the efforts for GFIN and a global regulatory sandbox. Global Financial Innovation Network (GFIN) is a network of 11 financial regulators mostly of developed countries and related organizations. The objective of GFIN is to establish a network of regulators, to frame joint policy and enable regulator collaboration as well as facilitate cross border testing for projects with an international market in view.

Final framework for RS

RBI introduced final framework[2] for the RS on August 13, 2019 which is almost on the same lines as the Proposal as mentioned above. However the RBI has relaxed the minimum capital requirement to Rs 25 lakhs in place of Rs. 50 lakhs as required under the draft framework with a view to expand the scope of eligible entities.

Conclusion

Regulatory sandboxes were introduced with a motive to enhance the outreach and quality of FinTech services in the market and promote evolution of FinTech sector. Despite certain limitations, which can be overcome by using transparent procedures, developing well-defined principles and prescribing clear entry and exit criteria, the proposal is a promising one. It strives to strike a balance between financial stability and consumer protection along with beneficial innovation. It Is also likely to develop a market which supports a regulated environment for learning by doing in the scenario of emerging technologies.

[1] https://www.rbi.org.in/scripts/BS_PressReleaseDisplay.aspx?prid=46843

[2] https://www.rbi.org.in/scripts/PublicationReportDetails.aspx?ID=938

 

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