The strategy of wrapping services around the sale of a product has been pursued for several decades by industrial goods manufacturers. Yet, surprisingly, few companies are fully exploiting their service opportunities. Many are leaving substantial value on the table.
Consider manufacturers of water treatment equipment. For their industrial customers such as microelectronic companies, water treatment is critical to the production process but accounts for less than 2 percent of total plant-operating costs. The treated water must meet certain quality standards, but exceeding those standards offers no competitive advantage. Hence, from the customer’s perspective, there’s no benefit to developing aan expertise in water treatment.
Many water companies, however, have not considered the customer’s point of view and, therefore, have not perceived the opportunity to offer a solution. Instead, they have focused on selling new products and viewed services in terms of spare parts, sold opportunistically. They have seen no need for dedicated service departments, which has resulted in their service activities being underresourced and undermanaged. Using this business model, companies’ earnings before interest, taxes, depreciation, and amortization (EBITDA) have on average shown lower single-digit margins.
A supplier that we will call WaterFlow adopted a different approach. It offered solutions rather than only equipment. These solutions typically took the form of “build, own, operate” contracts. That is, WaterFlow would provide its customers with a loan to purchase its water treatment equipment, then the company would run and maintain the equipment on-site on behalf of its customers. These water-by-the-hour deals allowed WaterFlow’s employees to keep in close contact with customers, advising them on retrofits, upgrades, and how to effectively treat water and wastewater in order to improve their sustainability record.
WaterFlow also professionalized its service business by making it a discrete unit and setting ambitious revenue and margin targets for the head of service. This helped to align the entire organization with the solutions strategy, and it encouraged employees to look for other service opportunities to grow the business, such as maintaining the equipment of WaterFlow’s competitors. WaterFlow’s ambitious service program resulted in the company outperforming its peers in both EBITDA-margin and market-share gains.
This divergence in approaches holds a key lesson: industrial goods companies should broaden their view of service operations. When managers think about services, they should avoid focusing on only spare parts. Rather, after-sale services comprise a wide variety of activities—traditional technical services (such as basic installation and training), enhanced technical services (such as retrofits and upgrades), and business services (such as consulting, financial services, and outsourcing)—all of which can be quite profitable because they provide high value to customers. (See Exhibit 1.)