What Infrastructure Do Manufacturers Need To Implement Servitization?

This post was originally featured on the Field Service USA blog.

This is the third post in a three-part series exploring servitization. The first post dove into the underlying problem that begat the need for servitization, and the second post dove into what servitization is and the impacts to manufacturers (OEMs) and their customers. This post will explore the infrastructure OEMs need to build in their organizations in order to bring servitization to life.

We’ll start with the implications of servitization on financial infrastructure, then dive into org structure, and lastly technology tools.

At the most basic level, servitization is about growing long term, recurring revenue while reducing short term business risk. More specifically, this is about moving from just selling capital equipment to selling equipment and services on top of that to maximize the value that customers can extract from a given piece of equipment. In the most extreme servitization models, this may even involve subsidizing capital equipment sales with service revenue, incurring a short term cash hit for even more long term recurring revenue.

The move to servitization has substantial impacts on cash flows. Traditional OEM cash flows tend to revolve around end-of-quarter as capital equipment purchases can take significant time to approve and typically revolve around quarterly budget meetings. Note that the numbers below are for a hypothetical OEM.

 

This stands in stark contrast to a more typical servitization based cash flow model, where revenue between equipment sales and service blurs and normalizes.

 

Although there is still seasonality in the servitization model, the month-over-month cash flow changes are tempered significantly. This reduces cash flow risk to the OEM, normalizes customer payments for the customer, and presents an opportunity for greater long term revenue capture per customer. Everyone wins.

Although every organization is different, it’s possible to paint broad strokes on the management structure needed to deliver servitized performance. The key to delivering servitized product delivery is organizational alignment. The lines between sales and service must blur: sales teams must learn, appreciate, and sell the value of service and customer-value-extraction. Service, on the other hand, must recognize that the company’s financial performance will depend on their ability to execute and ensure that customers extract the expected value from the OEM’s equipment.

If service fails, revenue will be negatively impacted. As a result of this interdependence, sales and service organizations need to work more closely together. These two organizations should report into a single unified head - with a title such as VP of Customer Success - whose two largest components of variable comp should be service delivery and sales, in that order. It must be clear from the top down that customer service is king.

Lastly, OEMs will need a new set of tools to succeed in a servitization world. Traditional field service management software will not be enough. Servitization is about customer service; as such, OEMs will need new tools to more effectively engage and support their customers. On demand support tools such as those offered by Pristine will become ever more important. So will tools that empower customers to diagnose and repair equipment on their own. These tools will become mission critical as OEMs won’t be paid if their equipment isn’t working as advertised. OEMs must find and implement the right tools so that their customers can service equipment on demand with OEM support and guidance.

How Can Field Service Organizations Reconcile The Incompatible Business Models of Yesteryear?

This post was originally featured by Field Service USA.

This is the second post in a three-part series exploring the two incompatible business models that coexist in most field service organizations. In the first post, I described the incompatible business models in depth. In this post, I'll outline how some of the leading field service organizations are reconciling the diverging business models of field service.

How can service organizations align these models into a single model that rewards their best and highest margin customers, while encouraging their lowest margin customers to invest and improve? To answer that, we must first understand the crux of the problem.

The vast majority of equipment manufacturers organizations aren't selling what their customers are buying. This sounds like an inflammatory statement, but it's not: customers are buying a capability - which happens to manifest as a physical tool - in order to accomplish a task. Customers extract value from the capability each time they use the capability. Customers are buying value extraction, not tools and service contracts.

On the other hand, vendors & suppliers are selling capital equipment and service contracts. These two items are enablers for customers to extract value, but they are not perfectly aligned. For example, customers often have to invest hundreds of thousands of dollars - or in some cases millions - before they can extract a single dollar of value. Once a customer buys a piece of equipment, they have transferred all of the leverage over to the manufacturer by paying a large fee up front. Once the manufacturer has been paid, there is a lot less incentive to guarantee that the customer extracts the expected value from the system.

How can service organizations rectify this discrepancy? In a word, servitization.  Servitization is a not a new concept, but one that is still only being pioneered by the earliest .1% of service organizations. It's a material shift from the traditional model of selling capital equipment and service contracts.  So what exactly is servitization all about? It's about aligning what equipment manufacturers sell and what customers buy to be 100% aligned. It has material impacts on cash flow, revenue recognition, business operations, hiring, culture, and more.

Let's walk through a few examples of servitization to understand what exactly it is, and what the impacts are:   What if airlines didn't buy planes, but rather paid Airbus for a certain number of flight hours, with Airbus supplying the necessary equipment to achieve the request number of hours?

What if hospitals didn't pay for MRI equipment, but bought a certain quantity of clinical hours per year?  What if manufacturing facilities didn't pay for conveyer belts, but paid for hours of belt rotation? In each of these examples, traditional capex is converted into opex.   What does this mean for the manufacturer?

1) The traditional payday from the sale of a piece of equipment now becomes amortized over the course of many years. This has serious cash flow implications.

2) Ongoing revenue from a sale indefinitely.

3) An incentive to ensure uptime at all costs.

4) That the solution needs to deliver value as quickly as possible; otherwise the customer will return the solution.

5) Solution vendors can generate more revenue per customers (over time) by providing a potent combination of equipment and associated service.

What does this mean for the customer?

1) No capital budgeting or capex.

2) Reduced risk associated with purchasing equipment.

3) Closer collaboration with the vendor.

4) Ability to return equipment without eating a massive sunk-cost.

But perhaps most importantly, the servitization model aligns incentives completely. In this model, customers pay as they extract value from the product, which means that manufacturers are incentivized to ensure that customers can extract as much value as possible. In this model, service organizations are incentivized to work with their customers to ensure success, rather than simply minimize service cost (whether by shaving staff or trips). Rather than look at service trips as a cost with no marginal revenue, service trips become revenue enablers for all customers.

So, what companies are implementing servitization models? How are they doing it? What are the outcomes? I'll explore that in the third post of this series.

Field Service Organizations Are Burdened With Incompatible Business Models

This post was originally featured on The Field Service Blog.

Field service organizations encompass two distinct business models that are intrinsically incompatible, yet the norm. How is this possible, and how can service organizations reconcile these models?

I’ll start by explaining the business models that service organizations are burdened with. They have two types of customers: those on contract, and those off contract. Sales divisions are asked to sell service contracts because they’re intrinsically high-margin, and in some cases, 100% margin if the customer never calls for support. And yet, once the equipment sale has been made, if the customer is on contract, the service organization is incentivized not to come out and actually service the customer. Why? Because the trip is purely a cost and is eating into what was 100% gross margins. I’m not suggesting that service organizations act unethically and violate service contracts by not sending staff out; rather, I’m saying that on a marginal basis, with a service contract in place, service organizations would rather not come on site to service a customer than come on site because on-site trips incur significant costs that cannot be recouped on a marginal basis.

On the other hand, service organizations are happy to service customers who are off contract. Why? Because the service organization can gladly mark up the cost of the ad-hoc visit to cover the marginal costs of the trip. For off-contract customers, service organizations profit from every service trip. The irony of this is that although service organizations profit from servicing off-contract customers, service organizations are always trying to upsell service contracts!

Thus is the paradox of service organizations: they’re incentivized not to service their best customers – those who have agreed to pay for a service contract – and are incentivized to service their worst customers – those who won’t pay for a service contract.

How did these incompatible models come to coexist?

In short, the current divergent business models are based on legacy assumptions. Decades ago, field service was different than modern service:

1) equipment wasn’t as complicated, and was thus more capable of being fixed by local technicians rather than experts employed by the manufacturer

2) there were fewer electronics. Electronic components are increasingly difficult to fix by non technical experts, requiring professionals with entirely new skill sets

3) customers were less demanding in terms of guaranteeing reduced downtime and response time

Over the last few decades, these assumptions have broken. Equipment is more complicated than ever, and businesses are increasingly less willing to deal with downtime. Despite these changes, the field service model hasn’t materially changed. Service organizations still try to up-sell service contracts, and still do everything they can to avoid on site trips since on-site trips are so expensive on a marginal basis.

The output of the structural changes is that field service has for many organizations devolved into a cost center, or at best a marginal profit center. But given the antithetical models that service organizations have to house, service has lost strategic relevance.

In the next post of this two part series, I’ll explore how some of the leading equipment manufacturers and their service organizations are re-inventing their service models to align with customers more effectively, and as a result, drive strategic value of service organizations.

Do Next Generation Reimbursement Plans Align with Healthcare’s Business Models?

This post was originally featured on HIT Consultant.

In The Innovator’s Prescription, Clayton Christensen identifies one of the core problems in healthcare delivery: a mix of intertwined business models that create massive operational overhead and inefficiency. He describes three distinct business models in hospitals.

Healthcare’s 3 Distinct Business Models

1) Diagnostics and non-linear treatments – the process of diagnosing and treating many complex patients is a non-linear process. There are often many unknowns that cannot be predicted or understood without sophisticated testing and experimentation. With enough time, money, and energy, physicians can usually diagnose and treat the problem.

Christensen compares the diagnostic and treatment business to the strategy consulting business. Strategy consultants are rarely paid based on outcome, but rather based on the time and energy they put into solving the problem at hand. Consultants can’t guarantee an outcome on a pre-determined schedule because they simply can’t understand the depth of the problem prior to committing to solving it. They rely on specialized training to determine the root cause of problems and devise elegant solutions that balance the needs of all stakeholders.

2) Repeatable, known procedures – unlike the diagnostics described above, there is a massive sector of medicine that is highly knowable and repeatable. Physicians can guarantee outcomes for many procedures because the diagnostics and treatments are extremely well understood and formulaic. Providers can diagnose quickly against explicit, easily measurable criteria. With a well understood diagnosis in hand, providers can prescribe a treatment plan, and patients verify everything independently online; patients don’t need to rely on their physicians prescription, although many do. This is particularly common in surgery, as well as many office based procedures and cosmetics. Using Dr. Google, patients already do this today en masse. Dr. Google helps patients keep providers in check.

Christensen compares the procedural medicine business to the manufacturing business. Factories guarantee 99.X% of the widgets they produce will come out to spec. They even typically warrant that the widget will work for at least Y days, and offer refunds in the case of failure. Manufacturing businesses take a set of inputs and guarantee a set of outputs at a known cost. Similarly, many treatments have knowable inputs – the patient, diagnosis, and tools for the treatment – and can guarantee results with precision.

3) Wellness and chronic disease management – most of the attention and innovation happening in healthcare today revolves around wellness and chronic disease management. The premise of this business model is predicated on tracking and understanding one’s health on an ongoing basis to make better lifestyle decisions to avoid interacting with business models #1 and #2 described above.

The fundamental problem with chronic condition management is assuring adherence to the prescribed therapies. Most patients unfortunately don’t adhere to the prescribed policies that are intended to – and are generally effective at – preventing costly hospitalizations. Thus, the challenge of chronic condition management is really one of behavior modification and change. The most effective therapies for behavior change have been social in nature. Patient networks such as PatientsLikeMe, Alcoholics Anonymous, and others have proven extremely successful in changing behaviors at scale.

Unfortunately, healthcare insurers today don’t financially support and providers rarely prescribe these programs. Thus patients who need a chronic disease management system are forced to interact with a system that’s designed to treat acute conditions.

Christensen compares the chronic management business to other online-enabled networks such as eBay. The goal of the marketplace provider is to ensure rich, dynamic, and meaningful interaction between the market participants to maximize mutual value for both sides of the marketplace. If the marketplace provider fails to facilitate interaction, the market fails.

Do changing reimbursement models align with the underlying business models?

Providers are increasingly assuming risk for patient outcomes. There are a number of reimbursement models that allow providers to assume risk – capitation, bundled payments, shared savings, and more. Do these reimbursement align with the underlying business operations? Remarkably, the answer is “yes.” Below I’ll provide a broad description of the reimbursement models that the Center for Medicare and Medicaid Services (CMS) has authorized, and how each of those models works with the operational business models outlined above.

Shared saving models are reimbursement models in which providers bill in a traditional fee-for-service model. However, at the end of a given time period, typically 3 months, providers compare their billings with a predetermined benchmark given the risk-pool and size of the population they’ve been treating. If the provider bills less than the benchmark, the provider shares in some percentage of the savings (the insurance carrier – in many cases Medicare or Medicaid – shares the remainder).

Bundled payments is a model in which providers received a fixed payment for all care associated with a given episode of care. If the patient has complications or requires extra care as a result of the procedure, the provider must incur all of the costs associated with that care without additional reimbursement.

Capitation models are models in which providers receive a fixed amount of capital per patient per month that providers must care for. The rate is adjusted to accommodate for the risk associated with the patient population and regional differences in costs. Integrated delivery networks (IDNs) such as Kaiser Permanente and Geisinger are among the few delivery models that have achieved global – or in other words, 100% – capitation because they are both insurers and providers. Let’s revisit our three healthcare business models:

1) Diagnostics and complex treatments – it’s always been difficult to account for risk in consulting businesses. After all, the premise of consulting is to solve a challenging, not-yet-fully understood problem. Shared savings models are aligned with the consulting model. Shared savings models* accommodate the intrinsic risk associated with consultancy by not forcing providers to take on risk they can’t control for, but at the same time create upside opportunity for innovative providers who excel in diagnostics and complex treatments.

2) Repeatable, known procedures – bundled payments align incentives for knowable episodes of care. Bundled payments are analogous to warranties that come with widgets that factories produce. If the widget is bad for some reason, the manufacturer warrants that they’ll provide a new widget at no cost to the consumer. Similarly, bundled payments create incentives for providers to find ways to lower costs, improve efficiencies, and ensure repeatable, scalable quality. This model encourages quality and scale, enabling profitable privatization without fear of rationing and unethical, short term profitability-centric thinking. If there are complications, the provider must address the complications without any additional reimbursement. This model incentivizes providers to deliver high quality results every time. Patients win in a big way in this model.

3) Wellness and chronic disease management – capitation aligns with this model reasonably well, although capitation is plagued with a number of intrinsic incentive problems: capitation models create incentives for providers to fight with one another over the distribution of payments; capitation models also create incentives to ration care to achieve desired financial return. On the other hand capitation models create incentives for providers to pro-actively monitor and care for patients to help patients lead healthier lives and use fewer healthcare resources. If providers can work with patients change behavior to adhere to clinical prescriptions, hospitalizations can be avoided. In turn, providers, as the patients’ guide through the support groups and functions, can reap material financial reward.

It appears that the leadership at CMS has read Christensen’s writing. They’ve created reimbursement models that align with the three major business models present in healthcare delivery.

If only it were that easy.

The Foundational Killer App of The Apple Watch: Notifications

I just finished watching the Apple Watch keynote. There's one thing that repeatedly stands out throughout the course of the presentation, even though Apple doesn't explicitly highlight it.

The Apple Watch allows you to interact with rich, contextual notifications with almost no friction.

This is far more profound than it sounds upon first read. Let me explain:

TouchID has changed how I interact with my phone. Anecdotally, I've seen many members of the press, VC, and entrepreneur community echo the same. TouchID brings incredibly simple security to the masses.

But TouchID has one glaring shortcoming: it doesn't solve the security challenges associated with consuming interactive, contextual notifications without unlocking your phone. If you want anything more than a simple alert while maintaining strict security controls, TouchID falls short.

And that's exactly where Apple Watch succeeds. Apple Watch can render rich, interactive, contextual notifications on your wrist. And you can interact with them without unlocking a device. Notifications on Apple Watch are an order of magnitude more convenient than pulling out your phone, swiping a notification, and then using TouchID to actually unlock the phone.

This interaction model appears to break security by skipping the step of user verification. But it doesn't. Apple Watch can skip the user verification test via a Bluetooth LE tie to your phone. Apple Watch knows that if you're wearing Apple Watch and your phone is close by, that it's safe to render information on the watch face.

I'm not as convinced about the fitness and health value of Apple Watch given the struggle that other fitness trackers have faced in the market. However, the notifications functionality is a step function better than the status quo. Notifications will be the foundational killer app of the Apple Watch just as the multi-touch UX was the foundational killer app of the iPhone and iPad.