Business Models

Everything as a service

Karl Poonawala
9th May 2016

The commoditization of hardware is forcing a range of product-oriented businesses to revamp their business model to remain relevant. instead of selling the product, companies are offering the benefit to customers in other ways.

The commoditization of hardware is forcing a range of product-oriented businesses to revamp their business model to remain relevent. Rising competition from emerging markets, continuous tech innovation and increasing information symmetry has squeezed the profits of traditional hardware companies and eroded their long-run differentiating factor.

Fundamentally product-led businesses have a large installed base to cash in on. Typically, they complement their revenue streams with aftermarket services such as operational support, repairs, spare parts, etc. But in order to generate superior returns and cover overbearing capex in today’s competitive environment, companies are experimenting by making service a core value proposition - offering it as a service. Essentially, instead of selling the product, companies are offering the benefit to customers in other ways. And it’s being applied to a whole range of industries.

GE transformed the heavy machinery market by offering its jet engines as a service on “power by the hour” basis. Likewise, Philips sells LED lights on a per-unit basis for large industrial buildings (in the Amsterdam Airport). Instead of paying for the entire lighting system upfront (installation, bulbs, etc), the Airport pays for a fixed level of lighting at a fraction of the price.

On the consumer side, most smartphone manufacturers are battling the commoditization of their hardware. Apple though has been extremely successful at creating a sticky ecosystem where consumers buy an iPhone with the preconceived notion they will have to access services connected to it - iCould, apps, ApplePay, HealthKit, etc. Xiaomi has taken this a level further, disrupting the market with its “Triathalon Model” – concentrating on software and services, using hardware as a means to provide it. Xiaomi prices its models almost at cost, generating all profits down the line through added services such as apps, games, software, customizations and tools.

In the realm of software, the invention of cloud-infrastructure made selling Software as a Service (SaaS) possible. Instead of manufacturing software on disks and shipping them to clients, software companies are placing solutions in the cloud charging clients a subscription fee (usually per user per month).

In many areas, pivoting to services increases accessibility to expensive products. SolarCity pioneered the movement for solar making customers pay for the energy generated by panels instead of the equipment itself. Kotak Solar is driving a similar trend in India. Its opex model removes the massive upfront investment needed to convert to solar. Kotak helps customers generate savings from day 1, without any upfront capital (around $15,000 - $50,000 for a average household).

Even industries as archaic as furniture are seeing this adaptation. Furlenco offers its furniture on subscription basis, with customers paying a monthly fee for however long they want. This is increasing access of (high quality) furniture across Indian metros, reducing ownership burden and increasing flexibility.

Its being applied everywhere: Content (Netflix), complex manufacturing (3D-printing, imaterialise), beauty care (Dollar Shaving Club & Birchbox), etc.

Advantage for Businesses

There are multiple benefits of shifting a typical product model to a service.

Above all, it allows businesses to convert chunky capex into more stable opex, improving cash flow visibility. Revenues can be evened out over a period of time, reducing the cyclicality of businesses (like education & tourism). In turn this can have positive impact on valuation. Furlenco’s furniture assets can be used over a long duration by multiple customers increasing utilization, NPV and ROE.

Most important in my point of view is that businesses can engage with customers over the lifetime of an asset when offering a service - no longer does contact with the customer end at the point of sale. This creates opportunities to up-sell products and increase stickiness in the ecosystem. More importantly it can have a positive impact on competitive differentiation.

Benefit for Customers

Cost advantage is the primary benefit for customers. Customers can spread out the cost of the product over a period of time. Reducing the burden of heavy capex helps businesses become more nimble - increasing investment flexibility and the ability to scale up quickly.

This particularly improves accessibility, particularly in difficult economic times. Pay-as-you go models lets customers use a product only as much is needed, removing the barriers to entry. Amazon Web Services is a prime example - letting small companies use complex cloud services without having to make chunky infrastructure investment.

This is a trend emerging across the board, in multiple industries. However I think this is only the start of a much broader effort by companies to remain relevent in an increasingly competitive landscape.