This is all part and parcel of the trend towards XaaS, when everything is sold and consumed as a service. This is the third in a series of articles in which we're exploring the practical implications of XaaS for CxOs. As we cautioned from the outset, there's so much going on that it's all too easy to seize just one part of the picture, and still miss crucial elements.
Yesterday, we explored how manufacturers blend products and services on the path to XaaS, and found that they have to do more than simply adding services alongside products. Today we're going to look at the new business models enterprises adopt to sell these new offerings to their customers. Again, it's not quite as simple as it might seem at first glance.
In many industries, the first step towards converting products into services has been the subscription model. We see this happening in the automotive industry at the moment, where carmakers are teaming up with finance houses to sell new vehicles for a recurring monthly fee. Often that monthly sum also includes servicing, perhaps insurance, even a regular top-up of fuel. All for a predictable monthly sum.
Funnily enough, this was the same model software vendors adopted in the early days of software-as-a-service. They would take a traditional perpetual software license, carve up the price into 36 monthly instalments, and add in the cost of hosting it on servers in their own datacenters. The only trouble was, they didn't adapt the software for this new model, so there were few economies of redundancy or scale they could leverage.
The Dollar Shave Club story
For a salutary example of what's wrong with this approach, let's turn for a moment to the consumer packaged goods industry, and the case of Dollar Shave Club, which launched in 2012 and which Unilever bought four years later for $1 billion. As Ben Thompson explains in his Stratechery newsletter, Dollar Shave Club used the online subscription model to fatally undermine the old Gillette model of marketing replacement blades at high margins.
Gillette's owner Procter & Gamble (P&G) can't simply rehash its retail pricing as a monthly subscription. That's because Dollar Shave Club completely cut out all of the R&D, marketing and distribution costs with a model that brilliantly uses Internet word-of-mouth to find customers and then ships no-frills blades in return for a low-cost subscription. This is the risk that every established business has to face up to when it shifts to the XaaS model — that some disruptive innovator will use the model to find a cheaper way of delivering the same (or better) outcomes to customers. As Thompson writes:
Gillette’s model and P&G’s formula generally cost a lot of money: R&D cost money, TV advertising cost money, and wholesalers and retailers had to earn a margin as well, and that’s before P&G realized the return on their investment. The result was that cartridges that cost less than a quarter to manufacture and package were sold for $4 or more. That worked as long as P&G’s other advantages in technical superiority, advertising, and distribution held, but were they ever to falter, it was eminently viable to sell cartridges for less and still make a healthy margin.
Most chilling of all, at the time of the Unilever acquisition, Dollar Shave Club had already captured 15% of the US shaving cartridge market by unit volume, but only 5% by value. In other words, if it triumphs, the value of the shaving cartridge market will contract by two-thirds, mostly at the expense of the advertising and retail industries.
Delivering enhancements is part of the service
But don't despair. There's one element missing from the Dollar Shave Club story. It doesn't factor in what happens when you add software around a physical product. When products become smart connected devices, it becomes possible to deliver functional enhancements as a part of the service, as we saw yesterday with the examples of Kone and Bosch.
This ability to deliver functional improvements can be applied to all kinds of traditional industrial products, from electric cars and elevators to kitchen appliances — maybe even razors. Many manufacturers are already wrapping their physical products with connected software to maintain a relationship with the customer that’s focused on constantly improving outcomes.
In fact, this is the competitive flaw in the Dollar Shave Club proposition. Rather than delivering blades for the cheapest monthly subscription, it could be adding value by using technology to improve the shave over time, and perhaps further enhance the customer experience by introducing optional grooming services.
Outcomes are the takeaway here. Connected digital technology opens up a new vista of potential outcomes. Mikal Hallstrup, founder and CEO of the Designit design agency says that whereas twenty years ago an enterprise might sell a thousand products each of which fulfilled a single function, today digital technology makes it possible to ship a handful of products supplemented by thousands of services. What's important, he says, is to focus on the human need that's being served:
What a lot of clients are realizing is that they are competing in a very different industry than they expected. Design comes in in a very new way. It’s not shaping formats … it’s shaping interactions.
Rather than replacing products with services, the as-a-service model delivers the product as a means to the outcome, in return for an ongoing subscription. We'll wrap up this discussion in our next post with some more real-world customer examples.