A glance through today’s headlines and stock reports suggests that services is the place to be. The five-year sales-growth rate for services is nearly double that of products—and for earnings, the rate is more than double. Some companies, such as IBM Corp. for instance, have used services to drive impressive turnarounds. Clearly, there’s a lot of money to be made in services.
With all the upside, it might be surprising to learn that most product companies struggle to make service moves pay off. Product companies that enter services usually don’t meaningfully outperform their “pure play” product counterparts in revenue growth, stock performance and profit margins. Often, these disappointments incur millions of dollars in misguided investments. Indeed, only 21% of product companies say their service strategies have met expectations for sustained, profitable growth, according to a Bain & Co. survey. Successful firms, such as Jubilant Organosys Ltd, Applied Materials and SAP, have gained traction in services by rigorously evaluating each opportunity, offering services well-matched to customer needs, adapting to new ways of doing business, and skilfully managing inherent tensions with the product side of the business.
In our experience, four principles can help companies make the leap from products to services:
# Use services to complement strong products, not to fix weak ones. Companies that launch services to protect underperforming products are three times more likely to fail, according to our survey. Service moves tend to pay off most for companies in a position of market strength, such as Jubilant Organosys, one of India’s leading pharmaceutical ingredient supply and drug discovery companies. In 2001, the company changed its name from Vam Organic Chemicals to Jubilant and started complementing its pharmaceutical ingredients business with drug discovery. The move allowed Jubilant to offer multiple services to the same client, a strategy that tapped into the growing use of outsourcing by European pharmaceuticals in search of ways to develop and manufacture low-cost drugs. By branching out into drug discovery and clinical trial services, Jubilant has established itself as one of India’s largest contract research and manufacturing services companies. In fiscal year 2006, Jubilant reported net European sales of €280 million (about Rs1,570 crore)—a 28.6% growth over the previous year, with revenues from international markets increasing 41.6% in FY 2005-2006 (source: Jubilant website http://investing.businessweek.com/research/stocks/snapshot/snapshot.asp?capId=4497477).
# Avoid aiming too high. Companies planning to offer “high value” services need to ensure that customers will reward the value added. Before making its service push, semiconductor-fabrication equipment maker Applied Materials carefully evaluated customers’ needs and determined what customers would pay for all levels of service, from minor support to turnkey solutions. Armed with that analysis, the company decided to focus its offerings on cost savings for maintenance and superior reliability for systems operations. With its biggest customers, Applied Materials then tested the appeal of specific service benefits—savings of 15-30% on maintenance with guaranteed productivity rates—before forging ahead.
# Don’t assume product capabilities transfer to services. Product company executives tend to view product capabilities as transferable to services. But because service businesses live or die based on human capital and loyal customer relationships, they require different talent, metrics, processes and culture. More than half of the surveyed companies that felt their service moves did not meet expectations cited a lack of experienced services talent and leadership as a major factor. Typically, product companies need to bring in experienced outsiders to make services succeed.
# Give services room to breathe, but integrate them appropriately with the product business. Executives often either subsume services under the product business, or completely separate the two businesses. The first approach risks making services a poor cousin to the product business; the second often creates damaging internal and external conflicts. But if companies can strike the right balance, the linkages between products and services can be a source of lucrative differentiation.
Consider software maker SAP. In the early 1980s, it began to provide basic “break-fix” software services. Later that decade, it ramped up to provide value-added consulting services and, in 2000, hosted services. Throughout, the company worked hard to communicate to customers and partners when products would take the lead, and when services would drive the relationship. It gave services independence to build momentum, without straying into opportunities that damaged vendor relationships. With this coordinated approach to the market, SAP created a profitable growth path that strengthened customer relationships while providing deeper understanding of product usage for “next generation” product development.
In spite of the decade-long boom in services, many product companies have yet to hit upon a clear pattern for success when they expand into services. The rewards can be high, but so are the risks, and companies making the move can improve their odds by knowing what to avoid.
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