By Dr. Timothy Chou
There are no shortage of research development teams (R&D) that built great — yet ultimately unsuccessful — products. And while any manufacturer — no matter the industry — is capable of doubling its revenues and quadrupling its margins by building digital service products, it’s a task that’s more easily said than done.
Why? Because the digital service product still has to be sold. And successfully doing so requires not only investment of time, effort and resources. It also requires a concerted effort to focus on five key components:
- Pricing the product
- Top-level marketing stories
- Developing a sales team and determining how they will be compensated
- Successfully managing business operations
- Determining how to pay for everything
Pricing the Product
Let’s start with pricing the product. While it can generate significant amount of debate within an organization, I propose you start with something simple. Price the digital service product as a monthly percentage of the purchase price of the machine. In the world of software, this often ranges from 2-6% of the purchase price of the product. Consider starting with 0.5-1% per month. So if your microplate reader is priced at $75,000, you should price the digital service product at $375-$750 per month. Of course, you’ll have a volume discount matrix, which will offer customers who spend more money a bigger discount.
Top-Level Marketing Stories
Next, you’ll need to define the marketing message. Since your No. 1 competition is the status quo, you should start with “selling the not.” Plenty of people both internal and external to your company think service is break-fix. A few months ago, I had breakfast with the CEO of a company that builds machines for the semiconductor industry. I asked him how many machines he had in the field. He responded by saying around 10,000 to 20,0000. The precision of his answer caught my attention immediately. I went on to ask him how much service revenue he generates, to which he responded with the universal sign of a goose egg.
I then asked “Why zero?” He replied “No one wants to pay for service.” Of course the reason no one pays for service is he defined it as break-fix support. Anyone who has just bought a $250,000 machine would assume it would work, so why pay anything more?
Well, service is not break-fix. Service is information, personal and relevant; information on how to maintain or optimize the performance, availability, security and changes of a machine.
Then there’s the importance of top-level marketing stories. In the modern era, it’s critical for you to find a way to tell your story as a story. Every night when you watch your favorite television show, you’ll see some essential aspects of storytelling. Stories have characters. Stories are set in a particular place and time. And all stories fall into three categories: man vs. man; man vs. nature; man vs. himself. Now check out your marketing collateral. How many stories do you see?
Developing a Sales Team
Once you’ve clearly articulated your digital service product story, your next major step should be to hire and organize your sales team. Make sure it’s a dedicated team. Selling service is not the same as selling new product features. Think of it this way… You may have noticed the Mercedes sales person and the Mercedes service manager isn’t the same person. Your digital service salespeople will be more farmer than hunter, since the goal is to monetize your installed base. Given these are all customers you should know, this is not the same as trying to prospect for new names.
No sales team works without a compensation package. Given you’re moving from selling one time to selling a recurring service, you’ll need to establish a compensation plan which both incentivizes the initial sale of the service, but also more importantly the renewal of this valuable recurring revenue stream. In software companies, it’s not uncommon to have customer success managers whose sole focus is continually satisfying the customer.
Managing Business Operations
Next you’ll need to have business operations create new contracts and ordering documents. You could borrow some of the terms and conditions from the software-as-a-service industry, but my most important recommendation is you avoid the creation of service level agreements with associated point-by-point penalties depending on how you did or did not perform the service. Instead, create a digital service product guarantee, which is all encompassing. In this guarantee, you should stipulate that, no matter the reason, the customer is entitled to a rebate of 20% in the month the claim is made. This will simplify revenue recognition, which will make your CFO happy, reduce legal expenses and expedite the contract signing (which should, in turn, make your sales teams happy).
Finally, building and selling a new product line will not happen without investment. You’ll be challenged to re-allocate resources from your traditional business. If you’re looking for a tool to help think about how to fund this transformation check out Geoffrey Moore’s last book, Zone to Win. He talks about putting your annual budget into four major categories:
- Transformation zones
The performance zone is money you spend to deliver material bookings, revenues, and contribution margins in this fiscal year. The productivity zone is money you spend to increase the efficiency and effectiveness of your R&D or sales organization. The money spent to deploy a new CRM application would fall into this category. Again, the time horizon is the current fiscal year. Most companies will have 100% of their budgets allocated to these two categories, which brings us to the last two categories. The incubation zone allocates funds to developing new business models or new products. The time horizon for these investments is 36-72 months. If you have not started a digital service product, then you’d allocate financial resources from the incubation bucket. Finally, the transformation zone is where you put the wood behind the arrow and fund not only the development of the digital service product, but all of the sales and marketing that’s required for it to be successful. Moore says pick only one project from the incubation zone. The CEO must sponsor it. Furthermore you’d expect to deliver 10% of the current company revenue in a 36-month horizon. Given the market opportunity is at least two times your current product revenues, this is certainly possible for any digital service product.
While not easy, the next major step for any company that makes combine harvesters, front loaders, industrial printers, water purification equipment, agitators or ultrasound machines is to build and sell digital service products. Digital service products deliver information on how to maintain or optimize the performance, availability and security of the machine. These are the fundamental components of the last major step, which is to deliver the product-as-a-service.
We’re already seeing the digital service product revolution occurring in certain industries. When will it start in yours?
Dr. Timothy Chou is a leader in the third generation of enterprise software, a computer science lecturer at Stanford University, the former President of Oracle on Demand, a technology consultant and an investor in emerging technology. Many AEM members may already be familiar with Dr. Chou, who partnered with AEM to present an executive business model workshop and was featured in an episode of the AEM Thinking Forward Podcast.
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