Daily Archives: November 5, 2018
This article is part of a series, The Seven Innovations That Will Change the World.
Servicization is a recent and growing trend. So recent, in fact, that Microsoft Word is trying to convince me that it does not exist by underlining the word in red. Typically, companies make products with a particular function. After selling the product, the company wipes its hands and moves on to its next customer. For instance, Whirlpool sells washing machines, and the function of these machines is getting clothes clean. Save warranties and guaranties, Whirlpool has no other contractual obligations to the buyer once the company sells the machine.
Servicization focuses on what consumers really want: the function. Instead of selling washing machines, Whirlpool could sell clothes washing as a service. The company could install washing machines in consumers’ homes and charge consumers based on how much they use the machine. The machine could have an attached smart meter that transmits the number of washes back to Whirlpool. The company would send you a monthly bill, just like your electric utility. Whirlpool, remaining the owner of the machine and simply the purveyor of a service, would be responsible for maintenance and would have an incentive for the machines to be reliable. After all, they would not get paid if the machines break down and the consumers can not wash their clothes.
Whirlpool could actually increase its revenue if it changes to a servicization model. Currently, washing machines cost around $2,000 and can last around 11 years (Consumer Reports). In contrast, a wash at the laundromat costs around $2. If a family of four does 500 washes a year, that’s 5,500 washes over the life of the washing machine, or the equivalent of $11,000 at the laundromat. If Whirlpool were to price its new service at par with the laundromats and Whirlpool’s weighted average cost of capital is 10%, then the value to Whirlpool is $7,145.
The consumer benefits in a servicization relationship because they do not have to invest in a depreciating asset and recoup the value of their purchase over time by washing their clothes. Besides the increase in revenue, Whirlpool would receive a large tax benefit as well. Since they do not sell the washing machines to the consumer (it just sits at the consumer’s house), they can keep the washing machines on their books as a depreciating asset and offset their income with the depreciation. Over the last four years Whirlpool’s average cost of revenue exceeded $17 billion. Even if only 5% of that is taken as depreciation on an annual basis it would have a sizable, if not transformational effect on Whirlpool’s tax bill.
In addition, new people would be able to afford washing machines in their homes, since they only pay by the wash, not for the whole washing unit up front. In this scenario, production would increase, and the company would be more resilient in downturns because people are more likely to continue washing their clothes and paying a small amount each wash rather than making large ticket purchases. Whirlpool benefits, its employees benefit, and its customers benefit as well.
For me, washing machines are a simplified example of servicization, but there are countless more applications of servicization beyond home appliances:
PRODUCT – SERVICE or FUNCTION
Computers – Digital computation
Automobiles – Mobility
Clothing – Warmth, style, status
Food – Nourishment, enjoyment
Copy machine – Printing
Aircraft engine – Thrust
Lightbulb – Illumination
Furnace – Heating
Voice-enabled digital assistant – Connectivity, convenience
Books – Knowledge, information, stimulation, storytelling, graphics, enjoyment, posterity of knowledge
Health care – Health, wellness
Hard drive – Storage, posterity, retrieval
Circuit breaker – Current, safety
Some of these products have already been servicized, but I can conceive of some sort of servicization scheme for all of them. Xerox has servicization contracts with offices. Instead of simply selling copiers it sells contracts that allow offices to use copy machines and pay by the copy (or more likely, for tiers or block-quantities of copies). Xerox is responsible for maintenance of the machines. Defense contracts are also servicized to an extent. Fighter jet engines have to guarantee a certain number of flyable hours to the military. The manufacturer is on the hook if downtime for maintenance puts the jets out of service for too long. One of the first commercial examples of servicization was for office flooring and carpeting. The concept was not very successful because facilities managers had a hard time shifting capital budget expenditure to operating costs. Consumers may be more willing to make the shift.
I could imagine Amazon switching to a subscription model for Alexa. Right now, the product is actually called an Echo, but many people refer to it as their Alexa anyway. Why not just make Alexa that actual product? Amazon could simply give people the device (or enable it over other devices that we use, such as our phones, televisions, and computers) and have us subscribe to various levels of service from Alexa (number of requests per week, music access, advanced information access, additional “Skills”, etc.). Undoubtedly one of Amazon’s objectives with their Echos is to increase engagement between consumers and all of the company’s products and services. Certainly, this new service-based model would incite more interaction and engagement with Amazon. One of the reasons I personally do not use Alexa is because I do not want to pay for one of the devices, especially when I already have a Bluetooth speaker that I am fairly fond of. If Amazon lowered the monetary barrier to access, I may be more inclined to become a user of the service.
Health care, for the most part, is already a service, but we pay for its delivery rather than its function. I could imagine a very different health care system in which we compensate providers for what we actually value: mainly wellness, as well as restoration in certain situations. We could actually wind up paying more the healthier we are rather than the sicker we are! Many people would appreciate that change, especially the government, which is the largest buyer of health care in the world.
The largest market in the world is the market for labor. Most labor, especially in developed economies, is full-time. Our time is bought as a product by our employers, but what the employers actually want is the function: applied strategic thinking, computation, applied engineering, customer consultations, treating patients, servicing vehicles, etc. In the current economy, in which there is extremely low unemployment, there is less risk to having salaried employees. Labor is in tight supply and companies are able to meet payroll by generating regular revenue. However, during downturns, when consumption decreases, full-time employment becomes a critical problem and companies wind up laying off employees, only exacerbating the downturns. Without guaranteed salaries no one would ever be laid off and the economy would have a natural hedge against severe downturns.
Freelancers have already servicized their labor, but nearly all professions could conceivably be servicized. Sales roles are partially servicized through the paying of commissions. The problem is matching service providers to customers. It’s typically easier to work with garages than for every person who needs an automobile repair to find a mechanic with some free time. The same goes for companies. It is difficult to find and contract on a continuous basis doctors, pilots, drivers, construction workers, bank tellers, data scientists, store managers, and nearly all other jobs, so they are usually just hired on at least a semi-permanent basis.
Aggregators have begun to servicized labor by ushering in the “gig” economy. An aggregator usually just replaces the old employer, but with none of the risk of having to pay salaries. For instance, Uber facilitates an income for all of its drivers, but Uber does not directly pay any of them, so in a downturn Uber would not be responsible for making sure any of them earn an income. For a truly equitable system to emerge the intermediaries would have to disappear and workers and companies (or the buyers of any service) would have to be able to directly contract with each other. Blockchain is one innovation that offers a solution to this problem. Blockchain allows for direct peer-to-peer transactions, so no aggregator is necessary to facilitate matching. In a way, all participants would own the matching algorithm and they would all benefit from it.
Another market that we may soon find to be servicized is automobiles. Automobiles are vastly under-utilized assets, spending most of their time taking up space in our garages or sitting outside of our workplaces. Instead of buying automobiles for personal use, imagine receiving an automobile on-demand from an auto marker or a fleet operator. Rental companies do this on a small scale now, but as autonomous driving technology develops, the scope of on-demand car service can expand. People will no longer have to own their own vehicle to guarantee themselves mobility. No matter where you need to go, a car will be available to you and you will pay based on how far you go and how long it takes you.
In the example of the Whirlpool washing machine, the consumer may very well pay for the electricity to operate the machine on her own. However, it is possible that for items like air conditioners, home furnaces, and automobiles, the manufacturer would pay for the utilities. In this arrangement, the manufacturer would save money the more efficiently the machine operates. Servicization has an opportunity to create a more sustainable economy. Carbon efficiency would be aligned with the financial incentives of manufacturers. No matter what the miles per gallon requirements legislated by the government it would always be beneficial for an auto manufacturer to exceed the standards. They could still charge the customer based on mileage, but the manufacturer would save money on gasoline.
Many developing countries do not have access to technology and machinery because purchasing them are too expensive and there is less access to credit in emerging markets. This leaves most low-income countries dependent on exporting raw materials to earn dollars and then spending those dollars on imported foreign goods. Servicization could change this. Farm machinery, manufacturing equipment, and construction machinery can all be servicized by the original equipment manufacturer. The amount of capital needed for new projects would be much lower, allowing for more development.
Around the world, many people buy big ticket items, like washing machines and automobiles, on credit. Servicization presents a large threat to consumer lenders around the world. Consumers would receive access to machines like washers for free and then just pay a little bit for each use. There would be far less need for consumer loans and credit cards. Consumers would be able to escape downward debt spirals, and finance ministers would be glad to see capital being deployed to more productive sectors of the economy.
Think of all of the items you use and rely on every day to go about your life. Sitting here at my desk (1) now there is a window (2) in front of me. I’m writing on a laptop (3). I’m listening to music from Spotify (4) of a Bluetooth speaker (5). The lights (6) are on, the air conditioning (7) is running, and my laptop is plugged into a socket to receive electricity (8). My food comes from a stove (9), I use a stationary bicycle (10) at the gym, and my cell phone (11) is never far from me. I enjoy cold water from a dispenser (12), and my clothes are washed in a washing machine (13). I take medicine (14) every morning to prevent malaria. We have an economic relationship with all of these items or services, but the terms of the relationship can easily be changed, both for the benefit of the consumer as well as the purveyor. The computing power of this laptop and my smartphone sit idle for most of the day. I have no way of knowing how efficient the air conditioning or the stove are, and I’m going to be quite upset if I get malaria despite having paid for the prophylaxis and adhering to the regimen.