Industrial Sector Enterprises Shift to Outcome-Based Model
The traditional business model of the industrial sector is changing. Traditionally, original equipment manufacturers operated on a product-based business model; they sold their products at low margins and profited from additional sales with higher margins. Today, the industrial sector is shifting from that traditional focus on product sales to an updated focus on outcome-based services.
This shift to subscription-based sales and outcome services in the heavy machinery and manufacturing industry is a historical disruption. It’s a disruption that we at Catalant Technologies, where we provide industrial sector enterprises with human capital solutions, feel we must document in order to educate industry incumbents. Tulio Scacciati, one of Catalant’s energy and industrial executives, is an industry expert who’s developed growth strategies for companies within this space. With Catalant, he crafted our newest whitepaper, “The New Competitive Advantage: Industrial Subscription-Based Models” that features case studies and Tulio’s best practices for industrial enterprises experiencing this business model shift to outcome-based services. His research further proves that these changes will force enterprises to evolve in order to succeed, as disruption often does.
This subscription-based model, currently popular in the software industry, is a game-changer especially in capital-intensive industries. With this model, high capital expenditures (CAPEX) are replaced by long-term contracts and managed as an operative expense (OPEX). This causes new forms of purchasing as buyers minimize business risk and improve overall cash flow with stabilized contracted sales. A perfect example of an industry leader operating on CAPEX and moving to OPEX through a performance-based model is Diamond Offshore.
Diamond Offshore and GE Oil and Gas, an industry leader with billions in revenues, entered into an industry-first blowout preventer (BOP) performance-based service agreement. The agreement gave Diamond the right to pay GE based on the BOP’s reliability and availability. The BOP could cost anywhere from $25 million to $60 million, and with a performance-based model, GE categorized the BOP as an asset on its balance sheet. Companies smaller than GE wouldn’t be able to keep assets this large on their balance sheet; GE used this as competitive advantage. GE’s size and understanding of the BOP’s components and reliability helped the agreement function. By absorbing the performance risk of the BOP, GE set a precedent for service-based business models throughout the industrial sector.
GE invested in research and development to build a subsea control system that would monitor the BOP’s performance, predict maintenance and guarantee service to Diamond. GE also company hired and trained new drillship personnel and accounting for the availability of spare parts. GE maintained a balance sheet, invested in technology to improve performance and operated with flexibility to be one of the first companies to offer a successful outcome-based service agreement. Leaders in the chemical industry are following suit.
Chemical Strategies Partnership (CSP) is a nonprofit organization with a goal of reducing chemical use, waste, risk and cost. CSP proposed a business model in which manufacturers would move from a traditional supplier relationship to a partnership; the manufacturer would contract chemical services from the supplier. This would align the service provider’s and manufacturer’s incentives to reduce use and cost. A reduction in chemical use would correlate to a reduction in associated costs, emissions and liabilities. CSP’s partnership model would function long-term and tie the provider’s payment to quantity and quality of services delivered – unlike the traditional product-based model. In these types of long-term, subscription-based models, suppliers are paid based on how they manage the total product cost instead of solely being paid on the product sale.
Quaker is one company that adopted CPS’s new supplier relationship model through a chemical management services contract with General Motors in 2007. As chemical managers in the relationship started to pinpoint where costs could be cut within the chemical process, a leak was found — an expensive performance issue. At this point, sophisticated statistical systems replaced Quaker’s technology to find the leak. When the analysis was complete and the leak was repaired, General Motor’s oil consumption was reduced. The new model reduced General Motor’s costs by $800,000 annually.
As cloud technologies, innovative analytics systems (like that of Quaker’s above) and the Internet of Things (IoT) technologies advance, relationships like Quaker’s, CPS and General Motor’s will become more efficient. Industrial sector leaders will optimize their product offerings for customers and gain control and predictability in their sales. Suppliers will gain competitive advantage by maintaining a balance sheet and more confidently guaranteeing performance and outcome with the help of these advanced monitoring technologies. As more partnerships like Quaker’s and General Motors form, and as cloud technology and IoT evolve steadily, we’ll find that this service and subscription-based model is the preferred standard in business.