The Importance of Servitization in Manufacturing with Paddy Dwyer

12 July 2018

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Terry Mallin : Welcome to this week's Manufacturing Ignition Podcast, thanks for tuning in as always, and I hope you enjoy this week’s show. I’m delighted to be joined by Paddy Dwyer who is the Co-head of DLA Piper Manufacturing Practice.

For those wondering who DLA Piper is, it’s a global law firm, I think that across roughly about 40 countries, but they work specifically with companies ranging from multi nationals you know, the global wind flow since its fortune five hundreds, to emerging companies developing within industrial leading technologies, and that covers manufacturing also. Paddy is a highly experienced commercial writer and a specialist within business to business contracts. Paddy I’m delighted to have you in the show today. How are you?



Paddy Dwyer : I’m good. Thank you Terry, I’m delighted to be here also, thank you for having me.


 Terry Mallin : Great to have you on the show Paddy, and you are known as an expert within the manufacturing sector in the UK, especially discussing this week’s hot topic which is going to be the importance of servitization within manufacturing. To get started and Paddy, we’ll be glad if you can give us an insight into what servitization is.


Paddy Dwyer : I can, so servitization is a term that has been around for many years, it’s coming to a bit more prominence of late for example it was front cover of the Manufacturing magazine last month, so it's an on trend, it's a hot topic. And what it is at its very basic level is the bundling by manufacturers of services with their products, and I think it's the buying manufacturer's point which is the important one so many people across many different industries within manufacturing provide services whether that's ancillary to their product offerings, whether it's maintenance, and a multitude of services all layered in with product offerings. Servitization, I think that the magic in it is it’s-- the OAM which provides the service accompanying the product and you’re providing a solution or an outcome to your customer rather than just selling goods.


Terry Mallin : So Paddy just to get that kind of clear in my head, so that would be for example, you bought that specific product and then bought it on the other aspect or about some other function? Would that be correct?


Paddy Dwyer : Yes I mean, that’s a one ended scale, I think there’s more advanced solutions which people offer at the different end of the scale so if I give you an example, Rolls Royce is probably the flagship sort of servitization example in the industry, and what that looks like is Rolls Royce manufacture and sell engines to among other people and commercial airlines, and they've done that for many years. The servitized approach to that is rather than selling an engine, getting a revenue streaming just from selling goods, they will allow their commercial airline customers use off the engine and the payment is powered by the hour, so the customer pays for the power which is produced by the engine rather than the engine itself.  So its providing a powered solution rather than selling an engine to a customer.


Terry Mallin : Okay interesting, and I watched your last post, and as I mentioned, the leaders within manufacturing businesses that will be meeting specific products, how would our listeners look to servitize their product also?


Paddy Dwyer : So, in terms of how to servitize it, it will be business specific as to a particular method by which you servitize. The first point in it how to achieve it is to understand what your business does well, to understand what your-- the market that you’re selling to what it requires, and we have a strategy and methodology if you’re like the talks to the how, which we call a rapid servitization methodology. And that involves research into what does your customer look for? What is it within your costumer’s industry so rather than your own industry, what in your customer's industry is it that you can plug a gap in? So if we take a different example of MAN Trucks, MAN trucking has historically competed with your Mercedes, your Volkswagens, your everyone who manufactures and sells Lorries and trucks to various businesses including logistics businesses. MAN took the view that we can compete with these other manufacturers who create the same thing, while actually we can drive down to the next level of detail of what do our customers worry about when they are buying vehicles or leasing vehicles?

And it's not just the reliability of the vehicle, with no disrespect to the industry, that truck is a truck, it’s a truck. However they took the view that we can look at the performance of our trucks, the fuel efficiencies, the number of insurance claims and we can reduce costs in other areas of our customer’s businesses by implementing a system which measures tyre pressure, which measures driver's performance, and then you can incentivize it as a business, you can incentivize your better performing drivers, you can ensure that the tyre pressure is topped up on more regular basis it spelt the gap, and you can come up with a solution which saves money on fuel, which is a much higher cost saving than actually the expense on the trucks in the first place. So the first step on how to servitize is research, and understand what it is in your own business that's good, what you do well, and also understanding and this in the more important part, what your customer does with the products that you sell to them and how you can improve that experience and it's maybe just thinking outside the box a little bit on that element. Once you've done that research, there's a whole process that then follows this.

So the first is a narrow weight co-exercise which is the A in our rapid servitization model, so the analysis comes of how can we as a business address those gaps that we've just found, and you may need to look at investments in technology, you may need to look at optically your own people, and you need to have an honest critical analysis of your own business to understand one; is this opportunity worth it and two; where are the gaps? And plus being able to take this to market.

The next step is then plan for what you've found, so if you've identified an opportunity and you've also identified some gaps in your own ability to deliver, then you need to plan for how to roll this out. So if there is a gap in the technology for instance, then do you employ a software engineer? is that the right scale of employing one person?

Or actually do you need to go out there and find a company that you need to acquire somewhere because that particular offering can plug into your overall service offering and make your servitized solution a market leader. Once you've got a plan in place you then obviously need to implement it, and that’s what it is an attempt but there are different ways to do that. So for example you’re going to market with a brand new way of working, you probably want to test it, so how do you test it? If you have a costumer with whom you've got a good relationship, then you might want to build a pilot with that costumer, relatively low cost or maybe even no cost, so that you can test it in the field, in the market, get the feedback from your customer, improve the product in that test environment, before rolling it out on a wholesale basis.

And then the last point to note rapid servitization methodology is to develop, you are continuously developing the product, making it better, improving it at all times in order that you can stay in front of the market in your whole solution. So in terms of how to servitize, that’s probably the methodology that we see work.


Terry Mallin : Great, and Paddy when you get through that the listeners must be thinking you know, getting people thinking outside the box from their traditional methods, they’re actually going to know how do you—thinking I'm guessing that's all be able to create. There's a lot more opportunity factors going on as well between.. we’re a specific company you might-- what part of your predictable revenue streams as well?



Paddy Dwyer : Yes correct. So that methodology that we talked about of how to servitize, how to roll it out, it makes an assumption that you decided almost to do it, that before you get there there's a question of why would you consider it, and I think the why you've touched on the main one I think which is the predictable revenue stream, so your listener’s traditional business model is transactional based, so months by months week by week, there will be volumes of sales which come and go and over a course of time a business has a relative predictability of how well their products sell. But there is no certainty involved and a customer could potentially turn off the tap at any point. With a servitized model, you are entering into a relationship with your customers so whether that’s three years, five years, 10 years, whatever it looks like.

And you are renewing at times and get income stream over the course of that contract, that relationship. So there is an increased predictability in the revenue. Most people implement it in parallel to the transactional business, so it provides that predictability which in turn-- at the bigger end of the spectrum if you've got a company which is listed somewhere and that predictability has a positive impact on the share price. If going lower down the spectrum, the predictability can be more attractive to potential investors who come in or potential purchases of the business and even if you're a leader of an organization that's not necessarily looking for an acquisition or for further investment, that predictable revenue can appeal to your financial institutions. So, you may get better interest rates from your bank, you may get higher or more ability to get credit from your bank simply because you've got a more predictable revenue stream that you can point to in the book.


Terry Mallin : Here's what we’ve gone through is a lot, and I was moving to this or embracing this paper model and an opportunity but what potential barriers should our listeners face?


Paddy Dwyer : It's a good question, I think again it will be distort to certain businesses, but there are some which are generic that think across most manufacturing industries and the first and often the highest hurdle to jump is a cultural problem. So for many years your listeners will have been leading an organization which is very good at making things and very good at selling things, to shift that business model into a model whereby you're going out to your customers, you're providing a solution, you're providing an outcome and you're building a long-term relationship with the end user of the goods, it’s simply a different business. So there's a cultural shift to overcome, I think and it can be objections from executive board level, from stakeholders, from personnel on the ground, from members of your supply chain and I think that the first hurdle and often the biggest hurdle is overcoming that cultural gap of we are not just manufacturing and selling widgets anymore, we are providing an outcome to a customer over a particularly long period of time, I think that's probably the biggest hurdle.



After that, you get into too much more tangible problems, and probably the biggest of them is a funding gap. So, if I roll back to the Rolls Royce example that we talked about earlier on, you go from creating an engine and selling an engine in a relatively short space of time, to creating an engine, entering into a relationship with a customer, receiving small but regular revenue over a period of time, maybe breaking even at some point during the contract so that if let’s say you’re entering into a five year agreement, your break-even point may be year three, at the end of year five, the intention is that it is more profitable to have entered into that contract than to have sold the engine on day one, but there is still a gap between that creation of the thing and receiving an investment or a return on the asset and whilst over a five-year period, the intention is it's more profitable, you do have a funding gap on the creation of that particular engine for a much longer period of time and then moving from that to the funding gap is very real one, but after that you need to create and come up with a business model which allows you to exploit the servitized solution that you've come up with whatever that looks like, and that involves people which may or may not have the necessary skills to sell a solution rather than a product, you may also need a different technology infrastructure for different resources in place, which if you look at the MAN example that we talked about earlier, that shifts very much from having a truck on wheels with a capacity to load to a whole system that measures performance, measures efficiencies and I think delivers the output of that to their own customers so having the necessary technology or the necessary resources and then finally from my point view the most obvious one me is the contract problem of the contract, which then depends the sale of this solution to your end customers looks very different to a contract for the sale of goods. So, I think there are a number of hurdles and none of which a material, if it makes sense to your business that you can be more profitable, then all of these hurdles can be overcome.


Terry Mallin : Makes complete sense and you know I'm guessing that you know the rest there fight it out and implemented me on top of the funding gap is probably the importance of the strength for the contracts as well start put in place and thinking off the top of my edges on the basis or you're rest and field yields a company end up the end to reimburse upon a couple years inside by those about a rescue obviously and actually make sure you book in a quite annual into the other contract and place another servitize up, what would you see as definite in the contracts when using this model compared to a traditional models such as there are on goods.


Paddy Dwyer : Yes actually you’re right, having a robust contract in place does mitigate a lot of the risks that we’ve just talked about to point to the one that you talk to first of the funding gap yes, you absolutely need to have a model first of all for a-- even independent of the contract, you need a model profitable and whilst there will be a funding gap at the start and a risk at the start, ultimately you want to get to a place where on fulfillment of the contract, it is more profitable to having done that, than to having sold the engine in the first place, then you think about some of the risks that might happen in between and you identify the one of them of what happens if your customer goes bust and you've not reached your break-even point? So you want to address that in the contract so that might look like a retention of title course for example, so the title in the engine never passes to your customer.

The customer never owns the particular engine, instead you retain ownership of the goods, you charge for performance of the goods and there are certain trigger points in the contract which mean that from time to time you can go in and want to inspect them, make sure they're still in good condition, take them back in certain instances under an insolvency situation would be one of them, so that you could take that particular good back in house or maybe resell it to someone else.

There are a number of different arrangements or a number of different protections that you could put in place to help you, you're never going to fully mitigate the risk of a customer going bust, but you're not going to do that today anyway in relation to say the goods contract. But they're no-- other differences between a servitize contract if you like and a simple sale of goods, if you do retain title in those goods then the insurance arrangements look different, so your.. they remain the manufacturers products, so you probably want to insure them rather than asking your customer to insure them and no longer looking at warranty claims so whereas historically you may have sold the goods, received payment for the goods, wave them off and crossed your fingers that you're not going to get a warranty claim in the next 12 months and once that's passed everyone's happy, you move from that to a very different performance regime, so you may have service level than that, so response times for maintenance agreements, availability for any particular technology portals that you may want to add onto your goods, and within that there may be some kind of inservitization regime as well so, if you over perform, you may receive a premium on how much your monthly payment is, if you underperform, you may want to give you a customer discount in any one particular month because of lack of performance. So the performance regime looks different, you're moving from warranty claims to service levels.

You also want an ability on your rent and the relationship as well so for a manufacturer point of view you raise the point of, if the customer goes bust before you reach your break-even point, and that’s a risk and absolutely correct that’s a risk. There may also though be a scenario where it's no longer in your interest to provide this service during the course of the five years, so in a simple sales agreement scenario you sell the goods the customer walked away, in a servitized solution, you're in a relationship with a customer for a particular period of time and at some point you may want to get out, so you want to have provisions in the contract which allow you to do so in certain circumstances. Probably the biggest difference from my point of view as someone who writes these things though is the burden of responsibility on the customer, so if you take a step back from the contract and just look at the landscape and the environment that you are now in, in a sale of goods scenario the only real obligation on your customer is to pay the invoice. So, there will be other restrictions around don't reverse engineer my goods, keep things confidential and so on, but ultimately a customer's obligation is to pay the invoices and that sort of it. In a servitize solution however, if your income depends on performance of the goods because you're charging for an outcome rather than to the goods themselves, then you want to ensure that the customer does or doesn't do certain things that can prejudice them.

So the customer for example can't use the goods outside of the way it's described in the manual or they may need to notify you from time to time of certain things that are happening to them, they may need to control the temperature around the goods, they may need to allow you access in an hour at particular times so that you can perform proactive maintenance. There's more obligations on the customer in this arrangement than there would be in a simple sale of goods arrangement. What those responsibilities are will be completely bespoke to what the product is and what the solution is, but they need to go into the contract because without it you're not going to generate the revenue that you would otherwise be able to. I think there are many other differences between the sale of goods contract and a servitized contract. We could talk about each of them and take it off a long time.


Terry Mallin : Yes and we’re excited.


Paddy Dwyer : I know that listening to lawyers will not be the top of your listener’s agenda on any particular day but I think the importance is they are different, these contracts do look different to a sale of goods agreement which everyone would have used for many years in whatever they're manufacturing business is.


Terry Mallin:  Exactly Paddy you’re an expert in national entity, you have been briefed contracts especially with your experience but your servitized models as well. As I mentioned, you could be speaking about all of those, I think you know given that ….  I mean I was switched on there at almost exactly each point of relevance, but they're all interesting and the importance to actually having an expert like yourself having that conversation and making sure that all bases are covered for whatever you may be doing because is not all the manufacturing companies will be the same, they’ll be different product options, they’ll be markets, they’ll be regions, can you kind of summarize another thing Paddy in bringing out together, because we’ve had really good answers to the others for the why people should look to servitize you know what potential barriers may be presented with this model, what can I take contract to actually make sure that often say the T's are crossed and the I's are dotted, but then given all your experience and companies you’ve worked with before the relationships and the implementations actually that you've done before Paddy, how do you servitize effectively as our listeners have a certain alert and thinking “do you know what I’m very interested at looking at any other”, how would you go about doing that effect for us?


Paddy Dwyer : So I think we looked at the methodology earlier on, that we have seen that rapid servitization model of researching, analyzing, planning, implementing and then continuously developing that solution. I think for me the difference that won't make servitization to be very easy to do, and it can be very easy to bundle a service with a product and take it to market. I think from what I have seen, the most profitable and the most successful transformations come from having invested a lot of time in the strategy and a lot of time in the research and a lot of time in what does our customer expect? What does the solution look like? How robust is it? Where are the gaps in our own business work? Where do we need to plug gaps? do we have the capability to do this? do we help the people? Do we help the technology? How do we roll this out and how do we test it? and how do we ensure that whatever this outcome, whatever this solution is, when we finally launch it on the market, how do we make sure that on day one, it works and it's attractive? and continually we are looking back at it to improve it and I think the most success transformations and the most successful journeys are the ones that have been planned well enough I think neither is obviously always a problem. There's obviously always a balance between, you could plan forever and never deliver anything and so it is obviously always a balance.

But I think having that strategic heart at the start and saying “we're going to achieve this and we're going to achieve it within 12,18, 24 months, these are the milestones that we're going to put in place so by month three, I want to have conversations with five of my key customers, I want to engage the consultants somewhere to check the rest of the market, by months six, seven I want to have a plan in place which the executive boards are behind, which our supply chain of obscene are now feeding into, by month 10, 11, 12, I want to flip the gaps that I've already identified, by months 14, 15 I want to have trials in place with two or three of my top customers, and by month 18 we’re taking this thing to market” and I think having that plan at the very start, identifying each particular path, identifying the deliverables in between each one, that's probably the most successful, the most profitable journeys because at that point, if it's not going to be profitable after 18 months you will know within three or four and you've invested no time, if it is going to be profitable and you've delivered at each point in time and in 18 months time you have a parallel profitable revenue stream which hopefully is reliable, hopefully is something that you can deliver makes you stand out from your competitors and it's an extra revenue line in the book.



Terry Mallin : Okay, I think one of the key thing is to open up people's eyes to other opportunities and actually how to change a potential business model and it doesn't a bit there’s a lot to think about, it could be you know as you briefly mentioned, it could be alongside and you know the current goods and operation that's actually happening at the moment within the business you know, it could be something that tasty though and if it works, amazing and if it doesn't it’s not a loss compared to what’s happening in that, a lot to think about there eh?


Paddy Dwyer : Yes I think so, I think the other reassurance for your listeners those-- they are probably already doing a lot of this, there's not many manufacturers at the moment who are not providing some form of service in one way or another. I think that the takeaway point is to take a step back and look at it and say actually “can we do something different with how we present these things to the market?” And planning for that and seeing if actually if we do tweak it a little bit, if we tweak how we deliver this bundle of things to the market, will it be more profitable?


Terry Mallin : Okay, I think you're really at this point of the show, you mentioned Paddy about the importance of taking that step by actually looking at where the strengths of your product offering is and actually how that would lead to you know the customer and how to allow it benefit the customer you know book through up on that and then you know working back from.. I think that’s valuable. Paddy thank you very much for that, my mind is blown you know all of for me I think that applies to all of our listeners learn a lot in manufacturing but, guys I think putting all that together I think that will bring us to the end of this week’s manufacturing Ignition Podcast.

I’ll say that let’s thank Paddy as we all kind of getting filled here, Paddy is a real expert, you know is a commercial lawyer for VOA paper but he’s an expert in business to business contact and if you are a manufacturing leader thinking about a you know, how to utilize servitization within your business or would like to discuss anything probably with Paddy, on a commercial front please do get in touch and directly at Paddy’s email address is paddy.dwyer that’s D-W-Y-E-R, or call Paddy directly +01512374737. Paddy thanks so much for being on the show.


Paddy Dwyer : Thank you Terry, I'm on LinkedIn as well if people feel that's an easier way to reach out to me, but thank you for inviting me, I've enjoyed speaking to you about this and hopefully I'll speak to some of listeners off the back of it. Thank you very much.


Terry Mallin: Guys, thank you very much for tuning in today, I hope you did enjoy the show. Until next week when we'll have our next week's hot topic to discuss then, thanks.


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