Article - Issue 44, September 2010

Growth of Services

Professor Tim Baines

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Professor Tim Baines of Cranfield University, leads the Product-Service Systems arm of a £5 million initiative creating a UK Innovative Manufacturing Research Centre. The centre helps manufacturers to innovate and exploit the opportunities offered by services. He writes for Ingenia about different types of service and how these can carry varying levels of risk and revenue for participating companies.

Professor Tim Baines used an Academy award to research the advanced
services contracts that Caterpillar have established in the US. He is
pictured on a D11 Bulldozer in Birmingham, Alabama. Since its creation
80 years ago, Caterpillar has grown to become the world’s largest maker of
construction and mining equipment. It has become particularly successful
in delivering advanced product-service contracts where monitoring
technology helps check the health and performance of equipment as it is
used by their customers.

Professor Tim Baines used an Academy award to research the advanced services contracts that Caterpillar have established in the US. He is pictured on a D11 Bulldozer in Birmingham, Alabama. Since its creation 80 years ago, Caterpillar has grown to become the world’s largest maker of construction and mining equipment. It has become particularly successful in delivering advanced product-service contracts where monitoring technology helps check the health and performance of equipment as it is used by their customers.

The prevailing view in the UK is that there is both a significant potential and a growing demand for advanced services which many manufacturers are anxious to exploit, but what does the increase and growing sophistication of services bring to manufacturers and their customers? What resources need to be made available for them to operate successfully, and how do manufacturers weigh the risks and rewards of developing the advanced services that very often involve considerable financial commitment through performance and availability guarantees?

It is fair to say that business practices differ across sectors, and there are plenty of examples where service contracts have been torn up after failing to provide the anticipated benefits. Furthermore, regulatory motives come into play when customers are organisations (such as government agencies and charities) with strict policies preventing the purchase of capital equipment.

Nevertheless, customers generally seek advanced services to improve their own operational efficiency by controlling costs, reducing capital investment and fixed overheads, smoothing cash flow and allowing them to concentrate on their own core activities to generate revenues. Furthermore, leaving key services to the original equipment manufacturer allows them access to the latest and most advanced equipment, while avoiding the need to provide maintenance and the people to perform it, and reducing the risks of adopting expensive new technology.

Services can help manufacturers to strengthen their relationships with customers, help their customers to gain greater value out of equipment, and generally grow business by selling on other products and services. Financially, developing effective advanced services creates new revenue streams that in turn offer the scope for improved margins and smoother cash flow. At the same time more advanced services can set high barriers to entry for competitors who simply exploit a lower cost base.

Categorisation of services

Understanding precisely what ‘services’ are can be challenging as different organisations or sectors use different terminology, and some take services strategies to a much deeper and more sophisticated level than others. A well-known leader of service provision is Caterpillar, the world’s largest maker of construction and mining equipment, diesel and natural gas engines, and industrial gas turbines.

The extended Caterpillar network in the US demonstrates a clear and well structured portfolio of services that can be easily grouped as either base, intermediate, or advanced. This clustering reflects the extent to which the services offered go beyond the conventional production-based competences of a manufacturer.

Base services directly exploit production competences, embracing the basic equipment, such as an excavator or quarry truck, together with spare parts and consumables, plus technical support and advice.

Intermediate services are still closely associated with production competences but their delivery requires extra resources, logistics or organisational capacity: Field servicing, maintenance, repair and overhaul would be typical, as would training in the correct maintenance and operation of equipment. These services can be more complex and riskier as they call for Caterpillar dealerships to take on greater responsibility and guarantees for the results of their services.

Advanced services stretch this risk and responsibility further still and are closely associated with taking on activities that would otherwise be internal to the customer, and are reflected in performance measures key to a customer’s own business objectives. Such services are often closer to outsourcing practices than equipment supply, leading to contracts based on guaranteed levels of performance or availability. In such cases, penalties are incurred if equipment performance fails to meet very specific expectations, which in the case of Caterpillar might, for example, be the anticipated revenue from a quantity of mined ore carried by a fleet of quarry trucks.

There is, however, a fourth level of service which manufacturers can offer that is no longer directly coupled to product based technologies. Here, typical services might include general consulting, dealing with such topics as business analytics and optimisation, financial management, customer relationship management, or even supply chain management. Few companies have stretched their organisation to this extent – IBM being one exception.

Most manufacturers, such as Caterpillar, have clearly decided that this is a step too far as it could place them in competition with some of their existing customer base. To Caterpillar, the preservation of strong relationships between themselves, their dealers, and customers, is critically important.

Excellence in product design and manufacture appears to be critically important as a foundation for a successful portfolio of services. As Rolls-Royce has built its services business on a reputation for excellent gas turbines, so has Caterpillar built its reputation on world-leading excavation equipment.

Performance based contracts

An example of an advanced service is a performance based contract. Such contracts can help companies to grow their sources of revenue and market resilience, but to do so demand innovation as much to business processes as the products and hardware they manufacture.

In the aerospace sector, for example, engine manufacturers such as General Electric, Pratt & Whitney and Rolls-Royce all offer some form of performance-based service contracts with commercial airlines. Many other western companies are following similar strategies, especially those in industry sectors with a large number of products already deployed such as Alstom (railways), Otis (elevators), IBM (information technology) and MAN (bus and truck manufacturers).

Alstom Transport, for example, has Train-Life Services agreement with many providers around the world offering a complete package of support that covers rolling stock, infrastructures, information systems and services. The agreement with London Underground contracts them to deliver train availability and reliability on the Northern Line. This contract of up to 36years in length, is based around the operation of a fleet of 106trains, transporting over 850,000 people across London each day.

One of their principal performance measures is ‘lost customer hours’ and corresponds to the length of any delays caused by train failures, factored against the number of passengers affected. This means a train failure during the rush hour carries much higher penalties than a failure at other times of the day. To deliver this contract Alstom undertakes live train monitoring whilst in service, maintenance, repairs and overhaul. The company operate extensive facilities close to the Northern Line itself such as the Golders Green Traincare Centre, and apply operating practices and technologies that ensure round-the-clock responsiveness.

Working practices in particular have changed. Before, maintenance work would usually take place during the day but now a lot of the main activities are undertaken at night. Within the supply chain, make-buy or capacity planning decisions are often mindful of greater service responsiveness. Alstom, for example, now in-sources the refurbishment of train air-conditioning units on the West Coast Main Line, and may run with up to 20% buffer capacity in their maintenance facilities to deal with the peaks and troughs of keeping a very busy fleet at high operational availability.

Minimising risks

Another key foundation to adopting services, and the level at which to deploy them, is assessing revenue potential against risk. Profit generated tends to track this relationship too, though exactly how closely is difficult to determine because businesses apply differing mechanisms to apportion their organisation’s costs and revenues.

Studies suggest that advanced services, even when managed well, are proportionately less profitable because they present more new challenges. On the other hand, the more ‘advanced’ the service, the greater the revenue generated and barriers to entry to low-cost competitors. Figure1 shows how risk and revenue grow through ‘base’ to ‘advanced’ offerings. Risk increases because customers will expect availability and performance guarantees with advanced services. Hence, managing risk is critically important to manufacturers: As risk exposure increases, so too does the scope for reduced revenue/profits. In fact, some advanced service contracts have been withdrawn because the risk exposure was found to be too great.

One way manufacturers are controlling risk is to employ remote monitoring technologies to provide real-time visibility of the health and performance of equipment as it is used by the customer. This in turn generates a large database that allows for equipment trending, and a predictive maintenance capability.

Rolls-Royce has developed engine health management systems for exactly this reason (see Engine Health Management, Ingenia, June 2009). Caterpillar has developed similar systems as have MAN. The MAN Group is one of the leading international providers of commercial vehicles and transport solutions. The company offer a range of service agreements that support repair, maintenance, and management of trucks. The MAN Trucknology brand, offers services that can encompass project management, vehicle tracking, driver and vehicle performance reporting, driver communication, and digital tachograph interfaces.

One of the main costs of truck operators is fuel which can be over 50% of the total running costs in a typical year. MAN’s advanced services include continuous monitoring of vehicle efficiency using sensors that measure such factors as continuity of vehicle speed, braking severity, and engine idling time.

The connection of the engine management system of MAN vehicles allows the continuous collection of information concerning the operation and performance of the vehicle. This data is transmitted in real-time to their website using GPRS communications. The data collected provides reports showing how the vehicle is being driven by the driver together with the actual fuel consumption and whether optimum fuel efficiency is being achieved. These vehicle performance reports mean that vehicles and drivers can be compared by vehicle type, depot, route or other parameters. This data can be used to evaluate driver behaviour, identify opportunities for training, and reward economical driving.

Summing up

The world for UK-based manufacturers continues to change. Rarely is it sufficient to compete on the basis of product innovation or production efficiencies.

Service-led competitive strategies offer opportunities for manufacturers to develop long-term relationships. These can increase revenue generation, and are more resilient to economic downturns. Paradoxically, such strategies also have sustainability benefits, as they emphasis the refurbishment and re-use of products, rather than their disposal at their end-of-life.

Such strategies however need manufacturers to adopt alternative technologies and working practices. Driven by the need for customer responsiveness, changes are often needed to working times, labour capacities, facility locations, and engineering designs. Technologies are often required to provide knowledge of how and where products are being used by customers, how they are performing and their state of health.

To support this industrial innovation, engineers will need to understand the implications of a services-led strategy, and most importantly, they can help create the technologies, systems and designs that allow manufacturers take on the risks that such strategies demand.

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