Ville Kosonen

BestServ
Industrial Service Business Strategy
Generic Framework and Case Examples

 Technology Industries of Finland All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior permission of Technology Industries of Finland. Publisher Technology Industries of Finland Etelranta 10 00130 Helsinki tel. (09) 19 231 http://www.techind.fi Printed in Finland by Painoprssi Oy, Helsinki, 2004 ISBN 951-817-853-4

TABLE OF CONTENTS

PREFACE.............................................................................................................1 EXECUTIVE SUMMARY ......................................................................................2 1 INTRODUCTION ...........................................................................................3 1.1 1.2 1.3 2 BACKGROUND ...........................................................................................3 OBJECTIVES .............................................................................................3 STRUCTURE OF THE REPORT ......................................................................3

BUSINESS STRATEGIES.............................................................................5 2.1 TEN SCHOOLS OF STRATEGIC MANAGEMENT ................................................5 Design school ..................................................................................5 Planning school ...............................................................................6 Positioning school............................................................................7 Entrepreneurial school.....................................................................8 Cognitive school ..............................................................................8 Learning school ...............................................................................9 Power school.................................................................................10 Cultural school...............................................................................10 Environmental school ....................................................................11 Configuration school......................................................................12 Conclusion.....................................................................................12 The siren call of industrial services................................................13 Different industrial service levels ...................................................14 Should my company enter the industrial service business? ..........15 Industrial services as a positioning tool .........................................16 Services as a way to learn.............................................................17 Impact of other strategic management theories ............................18

2.1.1 2.1.2 2.1.3 2.1.4 2.1.5 2.1.6 2.1.7 2.1.8 2.1.9 2.1.10 2.1.11 2.2 2.2.1 2.2.2 2.2.3 2.3 2.3.1 2.3.2 2.3.3 3

INDUSTRIAL SERVICES .............................................................................12

INDUSTRIAL SERVICE BUSINESS STRATEGY AND OVERALL STRATEGY............16

FROM MANUFACTURING TO SERVICES ................................................20

3.1

PROVIDING INDUSTRIAL SERVICES ............................................................20 New business models....................................................................20 From inter-firm rivalry to networks .................................................22 Forward integration........................................................................24 Customers as partners ..................................................................25 Organizational structures...............................................................26 The process of change ..................................................................28 Adopting a systemic approach ......................................................30 Systems technology ......................................................................31

3.1.1 3.1.2 3.1.3 3.1.4 3.2 3.2.1 3.2.2 3.3 3.3.1 3.3.2 3.4 4

TRANSFORMING THE ORGANIZATION .........................................................26

SERVICE INNOVATION ..............................................................................29

INDUSTRIAL SERVICE BUSINESS TRANSITION FRAMEWORK ...........................32

CASE EXAMPLES ......................................................................................34 4.1 4.2 4.3 4.4 4.5 CASE METSO ..........................................................................................34 CASE VAISALA ........................................................................................35 CASE INVISION TECHNOLOGIES................................................................37 CASE SUN MICROSYSTEMS ......................................................................38 CASE INDUSTRIAL EQUIPMENT MANUFACTURER..........................................40

CONCLUSIONS ..........................................................................................42 5.1 5.2 5.3 5.4 REASONS FOR ENTERING THE INDUSTRIAL SERVICE BUSINESS .....................42 TRANSITION IN THEORY AND IN PRACTICE ..................................................43 MODIFIED TRANSITION FRAMEWORK ..........................................................45 DIFFERENCES BETWEEN FINNISH AND AMERICAN COMPANIES .....................46

SUMMARY ..................................................................................................47

REFERENCES ...................................................................................................49

PREFACE
This report was prepared for the BestServ Forum, a research project aimed at improving the competitiveness of the Finnish industry through research on the possibilities offered by industrial services. This study was conducted during my stay in VTTs Silicon Valley office in California, USA, and I would like to thank Tapio Koivu and Petri Kalliokoski for giving me the opportunity to work there. I would also like to thank the interviewees for their contribution. And finally, my thanks go to the members of the BestServ Forum who funded the project and assisted in the making of this study: the member companies, VTT, Technology Industries of Finland, TEKES and Oy G. Andersson Management Consulting Ab. I hope this report succeeds in outlining the key challenges related to industrial service business strategy and will be useful for experts and novices alike.

In Espoo, 27th September, 2004

Ville Kosonen

EXECUTIVE SUMMARY
This report was prepared for the BestServ Forum, a continuation of the BestServ feasibility study conducted in 2003 that was funded by TEKES (The National Technology Agency of Finland) and eight companies. This study introduces the concept of industrial services, identifies the main problem areas associated with industrial service business strategies and presents a generic framework to help in the transition from a pure manufacturer to an industrial service provider. In the first part of this study a theoretical framework based on a literature study is presented in which the key issues related to the transition from a traditional manufacturing strategy to an industrial service business strategy are illustrated. The framework is tested with a case study involving two Finnish and two American companies: Metso Oyj, Vaisala Oyj, Sun Microsystems Inc. and InVision Technologies Inc respectively. Based on the results of the case study, a modified framework is presented.

1 INTRODUCTION 1.1 BACKGROUND

The aim of the BestServ Forum research project is to chart the possibilities offered by industrial services to the Finnish industry. It is a continuation of the BestServ feasibility study, which mapped companies interest and development needs around the subject. Eight companies participated in the feasibility phase (Metso Oyj, Wrtsil Oyj, Vaisala Oyj, M-Real Oyj, ABB Oy, Tamglass Oy, Valmet Automotive Oy and Patria Vammas Oy), and since then more companies have joined in so that the BestServ Forum has 20 member companies. One of the topics of interest that came up in the feasibility study was industrial service business strategy, and this study was prepared for the BestServ Forum project to serve as a short introduction to the subject.

1.2 OBJECTIVES
The purpose of this study is to familiarize readers with industrial services and industrial service business strategies in an international context. The main objective is to identify the main problem areas of industrial service business strategies and to build a general strategic framework that managers can use as a basis for creating industrial service business strategies for their companies. Detailed analysis of different strategies is intentionally left out of the scope because it would require a far more extensive study than this one.

1.3 STRUCTURE OF THE REPORT

The first part of the study, Introduction, is as the name suggests a short introduction to the background and objectives of this study. The second chapter, entitled Business Strategies, defines the concepts of business strategy, industrial services and industrial service business strategy. Different people use different terms for describing the same phenomena, and thus clarifying the terms used in this study is important. In the third chapter, From Manufacturing to Services, the changes that occur in an organization during the transition from a pure manufacturing company to an industrial service provider are discussed. Changes in business models, organizational structures, and research and development functions are outlined. The fourth chapter, Case Examples, describes the actual changes that have occurred during the transition in four companies. Two of the companies are Finnish and the other two American. The cases are based on interviews of key executives. 3

In the fifth part, Conclusions, the theoretical framework presented in chapter three is compared with the actual results of the case studies presented in chapter four. Based on the comparison, a final framework is presented. The sixth chapter, Summary, summarizes the key outcomes of this study.

2 BUSINESS STRATEGIES
Before discussing how companies should implement industrial service business strategies, it is important to understand what they are all about. As it turns out, even defining the word strategy is not that simple. In this chapter it is put into perspective by introducing ten different schools of strategic management. After that, the concept of industrial services is introduced, and finally industrial service business strategies are analyzed with respect to the different schools.

2.1 TEN SCHOOLS OF STRATEGIC MANAGEMENT

The traditional view of strategy is that it is a hard science; consultants who know everything about different strategies can tell managers what strategy works best for their company. In reality however, strategy is a much more complex issue. It should be the guiding force of an organization, yet there is more to it than managerial wisdom put into words. It is about vision, action, organization, culture, people, environment and much more. Certainly, the consultants analyses are an essential part of it, being efforts to conceptualize something tacit into more explicit guidelines that can be easily followed. But taking the concepts for granted and forgetting about everything else that strategy involves will most probably lead to failure, just as companies are likely to fail if the analyses are completely ignored. Mintzberg et al (1998) have identified ten schools of strategic management, each with different views on the subject. Consequently, each has its own advantages and limitations, described in the following.1 2.1.1 Design school Strategic management literature that can be categorized under the design school first appeared in the early 1960s. It represents the aforementioned hard science side of strategic management and is still very influential after some 40 years. The basic idea behind this school of thought is that strategy should be a match between the companys internal capabilities and the external environment. After a detailed analysis of the companys strengths and weaknesses, and the market environments threats and opportunities (the famous SWOT analysis), managers should be able to create a successful strategy. Naturally, all kinds of tools have been developed to support the detailed analysis required to come up with the strategy. What the actual content of the strategy is depends of course on the organization, but the idea that strategies should be based on a formal analysis is universal. After the formulation of an explicit

Based on Mintzberg et al. (1998)

strategy, it is formally implemented. In time, changes in the environment and the companys capabilities call for a new strategy, and the cycle begins anew. The drawback of detailed analyses is that they oversimplify things. Basing strategies on subjective views about the state of the organization and the environment is risky. After all, organizations and environments are complex entities that cannot be very accurately assessed. And simplifying things also leads to inflexibility; explicit strategies do not leave room for improvisation. Furthermore, separating planning from implementation inhibits fast adaptation to necessary changes, especially in turbulent markets. This is not to imply that analyses are not needed, managers should strive to understand their organizations and their environment. But relying solely on them in creating strategies is not the best solution. 2.1.2 Planning school The planning school emerged in the 1970s, focusing on the process of strategy formation. Its roots are in the design school, but the focus was not on what to do, but on how to do it. It adopted the views of the design school with all the analyses, and perfected them into an art of strategic planning. Companies were expected to hire a whole department of planners working directly with top management. This department would turn the managers visions into detailed plans that the organization could execute. As in the design school, the idea was that managers would conduct detailed analyses of the organization and its environment. But instead of creating an explicit strategy, they would establish a clear vision of the companys future and communicate the vision to the planning department. Following a well documented planning process, the department would then make plans for almost everything, ranging from R&D and operations plans to divestment and diversification plans: the plans were the strategy. They would be implemented and reviewed, and feedback given to managers as inputs for the next round of planning. After a short boom in the late 1970s, companies gradually abandoned such a complex and rigid system because it failed to work in practice. The main reason for this was that the process dominated over the substance, taking all the attention and rendering the strategy inflexible; planning was even more detached from doing than in the design school. Also, the bits and pieces, i.e. the different plans, often failed to make up a coherent strategy. Critical core business development plans received the same attention as more trivial but sometimes more interesting topics like mergers and acquisitions. But, once again, despite the drawbacks the whole idea of strategic planning should not be dismissed. Plans are a good way of formalizing parts of the overall strategy, but strategy has to be formulated prior to planning. First and foremost, planning is a tool. Nowadays literature falling under the category of strategic planning deals with 6

scenario building and the like, useful tools but not the sole basis for strategic decisions. 2.1.3 Positioning school Perhaps the most influential of all schools, the positioning school, emerged at the beginning of 1980s based largely on the work of Michael Porter (e.g. 1980, 1985). It adopted the ways of thinking of the design and positioning schools, but instead of the strategy-making process the focus was on the content of strategy. The basis of the whole school is the idea that there are only a few generic strategies that a company can adopt in order to succeed in generating aboveaverage returns. These generic strategies can be identified as positions in the marketplace, hence the name positioning school. Porter (1985) argued that there are basically two ways for a company to gain a competitive advantage: low cost and differentiation. Low-cost strategies translate to high production volumes and low cost per product allowing competition on price, whereas differentiation strategies focus on product quality to enable selling with premium prices. Add to these two a second dimension of competitive scope, i.e. whether to serve mass markets or specific niches, and the total number of generic strategies a company can adopt is four. The generic strategies lay the foundation for all other strategic actions a company takes. Adopting the views of the design and planning schools, the decision on which strategy to adopt should be based on detailed analyses about the competitive environment and the firms competencies. In addition to the traditional SWOT analysis, Porter (1980, 1985) also presented other tools to support decision making. These included the famous Five Forces Model and the value chain, which are still widely used. While certainly influential and insightful, and promoted especially by the strategy industry, the theories behind the positioning school should not be taken for granted. As discussed earlier, basing strategic decisions solely on analyses about the industry and the company itself can be dangerous. Furthermore, the generic strategy options are biased towards big businesses, and even certain types of businesses. They might reflect reality accurately enough in big, mature industries but industry dynamics are somewhat different in new and rapidly evolving ones. And is there even one best way of doing things? Does competitive advantage arise from doing things the same way but only better than competitors, or from creating novel ways of doing business? Probably both, but the positioning school does not take the latter much into account. Despite these shortcomings, managers will do themselves a great disservice by ignoring the theories of the positioning school. The promoted practices will provide valuable insight into the strategy-making process, as long as they are not allowed to limit decision making. The theories have inspired many highly successful managers and the positioning school definitely deserves its status as one the most influential schools in strategic management. 7

2.1.4 Entrepreneurial school The first three schools of strategic management emphasized the importance of analyses in defining strategic direction, leaving little room for management insight or intuition. The entrepreneurial school does exactly the opposite; it is based on the notion that managers (or even a manager, the CEO) have a clear vision of the companys future and that strategic actions can be derived from this grand vision. The influence of this school can clearly be seen in that almost every company these days has an official vision, be it a real entrepreneurial vision or a nicely articulated statement with no true insight behind it. When talking about a grand vision, one immediately thinks about the leader of an organization, the captain at the helm guiding the company safely through the storms of competition. An entrepreneurial organization needs strong leadership and the will to make the vision reality. A vision is not totally explicit, but arises from tacit knowledge and expertise. This also implies that the actual detailed strategy to implement a vision is more or less emergent rather than predetermined. The company sets out to do something and as problems arise they are quickly solved using the vision as a guideline. The drawback of all this is, of course, that everything is dependent on the capabilities of company management or, in some cases, one manager. As there is no clear process of strategy making and no formal analyses to base decisions upon, the strategy-making process is more or less a black box. Take the visions of the management, put them in the box and see what comes out not a very scientific approach. The good thing is that this encourages creative thinking, as there are no predetermined categories into which the strategy has to fit. This way, novel strategies that break the rules of the competition and lead to success can be formed. Although the entrepreneurial approach is clearly best suited for smaller companies, bigger ones too should take heed of innovative and flexible ways of creating strategies. 2.1.5 Cognitive school The cognitive school takes a whole different approach to strategy making, studying how strategies emerge from the psychological point of view. After all, strategists are human beings and are guided and restricted by the ways humans think. For example, one could ask a few people to describe the competitive environment of a company. The answers would differ from each other, as each of us sees the environment in a different way depending on the inputs we get. The question is does a quantifiable environment really even exist, or is it just created by our ways of categorizing things so that we can better understand them? If we could understand the limitations of human thinking and the factors that most shape our views, we could be more objective. Resistance to change for example is inherent in all of us to some degree, sometimes to the point that necessary changes to strategy are hindered. Learning to take this better into account would help managers in their efforts. 8

Due to the abstract and complex nature of its approach, this school has received somewhat less attention, and quite understandably especially among managers. Its biggest contribution is perhaps the awareness that strategy making is not just about analyses and visions, but has a much softer side as well that might sometimes play a big role. 2.1.6 Learning school Proponents of the learning school look at the strategy-making process as a process of learning rather than as a process of deliberate analysis. The underlying thought is that action comes before thinking, and while acting the organization learns to act better. In time, the different actions form a pattern, which is the strategy. The strategy therefore emerges from the actions taken, whereas the first three schools presented suggest the opposite: actions emerge from strategy. The entrepreneurial school falls somewhere in between these two views, suggesting that the final outcome of strategy is deliberate but the path leading to it is emergent. The learning school emerged as a counterbalance to the strictly analytical design, planning and positioning schools.2 The analytical models were popular, particularly in America, but Asian companies had always been somewhat skeptical about them. They had always relied more on informal management practices, emphasizing learning and the role of tacit knowledge in running businesses. Managers did not just sit in their offices browsing through reports and analyses, but really got their hands dirty and learned to know their businesses better. This helped them in making the right decisions, even though they did not base the decisions on formal analysis.3 But relying on organizational learning in creating strategies can be hazardous as well. Without some sort of grand strategy, an organizations actions can easily become incoherent, lead to sub-optimization and fail to create an effective overall strategy. The processes of learning are also deeply embedded in human cognition, and are not very well understood. Fostering learning, and thus improving organizational performance, is therefore more or less a leap of faith. As with all the other schools, strictly following the theories of the learning school will probably not lead to the best possible results, but some of the views are certainly worth adopting. Learning is an important aspect of organizational development, and organizations that are able to learn faster than their competitors will achieve advantages in the long run. Quick learners will also adapt faster to the environment when changes occur, and in times of disruptive change an experimental approach can be far more efficient than an analytical one.

2 3

Recommended reading about strategic learning: Pietersen (2002) For a popular theory of organizational learning, see Nonaka & Takeuchi (1995)

2.1.7 Power school Introducing yet another different viewpoint to strategic management, the power school has actually two different approaches. Research under the micro power school studies strategy making as a struggle for power between individuals within an organization, whereas the macro power school concentrates on the impact that other organizations and stakeholders have on strategy. After all, in most organizations the strategy-making process is also about politics. Especially the entrepreneurial school, but also the design, planning and positioning schools, assumes that the companys CEO always has the final say about strategic decisions. In reality, however, especially in bigger companies, there are several interest groups involved that can influence decisions. These include powerful individuals or alliances within the company as well as organizations outside the company, such as labor unions or even the government. Strategy is therefore more or less a compromise between what the management thinks is the best possible strategy, what internal interest groups promote and what external pressures dictate. Managers that make strategies have to take this into account and play the political game correctly; alliances (both internal and external) can be formed, information either disclosed or withheld, support bargained for and so on. This implies that strategy is more emergent than deliberate, as it is formed by the political play between individuals and organizations. The theories of the power school are perhaps most relevant in situations involving major changes to strategy. While hardly never absent, it is hard to imagine that politics would seriously affect the course of a company during times of relative calmness, involving only slight modifications to existing strategy. The power school certainly makes a very good point but, as we have come to see, all of the schools have managed to describe just one part of what there is to strategic management. This is also the case with the power school. 2.1.8 Cultural school An organizations culture has a big impact on its performance, and that impact also involves strategic management. The cultural school is actually the mirror image of the power school; it studies the influence of collective culture to the strategy-making process, whereas the power school concentrates on the influence of individual stakeholders on strategy. According to cultural school theories, strategy arises from the social interactions between individuals, mirroring the beliefs and understandings of the organization as a whole. Strategy is seen as the way an organization uses its resources and capabilities to gain competitive advantage. It can be deliberate, but it is never totally conscious, as its foundations are rooted in culture. It is therefore also impossible to fully imitate the strategy of another company; the exact same strategy would not work because it would conflict with culture at least to some degree. This is why 10

mergers and acquisitions often fail, even if they look perfect on paper. In order to change strategy, culture has to change, too. There is a certain amount of resistance to change in every organization, and this can sometimes discourage the management from executing necessary changes if culture is given too much emphasis. Changing culture in order to induce changes is very hard, as management and decision-making styles, organizational values etc. are deeply embedded in the organization. They will, however, change in time and sometimes culture has to be ignored when the circumstances demand radical changes. Ignoring culture altogether is not a wise thing to do, however, as it is fairly easy to destroy a good culture and thereby radically downgrade a companys performance, but hard to build one that supports the chosen strategy. If strategy changes radically, active efforts to change culture are needed as well. 2.1.9 Environmental school The environmental school takes a entirely different view on the subject of strategic management from all the other schools. The environment is seen as something omnipotent that cannot be changed or influenced, but should be adapted to. Strategic management is therefore about survival, interpreting the environment and ensuring that the organization adapts to it. Theories of the environmental school resemble those in the field of biology; the basic assumption is that the environment provides a limited amount of resources, and the resources can only support a limited number of companies. New industries have enough resources to support most companies, but as an industry matures the carrying capacity of the industry is exceeded and the weakest companies die. What the theories fail to take into account, however, is that unlike biological creatures companies can change themselves and influence the environment in which they operate. As pointed out in connection with the cognitive school, the industrial environment might not even exist in exactly the same way as the biological environment exists. The industrial environment is more dynamic and complicated, constantly changing, and exists perhaps more in our minds than in reality. The theories of the environmental school suggest that companies do not really have a strategic choice, but that the strategy is more or less dictated by the environment. This is not entirely true, however; there are plenty of examples of innovative companies breaking the rules of competition, doing something that was previously thought to be impossible. This is not to say that the theories would not be valid in some cases. The environment does influence companies and their strategies, and sets the rules of competition. In mature and stable industries where it is harder to break the rules, it might pay off to look at the situation from an evolutionary point of view. Looking at the big picture instead of immersing oneself in the details is sometimes helpful. 11

2.1.10 Configuration school The configuration school sees strategies as configurations of resources, aligned towards the accomplishment of a set goal. The configurations are relatively stable for long periods of time, but sometimes circumstances require a major change and the resources have to be reconfigured. During this short period of time, the organization is in a state of transformation. Strategic management according to the configuration school is therefore about maintaining equilibrium during calm periods and managing change when it becomes necessary. Contents of strategies or how they emerge are irrelevant in this theory. Configuration theorists have identified general categories into which most companies fall. They are organized and use resources in a similar way. Categorizing helps managers in understanding their organizations better, how they evolve over time and how different parts of organizations combine with each other. Also, recurring stages can be identified in the cycle of transformation. These configurations form patterns, making it possible to estimate the direction in which an organization is heading, or should be heading, and to anticipate changes. A lot has been written about organizational change and change management also in the context of other schools, but in the theories of the configuration school it is perhaps the most essential part of strategic management. However, change does not always have to be radical. A company can move from one configuration to another in a process of incremental change, just as it can do so in a process of radical change. There is always the question of accuracy, too. All categories are artificial and they do not tell the whole truth; sometimes they can even be misleading. But we need to simplify things in order to comprehend them, which is what all theories do. If the limitations of configuration theories are understood, they are a useful tool especially for managing change. 2.1.11 Conclusion After having read about all the schools, how each of them contributes to our understanding of strategic management and how each of them has limitations, the conclusion should be obvious: all of them are partially right and none of them is wrong. Strategic management is about all of them and even more. Being able to draw from all of the schools is essential, as all of them address important issues. Strategists should not limit themselves to the theories of a single school, seeing the big picture is what counts.

2.2 INDUSTRIAL SERVICES

Now that some light has been shed on strategic management, it is time to look at the concept of industrial services and why companies are interested in industrial service business strategies. In this study the term service refers to industrial 12

product-related services, i.e. services that are targeted to optimize the use of industrial products and to increase their value for the customer (Catinaud, 2003). Other terms meaning approximately the same thing are also used in the literature: product-service system and servicizing are perhaps the most common ones. In practice, this means that manufacturers of industrial products are moving partly into the service business. Certainly, manufacturers have been offering services like installation and maintenance for their products for a long time, but in most cases this has been seen more as a necessary evil than as a profitable business. And only in rare cases has the business model supported the provision of industrial services so that manufacturing and service businesses have been interrelated. In an industrial service approach, the product functions as a platform for service delivery (White et al., 1999), so that the businesses are combined. An industrial service business strategy requires a very different approach than a pure manufacturing strategy. A pure manufacturing approach concentrates on selling products, whereas in a service approach suppliers try to fulfill their customers needs as thoroughly as possible and commit themselves to improving their customers businesses. This is a very demanding approach, however, and requires commitment also from the customers. Collina (2003) captures the very essence of the industrial service business by calling it a solutions-oriented partnership approach. The core product and services together form a solution to the customers needs and, as explained later, companies have to work together in a partnership for the concept to work properly. 2.2.1 The siren call of industrial services Several factors have contributed to the rise of industrial services. First of all, increasing competitive pressures are forcing companies to seek new ways of profit creation. The development and standardization of technology lead to increasing difficulties in differentiating products and, at the same time, deregulation and globalization open up markets to an increasing number of players (Mont, 2001). Intense competition and diminishing profit margins from traditional manufacturing businesses increase the appeal of moving into the service business, which usually has higher profit margins and more stable demand (Frambach et al, 1997; Wise & Baumgartner, 1999). In addition to competitive pressures, changes in the composition of the product markets make the position of product manufacturers more difficult. As product quality has improved and product life spans have extended, the installed base of products has steadily expanded. In many industries, the number of units sold annually is an order of magnitude lower than the number of units in the installed base. In the car industry for example, the ratio is 1:13 (Wise & Baumgartner, 1999). The expanding installed base has pushed value away from new products into the after-sales market. Moreover, the value added in new products is already being largely created in non-material ways like branding, design and intellectual property (Mont, 2002). In the future, moreover, the share of manufacturing is 13

likely to diminish further. Industrial services can be used to tap into the aftersales value stream to provide new ways of profit creation for manufacturing companies. The outsourcing trend has also contributed to the rise of industrial services. Focusing on core competencies and outsourcing all that is non-core is popular, due to the fact that specialized organizations can achieve better efficiency. Few companies identify manufacturing as their core competence, and therefore even if most are not willing to outsource their entire manufacturing operations they are interested in outsourcing some aspects of it like equipment maintenance, for example. Industrial equipment manufacturers are sometimes even expected to offer certain types of services, and in the process they are also increasingly becoming aware of the possibilities of the industrial service business. 2.2.2 Different industrial service levels The level of service and the degree to which companies enter the industrial service business may of course vary. Five different levels of involvement were identified in the BestServ feasibility study (Kalliokoski et al., 2003), illustrated in Figure 1.

Figure 1: Industrial service business steps (Kalliokoski et al, 2003)

The lowest level, machine supplier, stands for a company with a traditional manufacturing strategy. A solutions provider will provide customized solutions to its customers needs, which usually but not necessarily includes providing some kind of service as well. The next level of involvement, service partner, means that 14

the supplier will be partly responsible for some of the customers operations like maintaining equipment. A performance partner will have some responsibility over the customers whole process, and finally a value partner is actively involved in improving the customers entire business. As responsibilities increase, the suppliers competencies have to increase as well. For example, a performance partner has to have a thorough understanding of the customers manufacturing process in order to be able to manage it efficiently. 2.2.3 Should my company enter the industrial service business? The decision to enter the industrial service business, and to what extent, depends on a variety of things. Although the new markets might seem lucrative at first, not every company should start climbing the industrial service business steps illustrated in Figure 1. The main issues are the expected profitability of the venture, customers and available resources.

Customers

Profitability

Resources

Figure 2: Industrial service business strategy vs. manufacturing strategy

Wise and Baumgartner (1999) suggest looking at the ratio of installed units to annual new unit sales, customers usage costs relative to product price, and profitability of downstream activities relative to product margins. The size of the installed base and product usage costs hint strongly at the possible revenue from the industrial service business and are fairly easy to assess. Profitability, on the other hand, is more difficult to estimate and is linked to customers. Moving into the industrial service business adds another dimension to the challenge of understanding markets and customers, and it is crucial to understand the conditions under which providing services will bring savings to both customers and the supplier (White et al., 1999). In cases where a win-win situation emerges between the customer and the industrial service provider, services will generate healthy revenue, but if the conditions are not suitable for a profitable partnership, manufacturers are probably better off sticking to their old business. Customer needs, of course, also dictate whether companies should or should not enter the service business. For customers, buying industrial services can in some 15

cases be the golden mean between own manufacturing and outsourcing. Companies that outsource manufacturing also cease to invest in process development, which can lead to some serious problems: product innovations often require simultaneous process innovations (Pisano & Wheelwright, 1999), and contract manufacturers are not always willing to develop their processes according to the needs of a single customer. In an industrial service business model the equipment manufacturer can be partly in charge of the customers manufacturing process and process efficiency improvement, thereby releasing customer resources and providing some of the benefits of outsourcing, but production assets still remain under customer control. Necessary process innovations can therefore be introduced without any further ado and the equipment manufacturer, with its expertise in equipment technology, can help in their implementation. In fact, equipment manufacturers might sometimes be in a position where they are the only party with the necessary expertise to provide certain kinds of services. This is usually the case with complex products requiring special skills to maintain. In that case customers might even demand that manufacturers provide services, which will act as a strong incentive to enter the industrial service business. Turning industrial services into the main business in that case will be easier than starting from scratch. The availability of resources is another big issue in the decision to enter the industrial service business. Successfully providing services requires an extensive service organization, which is costly to build. Smaller companies might simply not have the necessary resources (Mont, 2001), and even larger companies might rather opt to invest in boosting their existing businesses than in venturing into something new. Also, the transition process is a risk in itself. It takes time before a radical change in strategy starts bearing fruit and, in the meantime, the company is more vulnerable. Not all companies have the ability to take the risk.

2.3 INDUSTRIAL SERVICE BUSINESS STRATEGY AND OVERALL STRATEGY

In addition to the reasons that arise out of the companys operating environment, the companys overall strategy will also dictate whether industrial services are a viable option or not, and to what extent. Theories from nearly all the schools of strategic management are relevant in the context of industrial service business strategy, and their impact is presented below. 2.3.1 Industrial services as a positioning tool According to the positioning school, one of the dimensions on which strategic decisions should be based is source of competitive advantage. Companies should choose either to be low-cost manufacturers or differentiate their products from competitors offerings. Services fit in very well to this theory as a means to differentiate products. 16

Particularly when the traditional differentiating variables of the marketing mix (product, price, place, promotion4) are more or less neutralized, like in many of todays highly competitive industries (Frambach et al, 1997), industrial services are a good way of adding to the competitiveness of the customer offering in order to be distinguished from the mass. Industrial services enhance the value of the product for the customer, especially as industrial customers are increasingly starting to demand turn-key solutions to their needs. Furthermore, industrial services should lower the costs of using products by improving process efficiency, for example. This, too, adds to product value, although this kind of extra value, which materializes only after the point of sale, is harder to quantify and to market to customers. Industrial services can also be used as a basis for market segmentation in a focusing strategy. For example, services can be targeted at one significant customer segment, at all segments simultaneously or at different segments at different times (Pullman et al., 2001). All in all, services are a good tool for strategic positioning, adding a new dimension to the possibilities of both differentiation and focusing. 2.3.2 Services as a way to learn According to the learning school of strategic management, an organizations performance and the strategies it adopts are very much dependent on its ability to learn. One of the key elements of learning is to learn to serve customers better; in order to improve their competitiveness, industrial companies have to develop their understanding of and sensitivity to their customers needs (Frambach et al, 1997). Industrial services are very customer intensive and close interaction with customers enables companies with industrial service business strategies to learn rapidly from their customers. In pure manufacturing strategies, interactions are limited to the point of purchase, which inhibits learning. Industrial services can thus be seen as a tool for enhancing organizational learning and improving company performance. The industrial service business strategy should be in line with the organizations competence development goals, and vice versa. Strengthening competencies in the field of customer relationship management for instance might help the company in overcoming the first difficulties on its transformation path from a manufacturer to a customer-oriented service company. Learning from customers is also important for being able to move up the industrial service business steps (Figure 1), as higher levels also require more thorough understanding of the customers business.

See e.g. Kotler (2002)

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2.3.3 Impact of other strategic management theories The theories of other schools of strategic management also have an impact on industrial service business strategy. Although perhaps not as big and influential as the positioning and learning schools, some of them have theories that are also very valid in an industrial service setting and should not be ignored. As theories of the cultural school suggest, strategy is an incarnation of organizational culture. The transformation from a manufacturer to an industrial service provider is thus a big cultural challenge as well. Company culture has to support chosen strategies and an industrial service strategy requires a very different culture than a manufacturing strategy. Customer orientation, for example, is a prerequisite for the success of an industrial service business strategy, as is a cooperative spirit between different departments in the company. Nurturing these aspects of organizational culture is both important and challenging. If no attention is paid to cultural issues before and during the transformation, the existing culture might conflict with the new strategy and at least slow down, if not hinder, the transition. The entrepreneurial school, in turn, emphasizes the need for a unified management vision. At least in bigger companies, where the implementation of strategy lies in the hands of many managers instead of one, a perfectly unified vision is hard to achieve, but a general consensus of the future state of the company should be reached. This consensus would then act as a guideline for managers in their decision making. Having an implicit vision and an understanding of where the company is heading is important, as a written explicit strategy always fails to describe the intricacies of a strategic approach. At least the managers in charge, but preferably also other employees, should truly understand what the company is striving for. The change from a manufacturer to an industrial service provider is also a change in the companys configuration. Resources have to be reallocated and organizational structures changed. Simplifying organizational change with the help of configurations can be helpful in understanding the transition process, just as strategic positioning can be helpful in understanding general strategic direction. As a tool among other tools, configuration theories should work well in a service setting. Finally, there is the question of power. Radical changes are always problematic, and, like a conflicting culture, internal quarrelling may also delay or even hinder decision making. It can be hard to get the major strategic changes that are involved in moving into the industrial service business approved. Struggles between power factions are likely to arise, and achieving the aforementioned unified management vision can be difficult. Preparing for the struggle beforehand can save a lot of trouble. Also, issues of external power in the form of demands from customers or investors for example can play a role in the transition.

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Figure 3 summarizes the factors that need to be taken into account when designing industrial service business strategies.

Internal issues
Company vision External pressures

Strategic positioning

ndustrial service business strategy

Resource reallocation

Learning, competence devel.

Company culture

Figure 3: Strategic factors related to industrial service business strategy

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3 FROM MANUFACTURING TO SERVICES

In this chapter the changes related to the transition from a pure equipment manufacturer to an industrial service provider are analyzed. If, after having carefully considered its strategy and all relevant aspects of it, a company decides to adopt an industrial service business strategy, some major changes have to take place; the foundations of strategy, organizational structures and product development functions have to be aligned with the new approach.

3.1 PROVIDING INDUSTRIAL SERVICES

Traditionally, manufacturing strategies have been built on three foundations: superior products, economies of scale and mainly backward vertical integration. In pursuing an industrial service business strategy however, a different approach is required. In order to capture value from downstream operations, companies have to redefine their value chains, shift their focus from operational excellence towards customer allegiance, and rethink the strategies of vertical integration (Wise & Baumgartner, 1999). The whole business model has to be turned upside down and rebuilt on the new foundations.
Manufacturing strategy Industrial service business strategy

Superior products

Backward integration

Customer allegiance

Forward integration

Economies of scale

Redefined value chain

Figure 4: Foundations of strategy (Wise & Baumgartner, 1999)

3.1.1 New business models The traditional view of services as a means of pinching a sale is not valid in an industrial service business strategy. Instead, the sale should be viewed as a way to open the door for the future provision of services. The value chain does not end at product installation; this is what redefining the value chain means. Value can be extracted throughout the life cycle of the product, which ends when the product is disassembled and recycled. In fact, value from the downstream 20

operations can be much more important than the initial revenue from the sale, as it provides a steady high-margin revenue stream. Needless to say, the business model should reflect this. Metrics and incentives have to be re-defined and aligned with the real drivers of profit for the company; sales margin cannot be the primary measure, because it does not define overall profitability (Wise & Baumgartner, 1999). Since the profit of an equipment manufacturer with an industrial service business strategy is to a large extent dependent on after-sales revenues, the next step is to figure out how they can be maximized. Building profitable and lasting customer relationships is crucial. Successful industrial service providers should offer complete solutions to their customers needs and, depending on the level at which they operate on the industrial service business steps, use their expertise to improve their customers operational efficiency, thus generating significant savings. A business model that links customers profits to the suppliers profits creates an incentive for both parties to work for the common good, which deepens the relationship. In a traditional model, the supplier has an incentive to increase material consumption in order to sell more and get more revenue, whereas the buyer wants to do the opposite. Stoughton & Votta (2003) suggest that the new business model should be designed so that both parties have an incentive to lower life cycle costs, but an even broader approach would be to try to increase the life cycle value of the product (Figure 5). In other words, volume should be decoupled from profitability and the focus should instead be on functionality (Maxwell & van der Vorst, 2003). In this kind of a model, value is based on functionality instead of material content, which shifts the focus from sales to efficiency.
Traditional business model Industrial service business model

Material
(cost, volume) SUPPLIER wants to increase BUYER wants to decrease SUPPLIER wants to increase

Life cycle value

BUYER wants to increase

Figure 5: Aligning incentives (modified from Stoughton & Votta, 2003)

This way the economic value for individual stakeholders can be coupled with overall systemic performance. When the system is more efficient and uses fewer resources and/or achieves better results, its value over the life cycle is increased and the gains can be shared among the stakeholders. The stakeholders are all the companies that work together to achieve the results, which in addition to the service provider and the customer might include the providers subcontractors for example. The business model dictates the way in which the gains are distributed, and care should be taken to design it in a way that a balanced and sustainable win-win situation emerges. It is not a zero-sum game; if any one stakeholder 21

becomes too greedy, the others profits and thus incentives to cooperate are lowered, which decreases the overall gains from the system and lowers everyones profits. If the stakeholders are not able to cooperate fully and fail to communicate the goals of the system to each other, the situation will deteriorate.5 The business model need not, of course, be based on profit sharing; other models are also suitable especially at the lower levels of the industrial service business steps. A lot depends also on the customers willingness to radically change their relationship to their suppliers. The business model can be anything from charging customers for individual service deliveries to offering pure needs fulfillment. In the latter, all life-cycle costs would be aggregated to the service provider and the customer would pay according to the benefits it receives (Heiskanen et al., 2000). If taken to the extreme, customers would not even have to own the equipment themselves. Such a model in which service providers lease equipment and customers pay for the benefits might be appealing especially to small and fast growing customer companies that do not want to tie up capital in expensive equipment. The possibilities are numerous and the business model can even vary from customer to customer. However, a model that is not based on profit sharing exposes the service provider to a paradox pointed out by Oliva and Kallenberg (2003): increasing service quality extends product life and reduces replacement sales, and on the other hand increasing product quality reduces service revenues. This conflict in interests does not encourage the supplier to invest energy in providing quality products and services, and in the long run this kind of a model might undermine the feasibility of the industrial service business concept. A good solution is probably to gradually shift the business model from a more traditional one towards the profit-sharing model as the customer relationship develops and the supplier climbs higher on the industrial service business steps (Figure 1). 3.1.2 From inter-firm rivalry to networks In general, pursuing an industrial service business strategy is much more demanding than a pure manufacturing strategy. Service providers need to have an extensive service infrastructure in place and need a wide range of competencies to handle both product and service aspects of their offering. At the same time the trend towards outsourcing non-core functions creates specialized organizations that excel in a narrow competence area. It is thus becoming increasingly difficult for any one company to acquire sufficient competence in all disciplines. Building a network of partners is necessary to provide access to additional competencies and resources. Furthermore, equipment manufacturers are not alone in the service markets: component manufacturers, system integrators, end-users own service functions
Familiarizing oneself with game theory may provide insights for business model development. See e.g. Gibbons (1992) or http://william-king.www.drexel.edu/top/eco/game/game.html
5

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and third parties, among others, compete in the after-sales market (Oliva & Kallenberg, 2003). Although equipment manufacturers have some clear advantages in the after-sales market (established customer contacts, in-depth product knowledge etc.), they still face heavy competition. Returns tend to diminish in a competitive market but, instead of competing on their own, different kinds of players can form alliances and this way improve the competitiveness of all players in the network. As said, providing a complete set of services is hard for any one company, but by working together companies can pool their resources. Each companys core competencies can be utilized more efficiently, which lowers costs and improves efficiency. Building an extensive and well functioning network is not easy, however. All participants need to be convinced of the benefits of working together, which might be difficult as in most cases it requires a major cultural change. The big question then is who should take the leading role in building and coordinating the network? The equipment manufacturer is a strong candidate, as it is in the middle of the network between the customer and subcontractors. Or the coordinator could be the biggest and thus most influential company, or the most forward-thinking one. Whatever the case, strong leadership on the part of one network member is probably required to get others involved. In order to be able to build and control the network, it is crucial to thoroughly understand the functioning of the entire value chain, including customers operations, and the operation of customers customers and suppliers (White et al., 1999). It is essential to take a systemic view where the interests of all stakeholders are taken into account, which requires a deeper understanding of the business as a whole (Shireman, 1999). In an industrial service business model where customers and suppliers profits are coupled, the value chains merge together; one possible example is illustrated in Figure 6. Third parties may also be involved, which depending on their role can be members of the network. As the profits of all parties involved depend on the efficiency and functionality of the joint function, all have an incentive to contribute to the best of their ability. Ideally, all of the network members have specialized competencies that can be used to increase the efficiency of the whole system.

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Material flows

Raw materials

Distr./ installation

End use

Disp./ recycling

3rd party services

Manufacturing Use & maint.

Raw materials

Manufacturing

Distr./ installation

Disp./ recycling

Figure 6: A possible example of an industrial service business value chain

As companies seek synergies by building networks, it might very well be the case that competition gradually shifts from competition between individual companies to competition between networks of companies. Globalization further drives the need for networking; in some countries it is not even possible to do business without an alliance or a joint venture with a local company (Drucker, 1995). Being able to form alliances with other companies and efficiently function as a part of a network will be crucial to success in the future. 3.1.3 Forward integration Traditionally, manufacturers have integrated backwards to secure the provision of raw materials. Forward integration into distribution has of late become one of the key elements in the strategies of many companies, and moving into the industrial service business further drives the need to integrate forward in the value chain. In an industrial service business model where close customer interaction between the equipment manufacturer and the customer is needed, there is no room for an intermediary; the value chain dynamics would not function properly if distribution would be handled by an outside party. It also makes sense to further integrate forward to provide services throughout the whole life cycle of the product. Once the service organization is in place, it becomes more or less a fixed cost. This implies that capacity utilization becomes a key driver of profitability (Oliva & Kallenberg, 2003). By extending the service offering to cover the entire life cycle of the product instead of just installation and commissioning the capacity of the service organization can be utilized more efficiently. Extensive forward integration is thus necessary.

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Even at the lower levels of the industrial service business steps, where it would be viable to sell services through an intermediary, it should be considered carefully. Although in many cases relying on large distributors will provide manufacturers with much needed visibility, there is also the danger that distributors will become too powerful. It is not unheard of that distributors at some point replace the manufacturers service business with their own, thus becoming a competitor (Wise & Baumgartner, 1999). Carefully considering distribution strategies is necessary to secure a solid strategic position. 3.1.4 Customers as partners In the past, the combination of superior products and economies of scale provided a significant competitive advantage in any market, but not anymore. Differences among the products of different manufacturers have become marginal in many industries and economies of scale are easy to replicate or circumvent. Customer allegiance has therefore become the most effective barrier to competition (Wise & Baumgartner, 1999). Earning the loyalty of the largest and most profitable customers and building sustainable relationships that span the entire life cycle of the product is critical. Industrial services are a means of creating the sought-after sustainable and more intensive customer relationships (Frambach et al, 1997). Services cannot be mass produced for an anonymous market, but can be provided only after interacting with the customer first. In an industrial service business model where there is a joint interest in improving the efficiency of the customers processes, the customer becomes more of a partner than a customer in a traditional sense; the customer should be a co-designer rather than a pure consumer of services (Piller, 2003). Frequent interactions with customers should build up the service providers knowledge of their needs, which makes it possible not only to meet but to exceed customer expectations and to find new ways of co-operation that the customer might not even have thought about (Mont, 2001). Once a successful relationship with frequent interactions has been established, it is very hard for competitors to intervene. However, in order to be successful, companies need to build not just one but many sustainable customer relationships. It takes considerable effort to build and sustain them as each customers needs are unique, but it helps if there is some kind of a common platform that each relationship is built on. Having a system in place to customize the offering for each customer is called mass customizing, which has been a hot topic in manufacturing, but there is no reason why a similar approach could not be applied to industrial services as well. The goal of mass customization is to have learning customer relationships, in which there is a large volume of business over time in a permanent relationship (Pine et al., 1995). This is a valid goal for industrial service businesses as well. To repeat, learning to know the customers needs is crucial. A system, for example, in the form of a product/service platform to help in customizing service offerings for individual 25

customers would reduce the amount of effort needed to build learning customer relationships.

3.2 TRANSFORMING THE ORGANIZATION

When a companys business model is radically changed, its existing organizational structure often becomes unsuitable for the new way of doing business, or at least does not support it well enough. Building a proper service culture into the organization and changing its structure to meet the needs of the new business model is as important as it is challenging. 3.2.1 Organizational structures Services are more difficult to imitate than products because they are less visible and more labor dependent, and can thus be a source of sustainable competitive advantage (Heskett et al., 1997). On the other hand, services cannot be patented and competitors are free to try to copy them. The best way to protect against imitators is to build an effective organization that supports the provision of services well. The role of the organization is bigger in the industrial service business than it is in manufacturing, because controlling the quality of services is much harder. Products that do not meet quality standards can be screened out before they are delivered to customers, but as services are produced and consumed at the same time this is not possible. From the customers point of view, the service experience is also much more holistic. It includes everything from the appearance of the suppliers employees with whom it deals to the quality of the actual outcome of the service. Organizational structures that support the service process and a culture that promotes overall service quality are not only important factors in achieving customer satisfaction but also nearly impossible for competitors to directly imitate. Nowadays, most manufacturing companies already provide some kind of services with their products, and are in that sense already in the industrial service business. Service functions are, however, often fragmented and handled by small units all over the organization (Oliva & Kallenberg, 2003). In a business model based on services their provision has to be much more coordinated. There are essentially two possibilities: either to have separate organizations for services and manufacturing or to have both services and manufacturing under the same organizational unit (Figure 7).

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Manuf. division Service division

Products

Customer
Services

Joint entity

Complete solution

Customer

Figure 7: Different approaches to the provision of industrial services (White et al., 1999)

If the functions are put under the same roof there is a possibility of internal conflict because the incentives of services and manufacturing have traditionally differed from each other (Mont, 2001), for example with respect to product quality as mentioned in section 3.1.1. Although it should be possible to resolve the conflict by aligning the incentives of both groups to reflect total customer value added, the units might still battle over influence and not work well together as a team. On the other hand, tight integration allows services to drive manufacturing and product design changes to increase efficiency (White et al., 1999). If coherence is achieved, and services and manufacturing work together as one unit to increase the value of the product-service offering, the result will likely be better than if they were separate units. According to a study by Oliva and Kallenberg (2003), a critical success factor in the transition from manufacturing to services was to create a separate organization to handle services. This finding suggests that internal conflicts are very hard to resolve in practice. However, the study only covered the transition phase and, given the fact that organizational culture changes very slowly, it is likely that the risk of conflict is at its highest in the beginning and decreases with time. Having services and manufacturing as separate units at first and combining them later when the organization has learned the ways of the industrial service business might be a viable solution around the problem. Besides the suppliers corporate culture, the customers culture also impacts on service offerings. Pullman et al. (2001) found out that different cultural groups preferred service attributes that were in line with their cultural norms. Services should thus be customized according to the customers culture as well, which in a global business poses additional challenges. Oliva and Kallenberg (2003) identified the creation of a global service infrastructure capable of handling problems locally as a problem. Collina (2003) suggests that suppliers need to 27

organize a network that can provide localized solutions from a global array of products and services, i.e. a global platform. Local companies have to participate actively in the development of the localized solutions. This implies structuring operations as a global network of local sub-networks, something like the network illustrated in Figure 8. Another variant of the network would be to have a global service hub in the middle that coordinates all service functions globally.

Field office Local partner Local subcontractor

Figure 8: Global network with local sub-networks

3.2.2 The process of change Once it has been established what kind of an organizational structure is desirable, the change has to be implemented. The first challenge arises from changing company culture from product- to service-oriented. This includes all company functions, from management and R&D to manufacturing and sales; the whole company has to learn to appreciate industrial services and the way they are offered. For a traditionally thinking manufacturing organization this is not an easy task. First of all, traditionally thinking organizations might not believe the economic potential of providing industrial services (Oliva & Kallenberg, 2003). A service that yields a few thousand dollars a year for a piece of equipment worth a million dollars is not something that most people get excited about. It is hard to see that little drops of water eventually make up a stream. Second, industrial services can also be viewed as a threat within the company. The manufacturing operation and sales might oppose the idea, because it can be perceived as harmful to their profitability (White et al., 1999). And third, implementing an industrial service business strategy requires diverting resources away from manufacturing, which 28

for most companies is a major source of competitive advantage. Diverting resources from the core function is a risk that some companies are very reluctant to take. Overcoming the resistance to change within the company may require substantial effort and, once initiated, the change in the companys configuration takes time and money to complete. Building competencies and successfully deploying an industrial service business strategy is a long process that requires long-term financial commitments. The actual cost of the transformation is also very hard to quantify, as it involves all kinds of indirect and opportunity costs. The leap should thus be made when the company is still competitive, not when the effects of weakened competitiveness can be clearly seen in the financial statement. From the customer perspective, product-related services demand closer cooperation with the supplier, more trust in them and more understanding of costs than is typical for a customer-supplier relationship (White et al., 1999). For example, customers might not be too happy about giving away what they feel is sensitive information about their core competence areas, even though such information is essential for providing industrial services (Mont, 2001). A successful customer relationship hence requires a cultural change in the customer company as well. White et al. (1999) also found out that there were high costs associated with making the feasibility of services clear for customers. Significant costs related to managing products may go unnoticed among customers and therefore buying product-related services might not seem as appealing as it in reality is. Customers were naturally unwilling to pay for the extensive studies needed to prove the feasibility of the service approach. As major cultural changes are required at both supplier and customer ends, proceeding too fast and trying to change everything at once is a great risk. Taking it one step at a time and using pilot projects to prove the concept and to learn is probably better than turning the whole organization upside down straight away.

3.3 SERVICE INNOVATION

In contrast with product development, where formal innovation processes are common, innovation in services has traditionally been characterized by ad-hoc methods. In a strategy based on industrial services this can no longer be the case. Since company competitiveness is dependent on the service offering, services have to be developed systematically and efficiently. Innovation in manufacturing costs three times as much as innovation in services (Sirilli and Evangelista, 1998), so money should be no object either.

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3.3.1 Adopting a systemic approach As has been noted, successfully adopting an industrial service business strategy requires that customer needs are thoroughly understood. This understanding of the customers business has to be integrated into product design and manufacturing as well (White et al., 1999). The core product and accompanying services should be designed concurrently as a system; in other words, R&D has to adopt a systemic approach. This also includes infrastructures like IT infrastructure and logistics infrastructure, which have to be taken into account and developed accordingly, while also giving attention to network partners. The potential of system innovations is much greater than that of mere product design. Product innovation can be compared to sub-optimizing a part of a system, whereas system innovations optimize the functionality of the whole system. Brezet et al. (2001) outline the generations of eco-innovation, ranging from product improvement to system innovation (Figure 9). The impact on efficiency increases with the complexity of the approach, which is true for any innovation. The biggest impact can be achieved when the whole system is redesigned so that the new business model is taken into account. In the industrial service business the product and accompanying services form a package that does not function properly if its parts are designed separately; concurrency of the design processes is important.
Efficiency improvement
System innovation

Function innovation

Product redesign Product improvement

Time

Figure 9: Innovation generations (Brezet et al., 2001)

Technologically, system innovation is rarely challenging. Product-service systems often rely on existing technologies and are therefore relatively easy to introduce (Manzini and Vezzoli, 2003). Their novelty value does not arise out of 30

radical innovations, but out of the way existing or emergent technologies are combined and systemized. Shifting from product design to system design requires a major cultural change; the main barrier in creating system innovations is not the organizations ability to innovate in general, but the lack of willingness to change in a radical way and to innovate beyond organizational boundaries (Bijma and Haffmans, 2003). Although technologically not very demanding, system innovations are complex in the sense that a large number of different elements have to be taken into account. This often requires a multidisciplinary approach; innovations are a result of combining knowledge from different areas. As the complexity of the system increases, it becomes increasingly difficult for a single company to acquire the required competencies for itself. As with the provision of industrial services, the value of networking increases also in research and development. Cooperation between the members of the strategic network should thus cover R&D as well if necessary. 3.3.2 Systems technology Although the technology mostly used in product-service systems is not radically new, it nevertheless plays an important role in the functionality of the system. Proper use of technology can radically lower the costs of providing industrial services, directly affecting profits. Intelligent systems are often associated with industrial services. Intelligence in this context means that the product contains technology that enables it to gather information from its surroundings and itself, and is capable either of sending the information to another system for analysis or of using it to adjust its operation, or both. Accurate information is often the key to providing better service and sometimes the very thing that enables certain services. For example, product usage data can be used to forecast future maintenance needs and to improve process efficiency. There are also indirect ways for using information, e.g. usage data can be fed back to the R&D department where it can be used in product design to improve product durability, for example (Oliva & Kallenberg, 2003). Technology can also serve as a means of protection from competitors. Equipment manufacturers that have adopted an industrial service business strategy may try to expand their markets and offer certain services also for their competitors equipment. Embedding technology that competitors cannot utilize into products will provide a major cost advantage that makes it more difficult for third parties to intervene. It may even be possible to use technology to automate certain services. Wise and Baumgartner (1999) talk about embedded services, which means that technology embedded in the products actually performs the service. This approach is a double-edged sword, however. Although customers at first would be willing to pay for the equipment feature as if it were a service, services of this 31

kind have a tendency to become standard product features in the long run (Rekola & Rekola, 2003). This happens at the latest when competitors introduce similar features to their products. Embedded services are thus not a sustainable strategy by themselves and the industrial service business model cannot be solely based on them, but they might be a good complementary approach.

3.4 INDUSTRIAL SERVICE BUSINESS TRANSITION FRAMEWORK

As a summary, Figure 10 illustrates the most important aspects that should be changed during a companys transition to an industrial service provider.

Networks & alliances Customer relationships Transition to industrial service business Business models

Sales & marketing

Value chains

R&D Organizational culture

Organizational structure

Figure 10: Industrial service business transition framework

The business model should be changed so that the incentives of the supplier and the buyer are aligned, which means focusing on life-cycle value instead of material content. A win-win arrangement and true collaboration with customers are prerequisites for a service business model to work properly. Expanding the value chain to cover the whole product life cycle, i.e. to supply services for all stages of the product life cycle, is also an option for increasing service revenue. In a business model based on collaboration, the value chains of the supplier and the buyer merge partially, reflecting changes in earning logic. The supplier needs to integrate forward in order to expand the value chain, enhance interaction with customers and protect itself from competition. Understanding how the value chain works and where the money comes from is essential.

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The importance of networks and alliances also increases as it becomes increasingly difficult for any one company to acquire for itself the growing number of required competencies. Partnering enables companies to tap into external sources of expertise and other resources. The nature of competition slowly changes from competition between individual companies to competition between networks and, in order to be successful, companies need to be able to function well as a part of a network. This requires changes in company culture. In order to secure close cooperation with customers, which is the basis of a successful service strategy, customer relationships should become deeper. Customers should be partners and co-designers of services rather than customers in a traditional sense. Suppliers need to be able to continuously learn from customers and their businesses in order to provide good service. As customer relationships change, sales and marketing should change, too. The supplier has to be able to respond to each customers unique needs. On the other hand, suppliers should be able to manage a large number of customer relationships. A system to customize offerings should be in place to help in building unique solutions from a common set of products and services. Furthermore, organizational structures that support manufacturing businesses well are not necessarily suitable for the needs of industrial service businesses. Changes in the organization often need to take place to resolve internal conflicts between manufacturing and services and to enable efficient cross-functional cooperation within the company. For a global company, building an efficient service network that is capable of responding to local customer needs is important as well. Culture is another big issue in the transition. Resistance to change is a common phenomenon which has to be overcome before the new business model can work properly. Manufacturing and service cultures differ significantly from each other and it will take time for a traditional manufacturing organization to learn to appreciate industrial services and to excel at serving customers well. Changing a culture from product- to customer-oriented in not easy and, in addition to internal cultural changes, the new partnership-based business model requires changes in the customers culture, too. Finally, research and development functions have to be aligned with the new business model. Adopting a systemic view and developing the core product and services concurrently is important. Product technology can be used to support service provision, and services can give feedback to product development, but this is possible only if R&D and services work closely together. The increased complexity of the system might also require R&D networking to acquire knowhow that does not exist within the company.

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4 CASE EXAMPLES
In order to validate the transition framework in practice, four companies that had implemented industrial service business strategies were chosen to be analyzed. Two of the case companies were from Finland and the other two from the U.S., which enabled a comparison of practices in two different cultures. In addition, one company that had made a clear strategic decision not to enter the industrial service business was included to provide a different point of view. A senior manager from each company was interviewed to find out why (or why not) their company had decided to adopt an industrial service business strategy and how the company had changed in the process.

4.1 CASE METSO

Metso is a global supplier of process industry machinery and systems. It is the worlds largest supplier of paper making lines as well as rock and mineral processing equipment, and its other businesses include process industry automation systems, drives and panel board machines. Metso is headquartered in Helsinki, Finland. Changing customer markets are the main driver behind Metsos ongoing transformation to an industrial service provider. The paper and minerals processing industries in Europe and in the Americas are mature and thus focused heavily on increasing the performance of the existing installed base rather than investing in new capital equipment. Initiating the change was a clear strategic decision and the goal was to expand the customer offering from capital delivery to cover the entire life cycle of the product. Metsos aim is to have lifecycle services as a significant source of turnover in the future. At the moment, turnover still comes mainly from product sales, but efforts are being made to increase the share of services. The business model is being changed gradually, with the goal of attaining fixed-price maintenance and process improvement contracts with leading customers. Some pilots are already in progress and customer feedback has been positive. Metso has service organizations within its business units that are capable of handling customers maintenance needs and it is also an owner in a few separate service companies that provide daily operational services. So far, external partners have not been needed, but in the future when the service business grows partnering will become necessary. Metso has always provided maintenance services, but now the target is to move on to a solution-based model in which services would be an integral part of the customer offering. In order to speed up the implementation process of the new strategy, the organizational structure was recently changed so that service operations were embedded into the product business units. 34

The first visions concerning changes in the business model were already in the strategy a few years ago. There has been friction in adopting the new operating principles, mainly because production overcapacity in the main customer markets was regarded as a temporary state of affairs. Therefore changes did not pick up momentum in the business units until recently. Despite active efforts to speed up the business transformation, it took much longer than expected for the culture to change. One of the earliest changes that occurred in Metso was the effort to develop technology that would enable the provision of more advanced services. A technology program was launched with the aim of developing a common platform for business units to build their own solutions upon. Services were supposed to be developed at the same time as life-cycle technology but, due to the operationally separate service units, the effort did not succeed as projected. Recent organizational changes are likely to improve the situation. Some leading customers understood the potential of closer cooperation with the machine supplier and were chosen as pilot customers. There were, however, some operational problems that slowed down the piloting. Also, the division of responsibility and risk between Metso and the customer was a major challenge in the service agreements, as there were different viewpoints on the compensation models. Customers argued that value is difficult to measure and allocate undisputedly. In the end, the pilot cases succeeded well, but they required a lot of learning and new competencies. In many ways it was easier to work according to the old business model, which explains some of the reluctance to radically change the business. According to Metsos Senior Vice President Corporate Technology, Dr. Markku Karlsson, the most important thing in the transformation is to realize that the service business requires a customer-oriented attitude. A customers needs cannot be understood without knowing its business thoroughly. Also, services require a completely different set of skills than manufacturing. Building the service business requires resources and investments; the transformation does not happen by itself.

4.2 CASE VAISALA

Vaisala manufactures electronic measurement systems and equipment, mainly for weather forecasting purposes. It is a global market leader in many of its core businesses. Vaisala is based in Vantaa, Finland. Vaisala has been moving towards a solution-oriented business mainly because of changing customer demands. The service business was also seen as an opportunity for growth and a way to increase profitability. The company has been a system provider for a long time, meaning that it has provided complete systems according to the customers own specifications, but now it is in the process of 35

adopting a problem-solving approach where customers are consulted and solutions provided for their identified needs. The aim is to move towards servicizing products, which means that product systems would be provided as a service. Most of the revenue would in that case also come from services. The value chain should become a value shop6, so that customers can choose from a variety of value-added components those that best suit their needs. Vaisala has a broad product portfolio, and therefore strong partners are not needed. However, when providing global turn-key solutions local expertise is important, for example in installation, and in those projects networking is essential. The partner should be selected carefully, because the partners competitiveness also affects the competitiveness of Vaisalas solution. Distribution is handled by Vaisala itself, because contact with the customer is seen as very important. Separate solution business units responsible for developing and providing customer solutions have been established. Manufacturing itself is a separate business and the solution business units have an internal customer relationship with the manufacturing unit; they buy equipment for their solutions. Changes also included abandoning the functional organizational model and switching to a model that supports the value shop principle. The solution units also have their own R&D, which designs the solutions (i.e. product-service bundles), and their own profit goals. The biggest cultural change in Vaisala was to make the company more customer-driven. Understanding customer needs is the basis of the solution business and in fact the supplier should even exceed the customers level of know-how. This is a big challenge, which also requires that the relationship with customers deepens. Customer focus was also added to the formal company values after adopting the solutions approach. Pekka Ketonen, the CEO of Vaisala, thinks the most important issue Vaisala has faced in the transformation is learning to know the customer; thorough knowledge of customer needs is required in the service business. Other important aspects are the transformation of the value chain to a value shop, the change in core competence from product technology to application know-how and the switch from being a functional organization to one with a solutions-based organizational model.

See Stabell & Fjeldstad (1998)

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4.3 CASE INVISION TECHNOLOGIES

The Newark, California-based InVision Technologies is a manufacturer of explosives detection systems for the aviation industry. Their equipment is used in airports all over the world for screening luggage and business has been booming since the September 2001 terrorist attacks. InVision has been in the industrial service business for some time already. Their equipment is very sophisticated and, because of a 99% uptime requirement, quick and responsive maintenance is essential. The management saw services as a long-term business opportunity and their goal is to have a service technician in place at every airport where their equipment is used. Customers also played a role in the decision to enter the service business by demanding maintenance services. Most of the revenues still come from products, however, although services account for a significant 20-25%. The business model is product-based and services are a separate business. A service technician responsible for the pieces of equipment installed on site is in place at the airport and billing is based on hours worked. Customers have been happy with the arrangement and think the service is good value. Among the other services that InVision offers is training of the security guards who use the equipment. InVision has partnered with Boeing and Siemens to some extent, but partnership came into being mainly because of demands from the U.S. government. InVision has the resources to provide the products and the maintenance service by itself, so there is no real need to partner with anyone. The company has not integrated backwards and relies on subcontractors to provide parts for the equipment, but it does take care of product installations, upgrades and replacements. There was a small service organization in place before InVision started to provide maintenance services, but it has since grown significantly. They put in a call center and placed more emphasis on collecting data, as well as building a parts distribution system. Today, 50% of the employees work in the service organization. It is not a separate business unit, but has its own financial tracking systems and is thought of as a separate business. There was little resistance to change when services were introduced. Customer satisfaction has always been the primary focus at InVision and people saw services as necessary. The transition itself did not take place without problems, however, and a lot of work was needed to ensure sufficient service quality. The service people can be compared to fire fighters who need to respond quickly to problems at hand, whereas manufacturing is more process driven. People had to be trained, for example, to do paperwork correctly. To drive the change, measurement systems were adjusted and new measures added so that they were in line with the new operating principles.

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Since the introduction of services, research and development has mainly focused on increasing product reliability; more than 50% of the work goes into that. Other development focus areas include smart technology like fault resetting, but airports have not allowed the inclusion of remote diagnostic features in the products. Some statistics are gathered manually and the service organization provides measurement feedback. There are also regular meetings with service people. The government can be seen as the main customer of InVision and this has always been a close relationship. There are many customer layers though, one of which is airports. There is a special relationship with San Francisco International, which acts as a test-customer and provides feedback on how different systems work. All in all, customers are perceived to be a valuable source of knowledge. According to Don Mattson, InVisions COO, the most important thing in the service business is customer satisfaction. Companies have to make sure that they deliver the performance customers expect. Responsiveness to customer needs is also essential; if things do not get done the supplier is held responsible in the end. But if done right, services are a good revenue source and provide decent profit.

4.4 CASE SUN MICROSYSTEMS

Sun Microsystems is one of the biggest players in the IT industry with a wide variety of products and services, ranging from server hardware to operating systems. Sun is based in Santa Clara, California. Sun has always provided services for its customers, but changes in customers buying habits over time were the biggest driver for changing the business model. Even as recently as five years ago, customers were happy to only buy products, but not anymore. Competitors like IBM were the first to focus on services, but Sun has taken a slightly different, more technology-oriented approach. Currently, about a third of Suns revenues come from services. Service revenues are mostly based on service contracts, but efforts are being made to get more customers under fixed annual pricing. The change from product to service orientation has mainly been gradual, but some quantum leaps were also required on the way. So far, customer feedback about the new model has been very positive. To provide services, Sun has partnered with global system integrators, regional integrators and value-added resellers. There have always been partnerships, but their nature has changed with the introduction of the new business model. Partnerships are based on mutual benefit; Sun has not integrated forward, but instead partners will refer business to Sun if they cannot provide the service 38

themselves. Partnerships are based on subcontracting fees, and there are no profit-sharing schemes at least yet, because they would be extremely challenging. Sun already had a service organization in place before adopting an industrial service strategy, but the organization was changed to better suit the needs of the new business model. The professional services unit that was formerly part of the service organization was merged with the sales unit to provide a consultative approach to selling. The focus was changed from selling products to selling solutions. Although services are a separate business with their own profit goals, there is an integrative solutions-oriented approach despite the internal arrangement. Changes have not been easy to make, however, and there has been considerable resistance to change during the transformation. The change acceptance process is still ongoing and it took several years to even get all senior managers behind the new strategy. Sales has been a big point of resistance at Sun, as have some product groups. Change was driven by creating a vision and by describing a compelling business need that was communicated to the field organization. A lot of the change has had to do with being more responsive to customer needs, the whole way in which customers are engaged has been changed. Major changes took place also at research and development. A new system to release products was introduced so that, instead of releasing individual products when they are finished, software is bundled to packages. Services are integrated into the offer and the package is tested thoroughly before release to make sure that the different parts work well together. This new approach also enables the building of monitoring software into the package to support service provision. Although service and product development are separate units, they are very closely coupled and work closely together. Customers had doubts about Suns new operating model at first, but when they realized that Sun really had the capability to help them do business, their attitude changed dramatically. The change has been happening gradually and all of the customers have not yet overcome their skepticism, but cooperation with those customers that have embraced Suns service-led approach has become deeper. In those cases there has been a clear increase in customer loyalty also. The most important thing in the service business according to Suns Vice President Professional Services, Doug Kaewert, is being able to understand customers. Service providers need be able to quantify what is important to their customers and to make those requirements visible to all of the company. Customer needs drive the whole business model and, while the service organization may lead the transition, it eventually has to be incorporated into the whole company.

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4.5 CASE INDUSTRIAL EQUIPMENT MANUFACTURER

The organization studied is a US-based manufacturer of a range of bench top industrial products. Under its umbrella are three divisions providing equipment for electronics manufacturing and general industrial applications. The company has provided services for its customers in the past, but they have been mainly product support related and provided only to attract customers. Company management, however, recently felt that they had to make a decision either to fully pursue a service strategy or to only supply products. After careful consideration, they decided to choose a pure product strategy. The main reason behind the decision was related to the companys product portfolio. Because they provide a wide variety of products, a very broad service organization would be needed in order to supply adequate service. That would require resources that the management thought would be better used in strengthening the existing core business. Most of the companys products are also quite inexpensive by industrial standards and represent a relatively small portion of a typical customers investment in production capacity. Customers therefore would not have a strong incentive to put effort into managing them better. Simply replacing broken equipment is a typical approach. Furthermore, most of the products are fairly small pieces of equipment and it would be hard and costly to build in technology to support service provision. Adopting a strict product strategy also means that the company intentionally focuses on products that customers do not require services for, which basically excludes capital products. The management also thought that even if the service business would be highly profitable now, it would not necessarily be so in the future when competition becomes more intense. There have also been arguments that companies in industrialized countries would not be able to successfully compete with pure manufacturing strategies against competitors in newly industrialized ones because of higher labor and other costs. This notion was dismissed, because there is no reason to think that the new competitors would not be able to adopt service strategies in time as well. Strengthening the existing core competencies was seen as an equally valid defense. Taking a service approach would also have meant rethinking the companys distribution strategy. When products are sold through intermediaries, they usually also provide the service. Big distributors represent many suppliers, and therefore the volume of their service business is also adequate to make it profitable. A single supplier would be hard pressed to sell a large enough volume of products directly to customers. On the other hand, not providing service does not mean that profiting from services is impossible, for example through spare part sales; a good example is car manufacturers. Only time will prove if the companys decision to concentrate on product sales was the right one. Competitors, however, provide some short-term points of 40

comparison; of the three main competitors, one has adopted a service strategy, one provides some basic support services, and one no services at all. Currently, the one with the service strategy is in financial trouble, while the one that does not provide services at all is the most profitable of the three.

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5 CONCLUSIONS
In order to find out whether the theoretical framework presented in section 3.4 reflects reality or not, it has to be compared with the results of the case studies. The framework is then reconstructed so that it better models the real actions of companies. In addition to the validation of the theoretical transition framework, the reasons proposed in the literature for entering the industrial service business were also put to the test. Furthermore, the mapping of differences between practices in Finnish and American companies may provide some clues to differences in strategic thinking in the two countries.

5.1 REASONS FOR ENTERING THE INDUSTRIAL SERVICE BUSINESS

According to the literature, the most important issues leading to the adoption of an industrial service business strategy are competitive pressures and eroding profits in the core business, a growing installed base of products, and customers willingness to outsource. The case studies did support some of these notions but, on the other hand, some can be dismissed as not so important. All of the case companies listed changing customer demands as one of the reasons for entering the industrial service business, clearly indicating that this is the most important reason. Whether the change in demands is due to the outsourcing trend or some other reason is not clear, but nevertheless customers are obviously the main driver. Overall pressures to increase efficiency and focus on core businesses is the underlying factor in the outsourcing trend and probably also underlies the customers demands in the case of industrial services; even though the customers would not be willing to outsource functions, higher demands are placed on suppliers. Only one of the four case companies indicated that profitability was an issue that influenced the decision to enter the industrial service business. Competitive pressures were not mentioned at all, although the literature presents competitive pressures and profit seeking as the main reasons for adopting an industrial service business strategy. Their importance is thus perhaps not as high as presumed and the change seems to be more customer- than supplier-driven. Finally, one company identified services as an opportunity to grow, another said they were a good business opportunity and one talked about putting their installed base into use. These statements could all be related to limited possibilities of growing the existing business further or at least of doing so profitably; venturing into services provides an alternative way to increase revenue. None of the companies mentioned anything about industrial services being a strategic tool for them. Either they have not been considered as one or then the 42

interviewees did not want to reveal anything about their companies strategic issues.

5.2 TRANSITION IN THEORY AND IN PRACTICE

In addition to reasons why the case companies had started providing industrial services, they were asked about changes in each of the aspects in the transition framework: business models, networks, value chains, customer relationships, organization, culture, marketing and R&D. In theory, it is important to align the incentives between the supplier and the customer in an industrial service business model. This means that the profits should somehow be linked to process efficiency instead of material consumption or similar measures. One of the ways to do this is to have some sort of a fixedprice annual agreement between the customer and the supplier. In practice, two of the case companies clearly stated that they had implemented or were trying to implement such a model. In these cases, services were also integrated into the customer offering. In one case, services were a part of the offering but the business model was a more traditional one. The company nevertheless paid attention to cooperating with its customers and had adopted a problem-solving approach. In the last case, company services were not a part of the customer offer, but their service customers paid for the availability of a service technician instead of hours worked servicing products. Thus all of the companies pursuing an industrial service business strategy had also adopted a more or less nontraditional business model, which is in line with the assumptions. Changes in the value chain, especially forward integration, were also among the things that according to the literature should occur in the transition. Three of the case companies had indeed integrated forward at least to distribution, which at the same time also enabled them to expand the market potential of their services to cover more phases of the product life cycle. One company had a different approach, as it had partnered with distributors instead of handling distribution itself. In addition, one of the companies that had integrated forward had realized that the structure of the value chain had changed over time, so that it now actually resembled a value shop rather than a traditional value chain. All this indicates that changes do occur in the value chain during the transition. The importance of networking was another issue that came up in the literature, but the notion that competition would gradually change from inter-firm rivalry to competition between networks was not supported by the cases. Only one company had so far made a real effort to make use of competencies and resources outside the company. One other company had identified certain situations where having a partner was helpful and one had recognized the need to partner in the future, but all in all the case companies were not very interested in forming alliances and building networks. Perhaps in time, as companies begin to expand their industrial service businesses, partnering will become more 43

relevant, but the current situation suggests that networking is not an important issue in the transition. Customer relationships, on the other hand, were seen as important by all of the case companies. Every company reported that their relationships with customers had become deeper after adopting an industrial service business strategy and they were actively cooperating with customers to help provide better service. One company had also noticed a clear increase in customer loyalty. The theoretical framework suggested that changes would occur in sales and marketing as well. Suppliers should be able to respond to each customers unique needs and do so on a large scale. This supposedly would require cultural adaptation and tools to support customization. Two of the case companies reported that they had taken a more consultative approach to selling, meaning that customer needs are analyzed before an offer is made. Also, one other company mentioned that it had made an effort to build a platform upon which to build their solutions. The fourth company did not report any significant changes. It seems that some adaptation in sales and marketing is required during the transition, but it is not among the key issues that companies pay attention to. One of the assumptions also was that organizational structures that support manufacturing strategies do not necessarily support service strategies very well. Three of the case companies had made changes to their organization after introducing industrial services. Only one of them, however, had combined manufacturing and services under the same organizational unit. The other two that had made organizational changes had decided to keep them separate, but had nevertheless made arrangements to ensure that the customers were provided with complete solutions instead of products and services separately. In the last company where changes had not occurred services were under a separate business unit with its own profit goals, but cooperation with manufacturing was close. It looks like organizational changes are needed during the transition, but that it is not necessary to merge manufacturing and service organizations as long as actions are taken to ensure proper cooperation. Along with organizational structures, cultural issues were supposed to play a big role in the transition as well; both supplier and customer cultures would need to change in order for the new business model to work properly. The cases strongly supported theory in this: one of the case companies reported only minor changes in their culture, whereas the other three went through radical changes. Becoming more sensitive to customer needs was described as the biggest challenge related to the transformation in these three companies and, in addition, two admitted that there had been significant resistance to change. Culture thus seems to have a major impact both on the success of the business model and on the time it takes to transform the company. Two case companies also indicated that customers did not embrace the new model without question either and that it took time for them to accept the change and to cooperate fully as well.

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The final point in the framework concerned research and development functions. Adopting a systemic view and developing technology to help in service provision were important factors according to literature sources. Two companies had clearly focused on embedding service technology into their products and, in addition, one company had thought about developing similar technology but faced resistance from the customer side. Three companies had adopted a concurrent approach and were developing products and services simultaneously. Judging from the results, rearranging research and development functions appears to be an essential part of the transition.

5.3 MODIFIED TRANSITION FRAMEWORK

In general, the theoretical framework turned out to reflect reality quite well. All of the eight factors played a role in shaping the industrial service business strategy of at least one case company, although some of the factors were clearly more relevant than others. Organizational culture stood out as the most important factor. Three of the case companies strongly emphasized its relevance in the transformation and some changes occurred also in the fourth company, although cultural issues were not seen as a major challenge in that company. The other factors of the framework did not receive nearly as much attention. Organizational culture thus seems to be the core issue in the adoption of an industrial service business strategy. In contrast to culture, two factors were paid less attention to: networks & alliances and sales & marketing. This was rather surprising, as one of the most important predictions in the theoretical part was that the nature of competition would change from competition between companies to competition between networks of companies. A possible explanation for this could be that all of the case companies had only quite recently changed their strategies and were still struggling with internal problems like resistance to change. Not much attention therefore had yet been paid to external issues. Had this study been conducted a few years later, the emphasis between the factors might have been different. The five remaining factors in the framework fell somewhere between the two extremes in importance. Some of the case companies regarded them as important, while others did not. In the final framework these five factors form the middle layer around the central issue, i.e. culture, and the two factors that received less attention make up the outer layer. The final framework is illustrated in Figure 11.

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Business models

Sales & marketing

Customer relationships

Value chains

Organizational culture
Organizational structure

Networks & alliances

R&D

Figure 11: Modified transition framework

5.4 DIFFERENCES BETWEEN FINNISH AND AMERICAN COMPANIES

One of the assumptions made when this study was started was that some differences between Finnish and American companies would exist in the way they do business and that therefore the actions they would have undertaken in the transition from product to service oriented would also differ. The goal was to find out what these differences were and how they might impact on profitability. However, it turned out that the companies interviewed for this study are very similar to each other. The only notable difference that could be identified was in initial attitude towards customers. The Finnish companies had in general more difficulties in becoming customer oriented, although the one American company also reported that it had to change its culture in that respect. As the companies adopt industrial service business strategies even this gap will close, because customer orientation is essential for the model to work. All in all, it can be said that Finnish and American companies are very similar in respect to the transition to the industrial service business. It should be noted, however, that the scope of this study is limited and it is not possible to draw any wide-ranging conclusions due to the very limited number of companies studied.

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6 SUMMARY
Increased competition and changing customer demands, among other factors, have contributed to the rise of industrial services. The term industrial service refers to services that are targeted to increase the value of industrial products to customers, for example maintenance services and process improvements. The demand for industrial services is more stable than that for products, and services usually have higher profit margins as well, which enables manufacturing companies to expand their businesses profitably. The transition from a pure manufacturing company to an industrial service provider is not easy, however, as the foundations of strategy are totally different. Companies have to change in many aspects for the transition to be successful. First of all, the business model is very different from a traditional model. As a big portion of the total revenue will come from industrial services instead of products, the earning logic can no longer be based only on a healthy profit margin at the point of sale but on optimizing the stream of revenue that is dispersed over the entire product life cycle. The revenue stream is largely based on a long-lasting relationship with the customer. The business model should be built so that the incentives of the supplier and the customer are aligned and a close and cooperative relationship is formed. Customers should be seen more as partners instead of customers in a traditional sense. Responding to each customers unique needs and at the same time managing a large number of customer relationships is challenging also in the marketing sense. In a close customer relationship where incentives are aligned the value chains of the supplier and the customer can merge so that a part of the customers process becomes more or less a joint function. In such a case, both parties have a genuine interest to make the process work as efficiently as possible. From the suppliers side this requires a thorough understanding of the customers processes and a wider range of competencies than in a traditional manufacturing business. The need for an expanding knowledge base contradicts the recent trend towards outsourcing non-core competencies, but the problem can be solved with networking. Partnering with other companies to provide solutions to customers problems will possibly gradually change the nature of competition, although this notion was not clearly supported by the case studies. If theory is nonetheless correct, in the future networks of companies instead of individual companies will compete against each other, in which case the networking capabilities of companies will have a major effect on their competitiveness. A radical change in the business model and the way business is conducted induces a change in the organizational structure of a company as well. An organization built to support a traditional manufacturing business will not function properly in the industrial service business because of the inherent differences of the two strategies. The change also affects research and development: the core 47

product and supplementary services cannot be developed separately if the product-service package is to function properly. Finally, a radical change in business strategy also requires a change in organizational culture. The whole organization needs to be committed to the new way of doing business if the new strategy is going to be successful. Resistance to change may be hard to overcome even within the suppliers own organization, and the new business model requires a change in the customers culture as well. Culture was identified to be the most important factor in the transition from a manufacturer to an industrial service provider.

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