How IIoT Can Fuel Business Model Disruption
The sales pitch for the industrial Internet of Things and related terms is anything but subtle. One of its basic tenants is that connected technology can unlock trillions of dollars of revenue through efficiency gains and by spurring new revenue sources. A related idea holds that connected technology can help manufacturers make the leap to selling outcomes instead of products — or at least, recast their products as services. The German term “Industrie 4.0” even hints that connected technology can lay the groundwork for the next industrial revolution. The term IIoT, which is now frequently discussed in relationship to digital transformation, has a similar connotation.
But selling products as a service, whether it involves software or tangible goods, is less of a challenge for new market entrants than incumbents. “The problems occur when you have a legacy company that transitions over to the new model and pushes out a lot of revenue they used to get in one lump sum,” said Chris Kocher, managing director of Grey Heron, a management and strategic marketing consulting firm. A number of large software companies such as Adobe and Microsoft have made a smooth transition to the “as-a-service” model in recent years.
While “as-a-service” business models have yet to reach an inflection point for physical goods, they are growing more common for applications such as managed print services. It is also possible that the model helps do away with demand for physical products. One of the most prominent recent examples of this from the consumer sector is the rise of the MP3, which debuted in 1993 and ultimately paved the way to, first, music downloads in the early 2000s and, later, subscription music services, which became popular after Spotify’s debut in 2008. For consumers wanting to simply listen to music, purchasing CDs or digital music files was simply a means to an end. And for less money than buying a typical CD, a consumer could use a service such as Spotify for monthly access to more than 30 million songs.
While the concept is still nascent for many manufacturers, it has a history stretching back decades — notably in aviation. In 1962, the aviation firm Bristol Siddeley coined the term to refer to usage-based maintenance contracts for the Viper engine on British Aerospace 125 business jets. Now a Rolls-Royce trademark, “Power by the Hour” is a popular model with engine manufacturers as it provides increased aftermarket revenue. “The classic story is that General Electric and Rolls Royce and the like will sell you an engine the way they have always sold it — at 80 percent cost,” said Richard Soley, Ph.D., the executive director of the Industrial Internet Consortium. “And then they will make their money — five times that — in parts [and service fees] over the next 20 to 40 years.” The model also offers several benefits to their customers — most notably improved budget predictability of maintenance costs while doing away with the need for aircraft owners to worry about stocking backup engines or accessories.
The concept is gaining ground in the industrial sector with, for instance, the compressor company Kaeser Kompressoren recasting its business as “air as a service” or the tractor manufacturer like John Deere offering agricultural outcomes or a manufacturer selling “uptime” rather than a piece of equipment.
In both of those examples — and in many others, Internet of Things technology is helping enable such “as a service” arrangements by giving manufacturers a clearer sense of their customers’ needs.
But while the business logic behind such “as-a-service” arrangements is clear, the concept raises a number of questions for both the organizations choosing to offer them as well as the organizations choosing to enter into such arrangements. A company offering a jet engine as a service must decide if it is prepared to offer cost-savings from IIoT-informed maintenance with their clients (a practice known as “gainsharing”) or whether the savings will go directly to their bottom line. In the gainsharing example, a provider of a product as a service can receive a monthly fee as well as a portion of client cost-savings. “It can be very appealing to customers as they like the linkage to actual results and savings,” Kocher said. “In practice, this can be very hard to measure and customers’ CFOs usually back off of it as it can be very unpredictable. If a customer saves 1 percent one year and 3 percent the next, they may be writing checks that are three times as big. CFOs prefer a nice predictable number they can put in their budgets.”
The other possibility is that “as-a-service” arrangement can cause accounting challenges afflicting many organizations that have made the switch from a single product sale or license to an ongoing monthly or annual fee like a SaaS product. “The challenge is that when you move from one to the other it is no longer a capital expense on the books, which can be depreciated over many years and becomes an operating expense, which is paid monthly,” Kocher said. “It also affects revenue recognition. If you sell the engine, you can book the order, receive the money and recognize all the revenue (except maintenance) immediately.” But a monthly fee can only be recognized as the money is received over the years. A company transitioning from selling discrete goods to products as a service might take several years to recognize all of the revenue that they formerly received in a single payment.
But selling products as a service, whether it involves software or tangible goods, is less of a challenge for new market entrants than incumbents. “The problems occur when you have a legacy company that transitions over to the new model and pushes out a lot of revenue they used to get in one lump sum,” Kocher said. And a number of large software companies have made a smooth transition to the “as-a-service” model in recent years such as Adobe and Microsoft.
Other ideas for alternative business models and transactions — including the monetization of IoT data and using smart manufacturing technology to create individualized products — are still squarely in the testing phase. In the first case, buyers could be other organizations with a stake in the business, data scientists or insurance companies using it for assessing risk. Meanwhile, blockchain-fueled smart contracts could be especially promising in logistics.
As industrial companies deploy IoT technology across their factories and the entire value chain, industry leaders should begin exploring brand new ways of conducting business rather than solely focusing on operational efficiencies. “The real advantages come when companies say: ‘we can do business in a whole new way’ and come up with completely new products and business models. You might have small gains in the beginning and, as you move forward, you can rethink your entire process,” Kocher said. “That takes exec level involvement and direction.”