OEMs are generally right to retreat from general outsourced maintenance and other similar services. But not because this business is inherently problematic or too far away from core technology, but because they cannot win. This is a battle of physical footprint and competitive advantage lies with others.
Over the past 9 months, at least 4 major manufacturing companies have decided to divest significant service activities:
In Sep 2014, Johnson Controls (JC) announced it would divest its US$ 4.3 billion Global Workplace Solutions, a Facilities Management business –which accounts for fully 10% of its revenue. In the same month, Voith in Germany sold its DIW Instandhaltung, mainly a Facilities Management business, with 6,000 employees to Strabag, a construction group, and went even further in Feb 2015 by announcing the initiation of a sales process for its Voith Industrial Services division, an industrial maintenance outsourcing business focused mainly on automotive and process industries (rev. EUR 1.2 billion, 18,000 employees) -as part of a far reaching restructuring plan. In Aug 2014, ABB sold its Full Service (maintenance outsourcing – now Quant Service) business to Nordic Capital, a private equity firm. Earlier, in 2012, Caterpillar sold a majority of its parts logistics and services business (now Neovia Logistics) to Platinum Equity, another private equity firm, and announced last year that it would divest the remaining 35%.
It is of course interesting to note that buyers are either construction firms, eager to complement engineering/construction offerings with services to diversify revenue base and reduce fluctuations from economic / investment cycles, much as Bilfinger Berger, Hochtief or Vinci have done in Europe or URS and KBR in US, or private equity groups hoping perhaps to capitalize on potential consolidation of the market for maintenance and other industrial services.
Nevertheless, what is even more interesting in this supposed era of servitization, i.e. where companies are urged to increase services, is the reasoning behind the divestments. Perhaps not all services are “equal”. The companies justified their decisions based on “portfolio streamlining” and “core business” arguments. According to JC: “As we’ve focused to understand what is needed to win long-term, it is clear that GWS is really an exclusively service-based business and not core to our manufacturing, engineering and product-based portfolio.” In the case of Voith: “Management [will] shift the Group’s focus clearly toward its technological engineering expertise and initiate a sales process. The Voith Industrial Services business model comprises labor-intensive services largely performed at client sites and based on customers’ specific know-how and process knowledge”. Similarly ABB: “ABB is divesting this business because of limited synergies with ABB’s core portfolio”.
Of course financial considerations played a role. For example, according to a Forbes article, GWS revenues have recently declined and margins are very low, in the 1-2% range. Assuming a similar situation in the other cases is not unreasonable. Even though such businesses tie up only limited capital, low margins combined with high labor intensity and associated risks are not necessarily attractive for companies whose self-perception is as a technology leader -usually associated with capital intensive automation rather than labor. In addition the initial expectations of product “pull-through” through this type of services were not realized, mainly because most customers require service providers to be product agnostic and neutral.
This development is not limited to the mentioned companies. Others have preceded them and many others have decided not to go down the outsourcing route at all, whether maintenance or other industrial processes, or to limit their engagement to providing services only for their own or closely related asset base.
Still the question remains – are these fundamentally strategically “correct” moves or could one think of alternative approaches? Financial performance (good or bad) is not always the best indicator of strategic soundness. In the case of the low margins, they may be due more to offerings not generating sufficient value for customers and/or too high cost base for the outcomes to be achieved than to something inherently problematic about the service business per se. For instance in outsourced maintenance there is often a discrepancy between what customers require and what vendors (particularly technology oriented product vendors) want to provide: While most customers’ primary reason for outsourcing maintenance is cost reduction (associated chiefly with lower labor costs), most product vendors (want to) offer productivity improvements (as measured by Overall Equipment Effectiveness –OEE– associated with better maintenance methods and management). Cost reduction is mainly (local) scale driven and customers usually lack local scale in maintenance (and therefore the ability to pool and better utilize resources such as labor, equipment and tools or inventories), while productivity improvement is usually based on skills, which is in fact easier for (at least large) customers to achieve on their own –after all they can invest in productivity for their entire asset base, implement advanced methods or send highly trained specialists to troubleshoot and improve plants all over the world. For example, International Paper produces roughly 23 million tons of paper based product per year in over 100 facilities around the world employing just under 60,000 people, many of them in operations. It is highly unlikely that any outside supplier, even a vendor of core technology such as paper machines and pulp mills or the balance of plant and automation to go with it could amass the type of experience and expertise needed to systematically improve productivity of these facilities better than the owner/operator –at least under normal circumstances.
The result of this discrepancy in what is sought and what is offered, is that vendors invest in sophisticated methods and tools to improve productivity that customers don’t want to pay for (or even buy) and therefore end up selling their services (burdened with too high overhead) at lower prices than required to make sufficient margin, while in the end not delivering the cost savings that customers had expected. This is a strategic mistake in terms of not recognizing the sources of competitive advantage and wrong resulting actions rather than anything else. It could of course have been different if the investments were made in ways and means to reduce costs and limit overhead, e.g. in acquiring the necessary footprint/density to be able to pool resources or tools and technologies to make maintenance less labor intensive (and thus reduce required workforce over time). Often however that means acquiring even larger numbers of people, diversifying into non-related industries (to acquire local critical mass / density) or technologies and co-investing with customers, a commitment that requires time horizons, and contract durations, which go far beyond usual practice in most industries. The situation is, for example, different in defense or aerospace where the long and costly technology development cycles and the relatively small number and large sizes of both customers and suppliers result in much more integrated and longer term stable value chains that make very large, very long term risk/reward/resource sharing outsourcing contracts more feasible.
So the real reason engineering/technology vendors disengage from third party services is primarily that they can’t make it work at the scale these businesses are operated and it is not feasible to engage or commit resources to a any greater extent. In these markets they also come up against very large competitors, such as the construction companies turned maintenance providers whose core competences include managing large trades based (technical blue collar) workforces. This is a battle of physical footprint, which technology companies cannot win. The decisions to exit are therefore strategically sound (though not necessarily for the reasons given) -measured also in terms of avoiding opportunity costs, such as management time and distraction.
On the other hand, it should also be noted that by selling these businesses product companies are giving up potentially valuable customers and allowing eventual competitors to take positions between themselves and their customers. And smart service providers can use this situation and integrate backwards into technologies that customers require to reduce their costs, not OEM core machinery or process technology, but the Internet of Things, Data and Analytics. Service providers, close to customers, are quite uniquely positioned to take control of data flow and interpretation. The jury is still out on whether service providers or OEMs have the upper hand here.
Titos Anastassacos is Managing Partner at Si2 Partners, a consultancy helping clients leverage services to win in industrial markets
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