Strategic Analysis

Competing successfully in “solutions” businesses (a strategic perspective)

A successful solutions business is hard to implement. Whether or not it is the right competitive approach depends on a company’s strength in the market, how well it knows its customers and to what extent it is willing to invest in the necessary capabilities and see through the required operational and organizational realignments. Most of all it depends on whether the company can integrate products and/or services in such a way that the total provides more value than the sum of its parts.

The concept of competing through “solutions” has been around for at least 30 years. Numerous “tier 1” manufacturers / OEMs (power, plant and process machinery, aircraft and engines, earth moving equipment) created solutions business units to better target vertical markets, particular customer segments and/or large/strategic accounts. For example industrial automation companies created customer facing “systems” business units, which integrated various products and an automation system into a vertical market solution.

However it has not been all smooth sailing. Margin depended, among other things, on internal transfer pricing, however it was often the case that high product margins (arising from strong market positions and premium pricing) were negated by low systems margins. Over time many claims have been made about the positive impact of solutions strategies on profitability, customer retention, and competitive advantage, however the evidence on the ground is fairly thin. More recently OEMs have incorporated services into solutions offerings as a way to repulse competitive attacks from manufacturers with lower cost bases, mainly from emerging markets. It is thought that as (service-based) solutions place greater demands on processes (logistics systems and networks, business processes, project and risk management, pricing), they are more difficult for competitors to emulate, providing competitive advantage and a means for defending market positions. Again the evidence of success of such strategies is unclear. Undoubtedly some companies have been highly successful, others however less so, which is indicated by the fact that numerous companies at some point or other exit solutions businesses they had deemed very promising to begin with.

To varying degrees, for market reasons, most companies now self-report some sort of solutions offering, however a generally accepted definition of the concept remains elusive. In general a solution is considered to be a bundle of products and/or services that in combination purports to solve a customer’s “problem”. Some industries and markets have “naturally” exhibited stronger trends towards solutions than others, mainly driven by demands of large or very large customers (and the associated industry economics) with substantial buying power –requiring large investments by suppliers- examples being the defense, aerospace or infrastructure industries. This has usually been followed by industry consolidation as suppliers merged to form organizations capable of delivering significant scope (usually along a customer’s supply chain) of technology, products, services and financing over long time periods.

For example, in the large power business, many managers understood solutions to mean an expansion of product scope, so as to be able to offer turn-key power plant solutions: In the 1980s and ‘90s large steam turbine manufacturers acquired boiler makers and balance of plant companies to be able to cover the whole steam or gas and steam (combined) cycle. They often complemented this with a transmission or distribution business covering the full electrical cycle (from fuel to socket) – largely because of the structure of the market and the nature of customers (mostly large monopolistic utilities, covering both generation and transmission/distribution) –in spite of the fact that all underlying technologies and necessary competences were quite different. Typical examples of such strategies were Siemens, ABB or Alstom. However it is not at all clear that this strategy was more successful than, say, the one of GE which concentrated on dominating a relatively narrow product range (gas turbines) with the additional help of significant and high value service content. In fact GE’s (comparable) profitability has been consistently higher throughout, whereas its major competitors were often plagued by technology, quality and project problems while their profitability suffered.

The example of the power industry shows that simple expansion in scope of supply –even to match customers’ vertical integration- is not necessarily a winning strategy. In fact it is not obviously a solutions strategy at all –because a solution requires tight integration of the elements it consists of. The degree of integration of the elements of a “solution” differs significantly across companies and offerings. However it should be self-evident that if these elements are not tightly integrated so that the total creates more value than the sum of its parts there is hardly point to the solution at all and customers can rationally prefer to buy the elements individually. Once the commercial/technical logic of a “solution” is broken each element is subject to normal product competition or even commoditization with the associated margin pressure.

Furthermore, as the purpose of the solution is to solve a specific problem and as customers have problems often unique to their particular circumstances, solutions need to be (highly) customized – though of course there are often cases where customized solutions have eventually become fairly standard (though usually complex) offerings, applicable to a wider range of customers. Solutions therefore require both the ability to tightly integrate products and/or services so as to add value in excess of the sum of the individual products or services, and the ability to customize and place the offering in a way that the customer’s problem is solved according to metrics compatible with the outcome the customer is trying to achieve and therefore defined by the customer’s objectives. Given that solutions usually need substantial investment in either technical, commercial/sales or managerial capability and / or organizational re-alignment of processes and assumption of additional risks (all of which translate into upfront investment and higher overhead), it seems safe to assume that failure to achieve the solution requirements results in insufficient gross margin increases (reflecting insufficiently higher value added) to cover the overhead increases and therefore in reduced profits or even losses.

To succeed in solutions business it is therefore essential for managers to grasp the nature of customer demands*, basis of competition and successful value propositions, whether these be commercial or technical in nature. A proposed solution can only create additional value if it performs better, costs less or is better aligned to the customer’s specific situation than could be achieved by acquiring individual elements. This means effectively that the aspiring solution provider must be either a technical or commercial leader in at least one, preferably more of the solution elements and must know customers better than product or other competitors. It can be therefore concluded that solutions strategies must be aggressive competitive strategies and must be pursued from a position of strength. Solution strategies as defensive strategies (from positions of technical or commercial weakness or as a remedy for weakness in product business) usually end in failure. Companies with such weaknesses are better advised to remedy the specific weaknesses before pursuing solutions strategies. Even in the case of IBM, the most widely cited solutions transformation case study, the strategy was executed from positions of dominant strength in mainframes, software and know-how –not from a position of weakness, though it is true that IBM’s market was coming under threat from disruptive innovations, such as the mini-computer and distributed computing systems.

Managers contemplating solutions strategies must also understand how to calculate total economic impact of proposed solution on the customer’s operation and price according to additional value created. This is not a trivial endeavor. It requires utilizing technical and commercial experts, working closely and intimately with customers to understand their business drivers, base lines and improvement potential as well as risks. This necessitates a trust-based, non-transactional relationship with customers over longer time periods, which even today is not usually the norm.

In many markets, evolution towards solutions has not been as natural as the ones described above (mostly due to market structures, dynamics or industry economics) and suppliers have often struggled to find strategic justification for (product based) solutions offerings – and therefore sufficiently large markets- and/or could not adequately develop the capabilities required in terms of integration and customization. Many therefore turned to product-service bundles, now also deemed “solutions”, to jump on the bandwagon. Nevertheless, also in this case, the value created through the solution must be greater than the sum of its parts for the offering to make strategic sense.

In the same vain as product based solutions, product-service solutions require a significant degree of integration to create winning value propositions. Rolls Royce’s “power-by-the hour” concept, where a customer essentially buys jet-engine flying time and insights on how to optimize the flying process is a case in point. The customer pays for an outcome (optimized flying hours) which requires tightly integrated products and services to avoid disruptions, downtime or sub-optimized performance.

In contrast selling after-market services with a product in no way constitutes a solution. In most cases customers can (and do) buy services from third parties to reduce costs. As in the case of IBM, Rolls Royce deployed this solutions business model to expand market share not to defend a product weakness. Similar (though not identical) solutions strategy examples can be found in the automotive industry since the late 1990’s when car manufacturers, for cost reasons, decided to outsource discrete parts of production at manufacturing plants to large suppliers (Eisenmann, Dürr) such as the body-welding shop, paint shop or the chassis assembly line. The suppliers would own/operate the shops and receive payment by unit produced. The car manufacturers extended the concept to many parts of the supply chain, requiring higher tier suppliers to deliver a broad product-service scope and manage the delivery chain of lower tiered sub-suppliers, often competitors, even down simple components such as fasteners . Suppliers that benefited were those that achieved strong commercial and business process integration (procurement, contract and site management, fulfillment, billing, maintenance services, quality control) so that they were able to reduce total cost for the customer sufficiently while allowing for an increase in their own margins. It should be noted that outcomes were achieved not only through intensive or high quality services, but also through modifications to product characteristics to make them more “amenable” to the services, as they were being designed –with a view of achieving required outcomes for a specific customer (integration and customization!).

It is quite clear therefore that many companies touting “solutions” are not in effect offering solutions but non-integrated product and/or product-service bundles. This might be a good marketing tactic. On the other hand it might be a genuine misconception accompanied by high “solutions-type” overhead which has no possibility of being recouped through higher margins. This discrepancy is one of the major risks facing aspiring solutions providers. The other is implementation risk: either failing to correctly identify necessary changes in organization, processes or capabilities or executing them badly.

 

 

* A common mistake is that the nature of customer demand is misunderstood: solutions are offered to customers who actually prefer (rationally) to buy discrete products or services foregoing the higher value of the solution for an alternative. A good customer segmentation is therefore necessary, otherwise market potential will be misjudged. Breaking up a solutions offering in discrete products and services creates also significant pricing problems, which may be difficult to resolve.

 

 

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