Businesses Are Becoming Multifaceted
Manufacturers and wholesale distributors are going through a significant transition from primarily or exclusively selling physical products, to more diverse business models in which they also provide a variety of services. This includes offerings such as financial services (transaction processing, project financing, etc.), consulting and professional services, inventory management, procurement management, product-as-service with uptime guarantees, and an increasing array of creative, unique, often industry-specific value-add services.
Henry Schein — Driving Growth by Offering Much More Than Just Equipment and Supplies
For example, Henry Schein, founded in 1932, is a distributor of dental, medical, and animal health equipment and supplies. Their primary focus is dental practices. In addition to selling dental equipment and supplies, they created and sell a comprehensive suite of dental practice-management software; provide electronic claims processing services; dental practice analysis and consulting; financial services such as leasing, patient financing and collections, project and acquisition financing, credit card processing, and tax assistance; staffing and hiring solutions; outsourced creation of custom restorations (bridges, crowns, etc.); an inventory-management program; dental lab software; disaster management resources to get dental/medical practices up and running quickly after a natural disaster; formal continuing education programs; brokerage services for buying, selling, and valuing dental practices; and more.
Over the years, Henry Schein has become a one-stop-shop for virtually everything a dental practice needs. As a result, they grew from $225M in 1989 to over $13B today, becoming the world’s largest distributor of dental equipment and supplies. At the same time, they grew operating margins to above 7%, more than twice the average for wholesale distributors.1
The Outcome Economy: An Evolving Spectrum of Business Models
We are evolving towards the ‘Outcome Economy,’ where customers pay for the specific outcomes they are trying to achieve, rather than buying a specific ‘thing’ or product. Historically, manufacturers have traditionally focused on making and selling their products while distributors have focused on buying and selling those products. Of course, those roles don’t go away, but over time, there has been a steady expansion of the types of services manufacturers and distributors offer, the variety of financing options and business models used, and an evolving relationship with the customer.
Example of Selling Outcomes: Semiconductor Yield Management
In order to produce computer chips, semiconductor manufacturers must first buy some ‘things’ — in this case big expensive manufacturing machines for wafer fabrication, assembly, and testing. However, the outcome they want is not owning a bunch of machines, but rather to make a lot of chips profitably. One of the biggest determinants of profitability is the rate of improvement in production yield (percent of chips that pass all tests and thereby can be sold) during launch of a new line of chips. Annual yield losses can exceed $100M for a large manufacturer.
A manufacturer can literally buy better yields, via a gainsharing-based yield management service. The service provider helps the manufacturer through the mindbogglingly complex process of launching a new line of chip production and gets paid based on improving the yield at a rate faster than would normally be expected. They are paid for achieving a specific outcome rather than for simply providing a machine.
As manufacturers and distributors offer these richer outcome-based services, they take on more risk and responsibility for the success of their customers in exchange for bigger rewards. They also tend to become more embedded into their customers’ businesses and daily lives, leading to increased loyalty and stickiness. For example, managing an outsourced process for their customers demands that the manufacturer or distributor becomes much more integrated into their customer’s operations, systems, and processes. Some manufacturers offer product-as-a-service such as aircraft engine manufacturers selling power-by-the hour (instead of selling engines); Philips customers pay-per-lux with light-as-a-service (instead of buying light bulbs); and Schaeffler Industrial Services’ bearings-as-a-service for large complex machines like wind turbines or cruise ships with a multi-year, pay-per-rotation contract (instead of buying the bearing).
Imperatives Driving Business Model Evolution
Companies are facing several imperatives in the marketplace, driving this shift to expanded business models:
- Competitive Differentiation — Unique, higher-value services are vital to differentiate offerings. This has become critical for survival with appearance of new entrants such as Amazon.
- Margin and Revenue Challenges — Over time, products and services become commoditized and mature markets become saturated, putting tremendous downward pressure on margins. Unique, differentiated services can boost profits significantly. They also create new sources of revenue, which may ultimately become the primary revenue for the business. For many manufacturers and distributors, the majority of profit (in some cases virtually all of their profit) comes from services. Focusing on and improving these services will ultimately drive additional margin and revenue.
- Revenue Predictability — Subscription-based and/or as-a-service revenue models provide more repeatable and predictable income streams.
- Loyalty/Embeddedness — Many higher value services demand deeper integration into B2B customers’ systems, processes, and organizations. For B2C customers, these services can become repetitive and ultimately essential. In both cases this fosters longer-term customer relationships, with less churn.
Nutreco’s Unique Services Create High-barrier Competitive Differentiation
Nutreco is a provider of livestock and fish feed (via their Trouw Nutrition and Skretting brands). About a decade ago, they started efforts to provide more strategic ‘precision farming’ systems and services to their farmer customers. This includes sophisticated sensors and big data analytics. For example, for shrimp aquafarmers, they provide a system using audio sensors that detect the optimum feeding time, to maximize growth while minimizing wasted feed. They have a rapid analysis reader providing instant, reliable detection of mycotoxin contamination 2 in feed so farmers and feed mills can take immediate action, reducing negative impacts on livestock health. They sell modular precision-feeding systems that use nutritional data science to fine-tune feeding strategies, adjusting nutritional composition based on time-of-day, animal lifecycle, and individual animal differences. To keep the stream of new ideas flowing, Nutreco organizes hackathons and has their own venture arm (NuFrontiers) that invests in promising startups. By implementing these new value-add services, Nutreco has gone from being just another feed provider to becoming a strategic partner, essential to optimizing their customer’s farming operations.
In Part Two of this series, we look at how new technologies, combined with new business models, are creating new opportunities (and threats).
1 Even compared to other dental and animal health distributors, a category with higher than average profits for distributors, Henry Schein’s operating margin is about 50% higher than competing firms in that category. — Return to article text above
2 According to the FAO (UN’s Food and Agriculture Organization), a quarter of the world’s food crops are contaminated with mycotoxins.
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