Servitisation of the manufacturing industry: a funder’s perspective

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LL’s core model is vendor finance, setting up funding programmes with suppliers and manufacturers who want to offer financing options to their business customers. But, instead of their customer paying cash, we buy the asset instead and then lease it to the customer and we own a lot of assets, over €35bn worth in fact, from across a range of industries from transportation to IT to healthcare, and everything in between and we’ve been doing this for over 50 years.

So, when it comes to how businesses procure their operating assets, we’ve seen a lot of market trends come and go over this time. And we’ve disrupted and often pioneered new funding methods to meet those trends.

First, some observations of what we are seeing in our markets:

1. Customers want to procure their business assets differently: just like in the consumer space, businesses are looking for change.

2. Customers want to pay for assets according to usage or outcomes: they’re happy to pay for the asset so long as they actually use it or if they achieve their own business outcomes.

3. Outcomes aren’t derived by assets alone. Services are instrumental: outcomes require an all-in blended supply to make it happen.

4. The range of services on offer is getting much more data-sophisticated: data is the new differentiator, whether for connectivity between assets or for the insights it provides for a business.

5. Customers want complexity delivered simply: products must be complex and intelligent; admin and contracts must be simple and convenient.

6. All of this is heading towards more and more optimisation of asset use: perhaps most importantly we are seeing a rapid drive for efficiency in every industry in the ways they use and pay for their assets. Driven mainly by cost but also as part of the growing sustainability agenda, particularly in the bigger corporates.

7. There is a growing opportunity for suppliers to capitalise on this trend: traditional supply models aren’t structured in a way to easily meet this new demand, so this means there is a big early mover advantage for suppliers.

Now ultimately this all flows from a big shift at the customer level, their perception of value-for-money is changing when it comes to their business assets. We see customers wanting to be supplied with: 1) everything they need; 2) right now; 3) for this job; 4) no more no less.

It’s hardly surprising really, as we’re all consumers at heart and are already making these assessments when we look to buy in the home – for example, paying subscriptions for music streaming instead of owning CDs, car-sharing through an app instead of owning the car.

So, we believe the demand is there and growing. It just needs suppliers to answer the call and supply in a different way.

What does different look like and how does a funder like DLL come into this? Let’s start by taking a typical deal today. A customer needs an asset, in this case an excavator. They typically get presented with two simple options: pay cash and take over ownership, or sign a lease contract and pay for it over time. And this has pretty much been the same for the past 40 years.

Now let’s rewind the deal; instead of just supplying the asset, the asset now gets blended into a full service offering – the customer is now receiving a lot more: they are receiving use of the asset, repair and maintenance, delivery and calibration, consumables, data analytics, possibly labour – and all supplied with a promise to achieve the customer’s desired outcomes, which will form the basis of the agreed service levels.

The offering has now been servitised. In this case “excavation as a service”. As these are services rather than products, the customer signs up to a service contract which is inherently a time-based contract. The customer is signing up to receive services over time, which they pay for over time. And it follows that there is no “pay now” cash option. After all it’s a service contract so why would you pay upfront for services that haven’t been performed yet?

However, from the supplier’s perspective, there’s an asset in there that needs to be paid for today. The customer is not paying for it, so who is? There are two options here: either the supplier holds on to ownership, or the supplier sells the asset to a funder.

The first option is viable but can be problematic for the supplier in two ways: 1) they may need the cash flow from the sale today to keep their business churning; and 2) their business target metrics may be set to sale revenue. In other words, it may be important to register the full sale proceeds from the asset today rather than wait for five years to accrue the sale income.

This is where the second option can help. By introducing a funder to the mix, the supplier can get the best of both worlds. They can offer an interesting as-a-service (aaS) option to the customer, and they can still get to sell the asset on day one – to the funder. New product, tick, cashflow today, tick, and a sale revenue towards their annual target, tick. So the supplier gets what they need from the deal.

Let’s move them to one side and consider this through the customer lens which all starts and ends with the customer value proposition. We need to design something that the customer sees value in and will ultimately pay for.

So, is the customer getting what they need and are willing to pay for? Yes, “as-a-service” gives them everything they need, but what about the other criteria of value-for-money services, such as “right now, for this job, no more no less”?

To answer that, let’s take a look at the typical business output of a customer over time. No surprises here, it’s not flat – it ebbs and flows according to consumer demand – and this variability can be seasonal, it could be reactive to other factors such as what we’ve seen over the last year where there have been totally unforeseen events on a global scale.

So, if their business revenue goes up and down, it makes sense that they would want their operating costs to do the same. In our case the services will naturally align as most of these will align to usage – for example, change the oil every 3,000 hours. But what about the asset included in that as-a-service contract? This needs to be paid off over the term of the contract so it will be set to a flat monthly payment over the five years.

The problem here is that the flat payments for the asset have limited the full power of the as-a-service offering. The asset part hasn’t been unlocked. Instead of being a fully variable service offering that aligns to the customer’s business, it is really just a committed lease with services.

So, when the customer’s business is not doing well they are paying too much. When their business is doing well and they can therefore afford to pay more, they are actually paying too little. There is a disconnect between business cost and business revenue. This is a problem, which goes against the grain of a true as-a-service offering.

This should be simple to fix: just change the monthly asset payment to a variable payment according to usage or outcome. It sounds simple, but the problem here is that suddenly the risk for the supplier has skyrocketed. Excavators are expensive. What if the customer doesn’t use it as much, what if they don’t achieve their outcomes, what if their landscape changes and they no longer need the asset for a long time?

There are three options for a supplier here: 1) keep the asset in as a fixed payment and offer as-a-service which is good enough but not really aligned or flexible; 2) make it fully variable and take the risk yourself, but remember that keeping the asset on your own balance sheet may give you cashflow and true-sale issues; and 3) introduce a funder to the mix that is prepared to take on those risks – we call this pay-per-use.

Instead of being paid the same every month, we now take a view on how much the customer is going to use the asset over the next five years. And we relate this to whatever unit makes sense for the kind of asset.

So, for example, a photocopier may be cost-per-copy, a truck may be cost-per-mile, and in this case, the excavator could be cost-per-tonne.

If the customer wants to base it on some other measure that they feel is a closer alignment to their business revenue (for example, number of days that it’s out on a job earning money), then we can look at cost-per-day too.

Then, if the usage runs to forecast, we get repaid. If it doesn’t, we don’t. … And it’s as simple as that.

DLL, as a funder, will take genuine asset-usage risk. Now this is a massive evolutionary shift for us so it bears repeating – we will fund the asset and take pure usage risk. No minimum volumes, no true-ups or termination sums, no smoke and mirrors in the small print.

And just look at the difference this makes to the as-a-service offering. It converts the excavator into a true variable cost and aligns the repayments to the customer’s business output.

In effect, the funder’s pay-per-use unlocks the full power of the as-a-service offering. And if we look again at the value the customer is after, we now have a product that ticks all the boxes.

1. Unless you can carry the asset cost yourself, you will need to engage with a funder if you want to offer aaS: think about whether you want to offload the asset or not

2. The funder will be looking at a whole range of new risks, so involve them early in your aaS design stage: this is very different to leasing. Engage early as you don’t want to design something the funders ultimately won’t be comfortable funding

3. A successful aaS design will flex with changes in the customer’s business over time. Alignment to their business output is key: goes without saying. A great design has the ability to continually flex and align with the customer’s business

4. A funder can help with this alignment by adding true payment flexibility: payments according to usage is in my opinion, essential to meet the market. And a funder can make this happen

5. Don’t wait until tomorrow to start down the aaS path, this is happening now: we’re seeing a lot of demand building for better ways to buy. If its not already, product innovation ought to be at the top of the priority list

This is an edited version of a speech given by Lee Thompson at the World Servitisation Convention in September.

Main image: DLL Headquarters. Credit: DLL Group