Deciding whether to sell a product or offer it as a service depends on what the end customer wants. But there are some basics that you need to keep in mind before taking a call. Here are some of them.
Hardware companies’ business model used to be to sell a product to the customer for a certain price and make profit. And thereafter make money by servicing the product. This led to a category of products that could be thrown away after use or when these became faulty. But with pressure on reducing electronic waste there is now huge opposition to such use-and-throw products. Through directives like WEEE (Waste from Electrical and Electronic Equipment), manufacturers are being held responsible for the safe disposal or recycling of their products.
Of late, in many countries, Right to Repair is gaining momentum and product manufacturers are expected to allow users to repair the product if it goes bad. This is especially true in the case of mobile phones. Second, products which have long life need to be supported throughout their life. These products typically are large equipment.
These changes are putting pressure on product designers to find ways of recouping their investment. With the product-life reduced to less than a year, making money through pure play-box selling becomes difficult. With these challenges companies are finding new ways of making profit from their hardware sales.
The best example is the business model adopted by Apple in the US market. With their phones costing $800+ not many customers replace their phones frequently. So, Apple has bundled their phones with telecom services as monthly subscription with a lock-in period. This enables both Apple and the telecom service providers to make money and retain the customers.
Why this is critical?
Let us look at Fig. 1, which shows how the business works in a pure product selling model and how the revenues add up. As you can see, the brown boxes are for revenues that are collected by the manufacturers and sellers, leaving the designer high and dry.
Fig. 2 shows the model in which the hardware acts more as a vehicle for revenue. The subscription based business in this case reduces the overhead on solution and also restricts the cost to manufacture, allowing flexibility in the pricing model. This essentially makes the subscription model a better choice.
Some examples
One of the best examples is that of television set-top-box (STB) used for cable/direct-to-home (DTH) service. When you go for DTH service, you pay for the STB an amount that barely covers the cost of the box, without any profit margin. Also, the conditional access system (CAS) that India follows necessitates that every cable service provider’s service is unique, and the STBs are not interoperable. So, the cable vendors have an assured customer for a long duration.
We should also note that unlike USA, in India mobile phones’ SIM cards are interoperable, but the practice of bundling the hardware (phones) is not yet successful in mobile communication business.
Another good example would be of medical device leasing. Since the cost of an MRI or CT scanner is so high, most equipment vendors collect a subscription plus share in the revenue, so that the hospitals or the labs do not need to buy the expensive equipment but can still offer the service.
Subscription model has limitations too. A mobile phone service customer, for instance, would not like to be dependent on just one vendor for the hardware.
If the cost of the hardware is high, and it needs maintenance from time to time, a customer would prefer the subscription/leasing model as it needs low capital expense (Capex) and the subscription amount can be treated as an expense for income tax purposes.
The Internet of Things (IoT) solutions are taking this route. In fact, there was an interesting request for quote (RFQ) where a conglomerate wanted an LED lighting vendor to replace all their legacy lighting equipment with LED lights. But the condition was that the vendor would get paid from the amount saved due to lesser energy consumption. When the lighting vendor audited the setup, the current consumption by the legacy lighting was found to be already low. They realised that it would take at least ten years to recoup their investment and so they backed out!
So, proper homework needs to be done before you decide the model you should follow. But the trend is slowly moving towards subscription or pay per use, which can be called the Uber model.
What needs to be done?
When startups and SMEs decide on a product, they should draw their full solution chain (as shown in Fig. 1) and see where their product sits in the chain. At this stage they have to understand whether they will offer the solution, or they will be part of the solution. If they are part of a bigger solution, they can expect very low margin. If they are offering the solution (end to end), their costs can be recovered over a period of time, leading to better margin and committed customers. But remember that the capital needs are different for both.
In most cases, the biggest challenge seen is that the prototype is ready but the startup has no clear plan for revenue generation. Most startups assume that money will come automatically when they start selling. Here are some tips for them:
1. Determine whether your product is fit for the sale and support model, or part of a bigger solution (OEM), or you own the entire solution.
2. Whatever is your model, the basic cost of the product (BoM+Mfr Cost+Logistics+Support cost) should not vary more than 10%. If it does, your ride is going to be bumpy.
3. If your model is that of sale and support, only high volumes would make the business profitable.
4. If your product is part of a solution, nail the contract for a minimum of three years with price variation for different volume slabs. (Too many times startups commit to an unsustainable pricing.)
5. If you own the entire solution, you control you destiny. But you should have financial muscle to survive for at least 24 months after you get your first customer.
Deciding whether to sell or offer service depends on what the end customer wants. It is easier said than done. Having an old fox (experienced person) with you to validate will help you go a long way!
S.A. Srinivasa Moorthy is director at D4X Technologies Private Limited
Very useful article.
Thank you for your valuable feedback.