The U.S. economy still appears to be strong. Yet, there are enough negative indications that business leaders and economists are beginning to predict a downturn or recession in the next 12-24 months. If your business has not already started recession planning, you should probably start now.
Unfortunately, since the 2007 recession, many business leaders have taken their hard-learned knowledge and moved on. This will force many of you to learn how to prepare for a downturn without having a tested mentor still in your business.
Retirement Planning
When you get to the stage of life when you begin to think about retirement planning, you start by talking with a financial planner. First, you share your goals and economic challenges. Then they usually advise a youngish person to invest over 50% of their planned investment in growth stocks. Finally, they suggest you invest the rest in more conservative and less volatile instruments like bonds and CDs.
As you get closer to retirement, the adviser usually recommends cutting back on your equity investments and moving the money to the less volatile group. So, a fair question might be, is there a similar strategy for planning a recession?
The answer is a clear YES!
The Gillette model is the most common business model today. You sell a product to customers and then provide aftermarket services and consumables. The initial sale is invoiced, collected after the shipment, and comes in one “lump.” The services and consumable sales are distributed during the product’s lifetime.
Unfortunately, during a financial downturn, buyers defer capital purchases. This causes the manufacturers a significant drop in sales. But what if you could distribute the sale price over time?
Recession planning and recurring revenue
Recurring revenue is just like it sounds. The payment is received on a schedule every month, quarter, etc. This keeps revenue steadier, but potentially lower, than the outright sale. But it reduces the month-to-month fluctuations caused by buyers’ indecision or outright refusal to buy.
Types of recurring revenue
There are three ways to turn an outright sale into recurring revenue:
- Lease the product
- Servitization of products and services
- PaaS (Product as a Service)
Lease the product
I will not discuss this option much since many of you already use this tool. And if you can, you should include a service contract in the offer and amortize its cost as part of the lease payment.
Remember that interest rates are currently meager, so lease financing is inexpensive. But beware when interest rates again rise.
Servitization of product and services
This option is similar to a lease, except that the product’s ownership transfers to the buyer at the time of shipment or installation acceptance. The advantage is that there is a steady, predictable income and revenue stream if the contract term exceeds 12 months.
In January, I posted an article on Thomas Insights called Recurring Revenue Could Be Your Business’ Key to Securing Sales, which details service contracts.
Product as a service
Although this business model has existed for decades, it is becoming mainstream. At its simplest, the offer only charges the equipment user when the equipment is available. No costs are incurred when the product is not producing outcomes and generating revenue.
Here is an abstract of the October 30, 2012, Rolls-Royce press release (with British spelling):
“ ‘Power-by-the-Hour’, a Rolls-Royce trademark, was invented in 1962 to support the Viper engine on the de Havilland/Hawker Siddeley 125 business jet. A complete engine and accessory replacement service were offered on a fixed-cost-per-flying-hour basis. This aligned the interests of the manufacturer and operator, who only paid for engines that performed well.
Rolls-Royce CorporateCare®, launched in 2002, added a range of additional features. These include Engine Health Monitoring, which tracks on-wing performance using onboard sensors; lease engine access to replace an operator’s engine during off- wing maintenance, thereby minimising downtime; and a global network of authorised maintenance centres to ensure that world-class support is readily available to customers whenever required.
The service allows operators to remove risk related to unscheduled maintenance events and make maintenance costs planned and predictable. “
For PaaS to work, the OEM has to:
- install instrumentation on the product
- include a way for the product to share the data with the manufacturer in real-time
- have a real-time data analysis system with monitoring to detect operational anomalies
- include a way to determine critically of each anomaly and repair it before it becomes critical
These plans frequently include a payment program based on actual use or product availability, like the original Rolls-Royce offering. The net result is a greater monthly charge than the servitization model previously described because the data has real customer value. For example, how much is it worth to your customers to have a machine repaired off-shift, where there is no loss of production and people are being paid but not creating sellable products?
PaaS, also sometimes miscalled the Internet of Things (IoT), is no longer unique. We find it everywhere, from home doorbells from Amazon to Boeing 787 jet planes. GE, Siemens, Tesla, and many other industry giants are implementing this model on all types of products.
A final example from GE’s 2019 Financial Report
In its financial report for Q4 2019, GE stated, “The company ended the quarter with a strong backlog of $405 billion, up 15% year-over-year. Some 80% of the backlog consisted of services, an important profitability driver for GE to build long-term customer ties.”
Conclusion
If you currently offer a PaaS, congratulations. You are ready for the coming decade and taking a significant step to prepare for a recession.
If you are not yet offering PaaS, it is not too late to start.
About Middlesex Consulting
Middlesex Consulting is an experienced team of professionals with the primary goal of helping capital equipment companies create more value for their clients and stakeholders. Middlesex Consulting continues to provide superior solutions to meet the needs of its clients by focusing on our strengths in Services, Manufacturing, Customer Experience, and Engineering. If you want to learn more about how we can help your organization create more customer value by combining products and services, please get in touch with us or check out some of our free articles and white papers here.