Operations Management Research, Volume 1, Number 2, December, 2008
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EXPLORING THE FINANCIAL CONSEQUENCES OF THE
SERVITIZATION OF MANUFACTURING
Andy Neely - andy.neely@eng.cam.ac.uk
University of Cambridge and Cranfield School of Management
Institute for Manufacturing, University of Cambridge, Mill Lane, Cambridge, England, CB2 1RX
Operations Management Research, Volume 1, Number 2, December, 2008
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EXPLORING THE FINANCIAL CONSEQUENCES OF THE
SERVITIZATION OF MANUFACTURING
ABSTRACT
Commentators suggest that to survive in developed economies manufacturing firms have to move
up the value chain, innovating and creating ever more sophisticated products and services, so they
do not have to compete on the basis of cost. While this strategy is proving increasingly popular with
policy makers and academics there is limited empirical evidence to explore the extent to which it is
being adopted in practice. And if so, what the impact of this servitization of manufacturing might
be. This paper seeks to fill a gap in the literature by presenting empirical evidence on the range and
extent of servitization. Data are drawn from the OSIRIS database on 10,028 firms incorporated in
25 different countries. The paper presents an analysis of these data which suggests that: [i]
manufacturing firms in developed economies are adopting a range of servitization strategies – 12
separate approaches to servitization are identified; [ii] these 12 categories can be used to extend the
traditional three options for servitization – product oriented Product-Service Systems, use oriented
Product-Service Systems and result oriented Product-Service Systems, by adding two new
categories “integration oriented Product-Service Systems” and “service oriented Product-Service
Systems”; [iii] while the manufacturing firms that have servitized are larger than traditional
manufacturing firms in terms of sales revenues, at the aggregate level they also generate lower
profits as a % of sales; [iv] these findings are moderated by firm size (measured in terms of
numbers of employees). In smaller firms servitization appears to payoff while in larger firms it
proves more problematic; and [v] there are some hidden risks associated with servitization – the
sample contains a greater proportion of bankrupt servitized firms than would be expected.
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Keywords:
Manufacturing, service, servitization, product-service systems, value added, globalisation,
international comparison
1. Introduction
How can manufacturing based in developed countries compete in today’s global economic system?
Data suggest that US manufacturers have to cut the costs of their products by 30% to compete with
Chinese producers (Wu et al., 2006). Add to this the market opportunities offered by emerging
economies and the burgeoning regulation and legislation imposed on firms based in the European
Union, and it is little surprise that offshoring is becoming a key strategy for manufacturing firms.
Is this process of offshoring an inevitable one? Is it simply a consequence of globalisation
and the industrialisation of emerging economies (Friedman, 2005)? If so, what future does
manufacturing have in the US, the UK, or in any other developed economy, for that matter.
Already over 80% of people employed in the UK and the US are now employed in the service
sector (Spohrer and Maglio, 2008). Should developed economies abandon manufacturing and
accept that the former British Prime Minister Margaret Thatcher was right all those years ago when
she claimed that developed economies could live on services?
The problem with headline grabbing figures such as these is that they mask the real trends
that underlie the data. In fact the boundaries between manufacturing and service firms are breaking
down across the globe. As they have been for years. Rolls-Royce Aerospace no longer simply sells
aero engines. Now it offers a total care package, where customers buy the capability the engines
deliver – “power by the hour”. Rolls-Royce retains responsibility for risk and maintenance,
generating revenues by making the engine available for use. But even before Rolls-Royce changed
its business model and adopted “power by the hour”, the firm still used to sell spares and offer
repair and overhaul services. Indeed one could legitimately ask whether Rolls-Royce – or any
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similar manufacturing firm – has ever been a pure manufacturing firm. If the business has always
sold spares and offered repair and overhaul services then it has always offered a combination of
product and service. Similar examples can be drawn from a wide variety of sectors. Some
traditional manufacturing firms, such as IBM, have fundamentally reinvented themselves as service
businesses, moving away from the production of hardware to offer business solutions. Yet others
have integrated service operations with traditional manufacturing. BP and Shell both manufacture
oil, yet they also both run extensive service retail operations.
The point is that to survive manufacturing firms appear rarely to remain as pure
manufacturing firms. Instead they move beyond manufacturing and offer services and solutions,
often delivered through their products, or at least in association with them. This trend to
servitization was first discussed by Vandermerwe and Rada in the late 1980s, but appears to have
received relatively little attention in the mainstream engineering and management literatures
(Baines et al., 2007; Tukker and Tischner, 2006; Vandermerwe and Rada, 1988). Clearly there are
notable exceptions (Davies et al., 2006; Tukker and van Halen, 2003), but these exceptions are
generally based on case evidence and many of them focus on the potential environmental benefits
of product-service systems as oppose to their commercial advantages (Cook et al., 2006; Goedkoop
et al., 1999; Manzini and Verzzoli, 2002; Mont and Plepys, 2003; Mont, 2004; and Morelli, 2002).
Increasingly new technologies, especially those associated with information and communications
technologies are becoming an important enabler of servitization. Developments – especially in data
capture and information processing – allow manufacturing firms to develop new business models,
exploiting the potential of informated products. Concepts such as intelligent vehicle health
management (IVHM) and remote product sensing have entered the management lexicon (Baroth et
al., 2001). It is for these reasons that servitization should not simply be seen as a variant of vertical
integration, although clearly one way of adding services is through vertical integration. Hence the
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calls in the business strategy literature for manufacturing firms to go downstream (Wise and
Baumgartner, 1999).
Despite all of the discussion about the importance of servitization there is remarkably little
empirical evidence that explores the phenomenon. It is this gap in the literature which this paper
seeks to address, by presenting an empirical analysis of the servitization of manufacturing. The
paper seeks to explore questions such as: to what extent are manufacturing firms servitizing? If
they are servitizing, how are they servitizing and do the observed trends vary depending on firm
size and/or country of firm incorporation? The contribution of the paper lies in the fact that it is one
of the first to unpack the notion of servitization empirically.
2. Theoretical Background: Dimensions of Servitization
The notion of servitization was first introduced by Vandermerwe and Rada in the late 1980s
(Vandermerwe and Rada, 1988). They argued that there were three reasons why manufacturing
firms should servitize – (i) to lock out competitors; (ii) to lock in customers and (iii) to increase the
level of differentiation. In additional to these strategic rationales for servitization, other authors
have posed economic and environmental rationales (Goedkoop et al., 1999; Wise and Baumgartner,
1999). One particularly strong rationale for firms that provide complex engineered products is the
installed base argument, where ratios of installed-base-to-new-units of 13 to 1 for automobiles, 15
to 1 for civil aircraft and 22 to 1 for locomotives are quoted (Wise and Baumgartner, 1999). Clearly
with such market structures, especially when product life cycles have extended, it makes economic
sense to the manufacturer of the original equipment to offer through life support and servicing. An
alternative rationale is provided – especially from a customer perspective – when one considers risk
(Slack, 2005). Governments across the world are now declaring that they will contract for capability
rather than buy specific products (Ministry of Defence, 2005). The UK defence industrial strategy
makes it clear that the Ministry of Defence is interested in procuring the capability to carry out
