Product-related Services Still Growing in Importance

Product-related Services Still Growing in Importance Product-related services are increasingly being used by manufacturing companies in Germany as a strategic factor in competition. The tendency to offer customers integrated solutions is very evident. The slowdown in outsourcing and the high level of product-related services now being provided by companies themselves show that they are regarded as a key competence by the majority of firms. Product-related services are generally closely connected with the production of goods. In many cases, however, these services are provided independently of sales of a commodity. As with input services, not all product-related services need to be provided by the manufacturing company itself; some can be and are being bought from outside (services) companies as part of the growing division of labour (outsourcing). The importance of product-related services Many manufacturing firms traditionally regard productrelated services as part of the normal service connected with the product they are selling or have already sold, or indeed with products at the end of their life-cycle. Planning and consultancy, maintenance and customer training are often essential for the product to be used, while _ depending on the environmental regulations _ the manufacturer may also be responsible for the proper dismantling and scrapping of his products. The scope opened up by the information and communications technologies has also brought advances in some product-related services (examples are telemaintenance and telecoaching). At the same time these services have grown in size as products have become more complex. This is partly due to the greater technical flexibility that enables the firm to offer customised products. That applies to the pre-sales area (e. g. planning and producing customised controls for the operation of plant) as much as to the after-sales area (e. g. subsequent modernisation). Moreover, the importance of product-related services in corporate strategy has clearly grown. 1 Firstly, they are seen as a means of product differentiation that can greatly strengthen the market position of a company and hence its market success. In many cases professionalising and intensifying its product-related services gives the company a competitive edge. It can enable the firm to evade price competition in products to a certain extent and so increase its profits. Secondly, the inclusion of more and better targeted services in the range offered by a firm can increase customer satisfaction and bind customers more closely. It is then more likely that the company will be given follow-up orders. There are also more opportunities to increase turnover and earnings elsewhere in the chain of value creation and exploit the possibilities for cross-selling. Product-related services are thus increasingly becoming an essential component in an integrated package of products designed to meet all the requirements of demanding customers. Hence they cannot always be separately identified as add-on services (for example, delivery of a machine plus a maintenance contract), but must be seen as an integral building block in a package to cover all the customer's needs. Many customers' requirements and their cost-sensitivity are changing, and the preference for complete packages of this kind is growing. This article presents some of the main developments in product-related services based on current surveys of companies in the mechanical engineering and electrical engineering associations (cf. box). Statistics on product-related services in companies Figures are only available on some product-related services in companies. The relation between the percentages that can be directly calculated and those that have to be estimated depends on the way they are treated in the company's cost calculation practice. 2 Product-related services are frequently included in overhead costs. The more transparently they can be shown in the accounting system the more easily, as a rule, can their share of the company's turnover be calculated. Otherwise the company has to estimate the share of turnover that is not directly visible in the accounts, for example through implicit costs or the available prices for systems or packages. 1 Cf., for example, G. Lay and P. Jung Erceg: 'Elemente einer Strategieentwicklung für produktbegleitende Dienstleistungen in der Industrie', in: G. Lay and P. Jung Erceg (eds.): 'Produktbegleitende Dienstleistungen, Konzepte und Beispiele erfolgreicher Strategieentwicklung', Berlin 2002, pp. 5-58. 2 Cf. H. Simon and A. Damien: 'Preispolitik für industrielle Dienstleistungen', in: H. Corsten and H. Schneider (eds.): 'Wettbewerbsfaktor Dienstleistung', Munich 1999, pp. 157-188. 195

Box 1 The Data Base Little information is available on product-related services. Turnover earned by industrial firms from the sale of these services is part of their total turnover and so part of turnover to the manufacturing sector. 1 Only in exceptional cases do firms show this part of their turnover separately. The following sources are currently available: The Federal Statistical Office's cost-structure statistics, 2 for example, include turnover from other (non-industrial/non-craft) services. They include product-related services such as maintenance, repairs, planning and consultancy, as well as transport services for third parties. But they only cover some product-related services. Owing to the requests for information on internal structural change in companies in favour of services the Federal Statistical Office carried out a pilot survey in 1988. 3 It drew up a list of 19 different services and sent it to the companies questioned. 4 However, services such as repairs and maintenance were not included, as they were already in the cost-structure statistics. In 1998 and 2001 two major business associations, the Association of German Mechanical Engineering and Plant Construction Firms (Verband Deutscher Maschinen- und Anlagenbau e.v. VDMA) 5 and the Central Association of the Electrical Engineering and Electronics Industries (Zentralverband Elektrotechnik- und Elektronikindustrie e.v. ZVEI) 6 carried out surveys of their member firms on product-related services. The two associations coordinated their lists of questions and the timing of their surveys. The VDMA states that in 1998 about 450 questionnaires could be evaluated and in 2001 about 350; the figures for the ZVEI were about 200 in 1998 and about 150 in 2001. But as the response was better from the larger firms the turnover reported by the firms who replied represented a high share of the total turnover of all the firms in that sector. The Federal Statistical Office has now (April 2003) started a new survey of product-related services offered by industrial and services firms. The list of questions is based on those in the surveys by the two associations. 1 In surveys by the Federal Statistical Office companies are assigned to a certain economic sector according to their main activity as defined by themselves. The company's main activity is defined by its main product. 2 Federal Statistical Office, Series 4, Row 4.3. 3 Cf. Federal Statistical Office: 'Dienstleistungen im Produzierenden Gewerbe 1988', Series 4, Row 5, 12, Wiesbaden 1989. This survey is based on a representative survey of about 16% of the companies in mining and manufacturing. The questions covered not only which services the companies were providing for third parties and how they entered them in their accounts, but also the services they needed as input. 4 1: Data processing; 2: R&D; 3: Technical planning, consultancy etc.; 4: Renting (including leasing); 5: Maintenance, inspection; 6: Documentation; 7: Training customer personnel; 8: Designing consumer goods; 9: Advertising; 10: Waste disposal services; 11: Storage; 12: Transport; 13: Acquisitions; 14: Sales, distribution; 15: Training company personnel; 16: General administration; 17: Power transmission; 18: Other services; 19: Services not clearly assignable. 5 VDMA (Verband Deutscher Maschinen- und Anlagenbau e.v.): 'Ergebnisse der Tendenzbefragung '98: Produkbegleitende Dienstleistungen im Maschinenbau', December, Frankfurt a.m. 1998; VDMA: 'Ergebnisse der Tendenzbefragung 2001: Produktbegleitende Dienstleistungen im Maschinenbau', Frankfurt a.m. 2002. 6 ZVEI (Zentralverband Elektrotechnik- und Elektronikindustrie e.v.): 'Die produktbegleitenden Dienstleistungen in der Elektroindustrie', December, Frankfurt a.m. 1998; ZVEI:' Die produktbegleitenden Dienstleistungen in der Elektroindustrie', March, Frankfurt a.m. 2002. Another question, admittedly, is in how far companies wish to charge product-related services to their customers. In many cases a separate offer and hence a separate invoice will be advantageous; sometimes, however, the aim is to 'wrap round' the customer with services firmly integrated in the product. In this case a separate invoice will not be opportune. Where services are fully integrated in a product package a separate invoice would in any case be difficult. In the surveys by the VDMA and the ZVEI companies were asked what percentage of their total turnover in product-related services came from services invoiced separately. 3 In 2000 the mechanical engineering firms invoiced 45% of their services turnover separately to customers; accordingly, 55% was included in the price of the product or plant supplied (cf. table 1). The electrical engineering firms sent separate invoices for a good quarter of their services turnover. Among the product-related services offered by mechanical engineering firms, 'operating the plant' is almost always invoiced separately by the relatively few firms that offer this service. Teleservice, hotlines and similar services are also invoiced separately to customers in by far the great majority of cases. In the electrical industry dismantling tops the list. Otherwise the ranking is very similar in both sectors: maintenance, dismantling and scrapping, financial services (leasing, financ- 3 The shares are, thus, only partly comparable with the 1988 results. The pilot survey by the Federal Statistical Office of 1989 only shows that on average less than one third of companies had charged productrelated services to their customers (exclusively and separately). 196

Table 1 Separate Invoicing of Product-related Services in 2000 As % of value of 'services provided' ing, renting) and assembly services are shown separately in the invoices at an above-average rate, while planning, consultancy, project development (including contract R&D), certification and documentation are relatively rarely invoiced separately. Mechanical engineering firms indicated that they intended to invoice customer training and planning and consultancy separately more often in future. The frequency of services and their contribution to turnover Frequency Mechanical engineering Electrical industry Planning, consultancy, project development 1 25.0 26.3 Software 49.1 35.1 Documentation 27.9 15.8 Customer training 29.3 43.9 Assembly 56.1 57.9 Starting operation, acceptance 53.2 47.4 Certification 38.5 21.1 Maintenance 2 79.5 75.4 Teleservice, hotline etc. 74.0 24.6 Operating plant 95.1 49.1 Leasing, renting, financing 63.5 61.4 Dismantling, scrapping 69.4 64.9 Other product-related services 76.0 29.8 Total 45.0 26.7 1 Including researching and developing on order. 2 Inspection, maintenance, repairs. Sources: VDMA (2002); ZVEI (2002); DIW Berlin calculations. The Federal Statistical Office's pilot survey in 1989 showed that around 44% of companies in the producing sector in Germany have provided services for third parties. In the export-oriented sectors such as mechanical engineering and electrical engineering the percentage was higher. That is also evident from the surveys of the individual associations. In mechanical engineering customer training was the service most frequently provided _ by 80% of the companies surveyed _ in 2000. The VDMA stresses that this service has grown particularly in importance in recent years. They attribute this to the greater need for explanations as components, machines and plants have become more complex, and as customised solutions have become more frequent. 4 More than 70% of companies state that their range includes other services, such as starting up the operation of plant and acceptance, maintenance (inspection, repairs, overhauling), technical planning etc., documentation and assembly. Operating plant, certification, dismantling and scrapping are of least importance, along with leasing, renting and financing. However, the frequency with which these services were named does not correlate with the importance of the corresponding product-related services in turnover. Shares in turnover The surveys of the Institut Systemtechnik und Innovationsforschung (ISI) on 'Innovations in Production' 5 show that the average share of turnover in industry achieved with product-related services has risen over the years. In 1997 it was still 6.2%, while in 1999 it had risen to 7.9% and by 2001 it had risen further. 6 The question of turnover in product-related services as asked by the VDMA and the ZVEI covered not only separately invoiced services but also the hidden share of turnover. In 2000 product-related services on average contributed 18.5% to total turnover for the firms responding to the VDMA survey (cf. table 2). That was a clear increase over 1997. However, it must be borne in mind that in 2000 some services were new. The shares in turnover tended to be higher for smaller mechanical engineering firms than for larger ones, and this could be due to their greater orientation to individual customers. The share in turnover was greatest for maintenance work (inspection, repairs, maintenance) at 4.4%, so this contributed almost one quarter to the total services turnover. According to the ZVEI the electrical industry achieved a total turnover of DM 318 billion in 2000. Of this DM 69.6 billion was achieved by the companies in the ZVEI survey that also achieved turnover with product-related services. Their total for this was DM 15.6 billion, which is a share of 22.5%. Unlike the mechanical engineering sector, the electrical industry achieved on average 5.2% of its total turnover with software services, which thus accounted for just under one quarter of total turnover in services. 'Particularly in numerical controls and intelligent storage building blocks, providing customised software is an important part of the product. 24.6% of the workforce are employed on producing software.' 7 Financial services (leasing, renting and financ- 4 VDMA 2002, p. 6. 5 www.isi.fhg.de. 6 Cf. Lay and Jung Erceg, loc. cit. p. 7. 7 ZVEI 2002, p. 14. 197

Table 2 Turnover in Product-related Services As % of turnover Mechanical engineering Electrical industry 1997 2000 1997 2000 Planning, consultancy, project development 1 1.5 3.0 1.6 3.0 Software 0.7 1.1 3.8 5.2 Documentation 0.5 0.5 0.8 1.1 Customer training 0.4 0.8 0.8 1.1 Assembly 2.5 2.7 Starting operation, acceptance 2 2.4 1.3 4.8 2.4 Certification 3 0.3 0.1 0.4 0.5 Maintenance 4 2.7 4.4 3.1 3.8 Teleservice, hotline etc. 0.1 0.5 0.2 0.8 Operating plant 0.0 0.6 0.9 1.0 Leasing, renting, financing 2.6 0.0 Dismantling, scrapping 0.3 0.3 0.5 Other product-related services 1.1 0.8 0.2 0.3 Total 9.6 18.5 16.8 22.5 1 Including researching and developing on order. 2 1997 without acceptance. 3 1997 with acceptance. 4 Inspection, advertising, maintenance. Sources: VDMA (1998, 2002); ZVEI (1998, 2002); DIW Berlin calculations. ing) were of little significance in turnover in the electrical industry, unlike mechanical engineering. Apart from these two exceptions similar patterns are evident in the two sectors: services such as maintenance, planning etc., assembly and starting operation each made a notable contribution to turnover. Turnover expectations In both industrial sectors companies were expecting a further rise in the share of turnover from product-related services. In the electrical industry 69% were expecting a rise and 22% a reduction. A rise in the share of productrelated services in total turnover to an average of 30% by 2005 is to be expected for those companies that are offering them. The ZVEI actually regards this as rather on the lower edge of the estimated corridor, as companies with a high services potential, such as information and communications technology firms, were not included in the 2000 survey. For planning, consultancy and project development and also for customised software packages an above-average percentage of companies believe the share of turnover will rise. In mechanical engineering there were also aboveaverage growth expectations regarding product-related services. Here teleservice, software, customer training and planning topped the list. The expected growth in turnover in these services is probably chiefly due to the current developments in the new technical possibilities now available for the provision of 'modern' services. In assembly, dismantling and operation, on the other hand, slight reductions were regarded as likely. Slowdown in outsourcing Companies can choose between providing productrelated services themselves or having them provided by specialised services firms. In certain conditions buying services from outside firms (associated or not) is preferred as an alternative to producing the services inhouse. The decision on whether to outsource productrelated services will depend for a company, among other things, on whether this will save costs and maintain or improve its competitive position, and whether this will enable it to be more flexible and altogether better able to achieve its strategic objectives. 8 It will decide not to outsource if this will negatively affect key competences, e.g. loss of contact with customers or with market developments. 9 Companies will also decide against outsourcing if it is difficult effectively to offer product-related services in division of labour with other firms. These diffi- 8 Cf. for example Rheinisch-Westfälisches Institut für Wirtschaftsforschung: 'Industrienahe Dienstleistungen am Standort Deutschland', Essen 1995. 9 On international comparison the institutional framework conditions may also play a part. Differences in the laws on liability in individual countries may cause outsourcing to be undertaken with greater or lesser intensity. 198

Table 3 Outsourcing Product-related Services % of companies 1997 1 2000 1 Realised Intended Realised Intended Mechanical engineering 29 22 15 15 Electrical industry 32 34 31 14 1 In each case in the last or next five years from the date of the survey. Sources: VDMA (1998, 2002); ZVEI (1998, 2002); DIW Berlin calculations. culties may be expected to increase the more complex the packages of services are. Both the association surveys included questions on planned and intended outsourcing in 1997 and 2000 (cf. table 3). In 1997 29% of the mechanical engineering firms still said that they had outsourced in the last five years before the survey, and 22% intended to undertake further outsourcing. In 2000 the outsourcing intensity had clearly diminished, with only 15% of the firms stating they had outsourced services in the last five years before the survey (hence since 1995); there had also been a relative reduction from 1997 in the intention to undertake further outsourcing. For both periods assembly and software topped the outsourcing list. In the electrical industry the process of outsourcing was more dynamic than in mechanical engineering. In 1997 32% of the firms said they had outsourced and 34% intended to do so. Essentially these intentions were also realised. In 2000 31% of the firms in the electrical industry said they had actually outsourced since 1995, to associated and non-associated firms in about equal measure. As in mechanical engineering, assembly topped the list of outsourcing candidates; it was followed by dismantling and scrapping. The electrical industry firms also showed a clear change in their attitude to further outsourcing. Only around 14% were then planning to undertake further outsourcing, and unlike their previous behaviour, it was now mainly to associated companies. A comparison of the statements of intent in 2000 with those in 1997 shows that a clear slowdown in the outsourcing process in both sectors is to be expected. That corresponds with the increasing difficulty of outsourcing in view of the technical know-how required; secondly, the slowdown in the outsourcing process also indicates the greater importance attached to product-related services in corporate strategies. Make or buy As well as the overall development in product-related services the decisions made on outsourcing are also reflected in the shares of product-related services produced by the firm or purchased outside. High shares of self-produced services show that these are of relatively great importance for the company's strategic direction. Table 4 The Provision of Product-related Services in Mechanical Engineering % responding Provided by the firm Associated firms Outsourced to Nonassociated firms 1997 2000 1997 2000 1997 2000 Planning, consultancy, project development 1 82 96 8 3 10 1 Software 62 69 12 7 26 24 Documentation 84 91 6 4 10 4 Customer training 85 97 10 2 5 1 Assembly 87 5 8 Starting operation, acceptance 2 71 95 14 2 14 3 Certification 3 73 65 8 11 19 24 Maintenance 4 74 93 13 3 13 4 Teleservice, hotline etc. 77 96 10 1 13 3 Operating plant 79 69 13 8 8 23 Leasing, renting, financing 59 9 32 Dismantling, scrapping 74 9 18 Other product-related services 81 76 10 1 9 23 Total 80 4 16 1 Including researching and developing the order. 2 1997 without acceptance. 3 1997 with acceptance. 4 Inspection, maintenance, repairs. Sources: VDMA (1998, 2002); DIW Berlin calculations. 199

Table 5 The Provision of Product-related Services in the Electrical Industry Number responding in % Provided by the firm Associated firms Outsourced to Nonassociated firms 1997 2000 1997 2000 1997 2000 Planning, consultancy, project development 1 78 82 10 6 12 12 Software 64 59 18 12 18 29 Documentation 77 86 12 5 11 9 Customer training 83 82 11 9 6 9 Assembly 2 52 18 31 Starting operation, acceptance 3 67 68 11 12 22 20 Certification 4 63 57 10 6 26 37 Maintenance 5 75 68 11 12 14 19 Teleservice, hotline etc. 77 82 13 6 10 11 Operating plant 63 35 16 29 21 36 Leasing, renting, financing 20 31 49 Dismantling, scrapping 60 40 10 23 29 37 Other product-related services 73 65 13 11 15 24 Total 70 67 12 12 18 21 1 Including researching and developing on order. 2 1997 with starting operation. 3 1997 no information given. 4 1997 with acceptance. 5 Inspection, maintenance, repairs. Sources: ZVEI (1998, 2002); DIW Berlin calculations. In 2000 the member firms of both associations were producing much the greater share of their productrelated services themselves. In mechanical engineering the share was about four-fifths; this was clearly higher than in the electrical industry, where about two thirds of the product-related services were produced in the firms (cf. tables 4 and 5). In the electrical industry this difference is partly counterbalanced in that here outsourcing to associated companies played a much bigger role, at 21%, than in mechanical engineering at 8%. This high share of self-produced services, including those produced by associated companies, can be seen as an indication that the companies in both sectors largely regard product-related services as key competences. Nevertheless, the alternative of outsourcing does seem to be of greater importance in the electrical industry than in mechanical engineering. In the order of importance of the individual productrelated services provided by the firms the mechanical engineering sector and the electrical industry are largely the same. The level of services provided by the firm was particularly high for customer training, teleservice and planning (although in the electrical industry documentation was right at the top). There were also similarities in the provision of services by nonassociated firms, where financial services (leasing, financing, renting) predominated, with dismantling and scrapping, certification and software packages for customers. Conclusion Companies in both the mechanical engineering and the electrical engineering industries belong to those segments of manufacturing where the inclusion of productrelated services in the range offered by a company is most advanced. So to a certain extent they are evidence of future developments that may well become important for companies in other segments of industry. The tendency to integrated customer-packages is very evident here. In the two industrial sectors examined here it is clear that outsourcing has lost some of its attractiveness. Altogether, the outsourcing of product-related services may be taken to be very much lower than industrial companies' input services. Customer-oriented productrelated services are clearly of much greater importance for corporate strategies than the services needed for production. However, it must be taken into account that services cannot always be clearly assigned to one of the two sides of the production process _ input or output. Innovative and successful industrial companies are no longer distinguished only by the technical properties of their products; they are increasingly distinguished by their competence to handle and offer complex customised packages that include a range of product-related services. These are constantly changing and becoming ever more professional. Frank Stille 200