Does Selling Services Create Value for a Product Firm?

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There are many popular stories about product companies like IBM and GE transitioning successfully to service-based sales. And while there are also stories of the occasional failure such as Boeing’s offer of financial services, the conventional wisdom is increasingly that all product firms should transition from dependence on product sales to selling value-added services. But is this valid?

Research in a paper published in the Journal of Marketing, “Effect of Service Transition Strategies on Firm Value,” looks precisely at this issue. In the paper, the authors report the results of a study that investigated the impact of service-based sales on firm value across a 16-year period (1990 to 2005) for 477 publicly traded manufacturing firms.

On average, the results show that a higher ratio of service-based sales is associated with higher firm value (using a popular measure of firm value called Tobin’s q). However, there is a critical transition point between about 20 to 30%. Up until about 20%, the impact on service-based sales on firm value is flat or slightly negative. In other words, the drawbacks of adding services prevail (potential conflict, struggles with resource allocation). After about 20%, however, the benefits of adding services prevail (differentiation, closer relationships with customers) as a higher ratio of service-based sales (even beyond 50%) drives higher firm value.

Now, while this is true “on average,” it is not always true. In fact, the research revealed that adding valued-added services actually detracts from firm value in a company with high industry growth in its core products. And the same is true of a company in an industry with very stable product sales. In both of these situations, the negatives as adding services outweigh the positives. In contrast, the positive impact of adding services are magnified in low growth and high sales turbulence industries.

In a parallel manner, adding value-added services that are unrelated to core products has no impact on firm value. But adding services that are related to core products has a favourable overall impact on firm value after about 20% service-based sales.

Overall, the results make it very clear that adding service-based sales will increase firm value under certain conditions – but only under certain conditions. In other words, it is inadvisable for a company to try to transition all of its product categories to greater service-based sales – as some corporations are trying to do. In some cases, the effect could actually be negative.

For example, from 1995 to 2005, John Deere went from 17% service-based sales to 36%. In the same time period, Texas Instruments went from 14% to 33% service-based sales. Remarkably similar. And yet, the market value of John Deere increased 76% over this time period whereas the value of Texas Instruments decreased by 3%. Why the difference?

While both John Deere and Texas Instruments added services from 1995 to 2005 that were related to their core product business (adding synergy to each business), Texas Instruments’ product sales were in an industry that was experiencing rapid growth (higher than 20%) whereas John Deere was offering products in an industry that was stagnant.

For John Deere, the addition of services deepened its existing relationships with customers in a way that was needed to maintain loyalty. For Texas Instruments, in contrast, the addition of services detracted from a strategic emphasis on its core products that would have led to long-term market value gains.

So where does your firm stand? Is your core product business in an industry with slow sales growth? Is your industry particularly dynamic in terms of sales and changing customer needs? If you answer ‘yes’ to one of these questions – and especially if you answer ‘yes’ to both – then your firm should make it a strategic priority to add services related to your core product offerings.

The question then becomes how to do this. The best approach to finding opportunities for service innovation or acquisitions related to product use is to look at the market in terms of the customer job-to-be-done. The customer job offers a solution-independent perspective of the market that is perfectly suited to uncovering market adjacencies, and we are experts in this applying perspective to guide innovation and strategy.

You can read more about the relevance of the customer job for service innovation here and you can read about our expertise in helping companies to apply this thinking here. Be sure to check out our resources page as well.

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