Business model innovation in the tyre industry

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This report focuses on Michelin’s fleet solutions (MFS) activity and the way the company has dealt with the transition from product provider to service provider so far. It sums up some major strategic …

This report focuses on Michelin’s fleet solutions (MFS) activity and the way the company has dealt with the transition from product provider to service provider so far. It sums up some major strategic and business-environmental reasons for making services a core business, even though the results have not been as convincing as expected. It identifies the key elements of the company’s business model that should be strengthened and innovated upon for Michelin to build its service activity as a successful complement to tyre sales. Finally it details the impact of the suggestions on the cost structure and revenues streams, and the challenges associated with the proposed innovation.

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  • 1. FRONTERE Noémie Business Model Innovation in the tyre industry 28/06/2013 Business Model Innovation in the tyre industry June 2013 1
  • 2. FRONTERE Noémie Business Model Innovation in the tyre industry 28/06/2013 Michelin: Business Model Innovation Executive summary: This report focuses on Michelin’s fleet solutions (MFS) activity and the way the company has dealt with the transition from product provider to service provider so far. It sums up some major strategic and business-environmental reasons for making services a core business, even though the results have not been as convincing as expected. It identifies the key elements of the company’s business model that should be strengthened and innovated upon for Michelin to build its service activity as a successful complement to tyre sales. Finally it details the impact of the suggestions on the cost structure and revenues streams, and the challenges associated with the proposed innovation. Contents: Introduction: MFS and its strategic importance ..................................................................................................................................... 3 Part 1: Analysis of the Business Model components to strengthen ...................................................................................................... 4 1. Redefining the value proposition ............................................................................................................................................. 4 1.1. 1.2. 2. Service at the core of the value proposition .................................................................................................................. 5 How to define the right price and the impact on the revenue structure ..................................................................... 5 How to manage resources in line with the new value proposition ........................................................................................ 6 2.1. 2.2. 3. Managing human resources: the culture shift............................................................................................................... 6 The need for a separate MFS business unit ................................................................................................................... 7 New activities to conduct in line with the new value proposition.......................................................................................... 8 3.1. Innovating marketing and customer relationship ......................................................................................................... 8 3.2. International management of R&D and innovation ...................................................................................................... 8 3.3. The need to decentralise the new MFS business unit ................................................................................................... 9 4. Managing the key partners: integrating the distribution network ....................................................................................... 10 5. Summary: Suggested innovations represented on the Business Model Canvas © ............................................................. 11 Part 2: Evaluation of the financial and strategic impacts of BM innovation ....................................................................................... 12 1. Financial value of the business model innovations for Michelin .......................................................................................... 12 1.1. 1.2. Impact on the cost structure ........................................................................................................................................ 12 1.3. 2. Impact on the revenue structure ................................................................................................................................. 12 MFS valuation after innovations .................................................................................................................................. 13 Strategic advantages of the new business model ................................................................................................................. 14 Conclusion and challenges of the new approach ................................................................................................................................. 15 References .............................................................................................................................................................................................. 16 2
  • 3. FRONTERE Noémie Business Model Innovation in the tyre industry 28/06/2013 Introduction: MFS and its strategic importance Over the past decade, Michelin, a traditional tyre manufacturer, has been experimenting with a radically new service and customer-centric approach to maintain its leadership. Michelin Fleet Services (MFS), also nicknamed the TK business model (Ton-Kilometre), first started in 2001. The concept is innovative: tyres are not sold but rented to large companies; Michelin takes care of the maintenance of the fleet and reduces the oil consumption and CO2 footprint by choosing the right products for the customer. Michelin’s first step towards a different approach was taken in 2001 with TK services targeted at the trucking industry. The modern version of MFS (post 2011) is targeted at all fleets large enough to require a significant maintenance effort (trucks, buses, construction/mining equipment etc.). However this model has for the present failed in providing Michelin with a strong secondary source of revenues: the customer basis is lower than expected and profitability is disappointing (see Figure 1). Three strong arguments are generally given by the literature in favour of the transition from products to services: 1) There is statistical evidence that services provide a profitable and a more stable source of revenues (Quinn, 1992) 2) Across a wide range of industries customers are outsourcing more activities to concentrate on their core business, therefore generating opportunities to be seized (Lojo, 1997) 3
  • 4. FRONTERE Noémie Business Model Innovation in the tyre industry 28/06/2013 3) From a strategic point of view services are a source of enduring competitive advantage, because they necessitate a complex internal organisation and a special business model than competitors will find difficult to replicate (Heskett et al., 1997) In addition to these considerations, it seems that Michelin’s functional economic approach is a perfect solution given the evolution of the industry’s external environment: environmental norms play an increasing role in recycling policies (rubber) and push Michelin’s large clients to control their CO2 emissions more tightly: this is easier to do with the new MFS services. Other benefits of MFS for Michelin will be detailed and quantified in part B of the report. However the case highlights the difficulty of the transition from providing goods to providing services: the business model has to be significantly modified to allow such a change in strategy. This paper thus focuses on some of the major elements of Michelin’s business model that should be strengthened (in addition to what has already been done) to allow the company to take advantage of this new source of revenues. Part 1: Analysis of the Business Model components to strengthen If Michelin is the first player in the tyre industry to attempt a move towards services, it is not the first company to be confronted to challenges in designing the right business model for its new service activities. The following paragraph draws on existing literature and examples from different industries (particularly automobile, equipment manufacturers and technology) to provide Michelin with suggestions to improve its existing MFS business model and make services a core of its business. It first highlights the clarification in the value proposition that Michelin should undertake and subsequently the different parts of the business model that should be innovated upon. 1. Redefining the value proposition Michelin has been confronted to serious difficulties in designing and defining its new value proposition (Lehrangebot 2011). Currently, in internal and external communication, the company still positions itself as a tyre manufacturer which emphasizes on high-tech and quality products supported by intensive R&D (see ‘Mission’ section in Annual Report 2012). Figure 1 highlights the gap between the current size of MFS’s customer basis and the company’s 2005 expectations. It proves that clients are not fully convinced of the interest of the new service offer. The intangibility of services, compared to products, makes it difficult for them to estimate the value of MFS (Lehrangebot 2011). Therefore a new – and clear – definition of Michelin’s value proposition is required. 4
  • 5. FRONTERE Noémie 1.1. Business Model Innovation in the tyre industry 28/06/2013 Service at the core of the value proposition First, Michelin’s innovative value proposition should position the product as part of the offering only, as opposed to being in the centre. The value proposition would therefore involve more customization: as opposed to tyre sales which are largely standardized (and quickly becoming commoditized, according to Young 2008) a higher mix of services tends to require higher levels of customization (Brown 2012). For instance most maintenance and service providers establish service modules to deliver unique solutions to customers (Gillai and Yu 2013). Second, if Michelin is responsible for maintenance of fleets there will be an incentive to develop products with longer lifespans: in terms of R&D the new activity will presumably reinforce the premium segment which will also have an impact on product offering. Selling premium tyres has always been a priority for Michelin: in the early 2000s the company transferred all non-premium product lines to affiliated brands (BFGoodrich, Kleber) and kept only the highest quality lines under the Michelin brand which represented 83% of sales in 2012 (Annual Report 2012). The premium segment is the most profitable and fastest growing in the global market, in line with tougher environmental norms (see Figure 2). As the company becomes involved in MFS services it should focus even more on product lines that offer longer lifespans, better security and save energy (thus oil and CO2). 1.2. How to define the right price and the impact on the revenue structure In the case of MFS prices are negotiated per kilometre on a contract-per-contract basis. While prices were raised in 2011 because many fleets under the fleet solution contract were believed to be unprofitable, on the contrary many customers considered the price of the service was too high (Lehrangebot 2011). Therefore Michelin has to work on its pricing system to convince more customers to completely outsource their tyre maintenance while making services an economically viable activity in the medium term. 5
  • 6. FRONTERE Noémie Business Model Innovation in the tyre industry 28/06/2013 Oliva and Kallenberg (2003), who have analysed the transition from products to services of a large sample of machine manufacturers1, underline an important factor that explains many product-to-service transition failures: companies have to make sure prices of services are established, even at the very beginning, ‘on the basis of equipment availability, and not based on the provider’s cost of monitoring the equipment, and performing scheduled maintenance and emergency repairs’. The customer has to be able to evaluate straight away the value created for him by the new service offering. This will allow a larger customer base and therefore a great database: more experience and information on maintenance costs for the company. Once enough data has been collected prices can be raised for certain customer segments because the company will have new evidence to convince them that outsourcing maintenance is profitable for them. Short term profitability has to be sacrificed for the sake of medium and long-term success. In the case of Michelin, prices have been raised early on because of fears that the activity was unprofitable (Lehrangebot 2011). There is no reason why Michelin’s services activity should not be economically viable in the long term. As a tyre manufacturer the company possesses many advantages over traditional maintenance companies: lower customer acquisition costs, lower knowledge acquisition costs and lower capital requirements. However over-pricing contracts today for the sake of short-term profitability is not the best alternative. Michelin has to assess properly tyres wear rates in different environments and usage conditions before defining an optimal pricing system. This assessment requires not only time and a large customer base but also new skills and activities, particularly information gathering and data processing, which are still underdeveloped as we will see later on. 2. How to manage resources in line with the new value proposition 2.1. Managing human resources: the culture shift Michelin is traditionally a very product-centric organisation, which translates in its external and internal communication. The most recent internal newsletter (April 2012) and the company’s 2012 Annual Report highlights new product development as a key to future success, but services are only mentioned twice in the annual report (no mention of MFS). In an interview given to CEO Forum (2011) Alan Hyde, MD of NEC Australia and New Zealand, explains how services have come to play a significant role in NEC’s current strategy and the importance of resources management in an effective transition. If services are to have a place in future strategy employees and managers have to be convinced that those services are more than add-ons designed to showcase the product. For instance they should not be given out for free to facilitate a sale. Hyde further emphasizes the need for employees in the service sector to be empowered, to ‘quickly anticipate and respond to the needs of customers’ with whom they will work in close contact. 1 The machine manufacturing industry is similar to the tyre industry in many aspects, especially its maturity (slow market growth, slower technological innovation and commoditization) 6
  • 7. FRONTERE Noémie Business Model Innovation in the tyre industry 28/06/2013 This new attitude has to be translated directly in Michelin’s general HR management – not only in the MFS branch – to promote the concept of services. Concerning MFS specifically, due to the complexity of the new services, special competencies have to be developed through new recruitment policies and staff dedicated to MFS need to be more entrepreneurial and ‘pro-active in engaging with customers’ at every level (i.e. not only employees working in sales or directly in the client’s premises). The need for a different corporate culture calls for a business unit specially dedicated to MFS. 2.2. The need for a separate MFS business unit MFS possesses presently dedicated resources (sales force and marketing) but is not an independent unit. Lehrangebot (2011) underlines the impact of conflicting interests on the ‘failure’ of MFS. Competition between the traditional tyre sales department and the new MFS dedicated sales force has been detrimental to the MFS activity. It is not surprising that the product sales force has more influence inside the organisation (96% of Michelin’s revenues in 2012) and the power to shape other activities (R&D) to achieve the highest sales of new tyres possible. Meanwhile, the objective of MFS is to increase the lifespan of those tyres. According to Oliva and Kallenberg (2003), a success factor at this stage is to create a new business unit totally dedicated to the service offer. This unit should be run as a profit centre, with not only its own sales force but IT, HR, R&D etc. This requires duplicating some resources but will empower the new unit which will have higher chances to thrive and eventually become a second pillar of the organisation. As well as new resources, Michelin also needs new performance indicators to monitor service activities and incentives (pay schemes used to interlink departments) in order to reduce sabotage of the service activities by the product teams. Making MFS a new profit centre will also involve reconfiguration of systems, for instance the information system. The increased amount of invoices sent to the central server by MFS (over one third of Michelin’s total volume of invoices2, Young 2008) should be handled directly by a team inside the MFS business unit. This will allow better data processing and make the pricing system progressively more efficient thanks to a deeper understanding of the specific maintenance required for different types of customers. Finally it is interesting to note that the idea of making MFS a stand-alone subsidiary had been discussed internally as early has 2006 but dismissed by product division managers on the basis that the two separate Michelin offers could blur the company’s image in the eyes of its customers: Michelin would not be identified clearly as a tyre company any longer (Young 2008). This argument reveals the productcentricity and the need for an internal culture shift that have already been discussed. It is obvious that top management should be involved in the transition and support MFS if they believe in the concept of services and not only product. 2 Each work on a tyre by a service provider generates a new invoice (Young 2008) 7
  • 8. FRONTERE Noémie Business Model Innovation in the tyre industry 28/06/2013 3. New activities to conduct in line with the new value proposition 3.1. Innovating marketing and customer relationship As discussed previously the economic performance of the company depends on the ability to get access to data concerning tyres wear rates and usage by customers. There is a need to understand in details how the customer uses the product and what his needs and business model are. Information gathering requires stronger customer relationships therefore specific external marketing efforts and time. Business development today is carried on by Michelin managers from the product divisions based on their existing contacts (Lehrangebot 2011). However selling a ‘solution’ requires the company to develop new contacts inside potential customer’s organisation and to talk to more senior executives. MFS’s marketing and business development teams should thus have a different profile. The company’s marketing program itself has to be re-designed to ‘reposition the company’s brand in the mind of current and potential customers’ (Oliva and Kallenberg 2003). Michelin should not be pictured solely as a tyre manufacturer. 3.2. International management of R&D and innovation In terms of innovation, it would be interesting for Michelin to draw on the example of NEC. NEC operates in a different industry more exposed to technological change (see Figure 3) however it has been confronted to similar problems as Michelin when changing its value proposition. 8,2% 7,6% 7,7% NEC 5,7% 3,0% 2008 3,4% 2009 3,0% 2010 Michelin 5,3% 2,9% 2011 2,9% 2012 According to MD Alan Hyde, organisations willing to succeed in the transition have to change their approach to innovation and R&D (CEO Forum 2011). Unlike innovation in a product centred organisation which is focused on technical R&D, innovation in services is interlinked with the organisation’s internal processes and structure, in accordance with customer needs. For Hyde, process innovation plays a major role and involves IT systems, logistics and Human Resources. Innovation is therefore ‘more internal in scope’. It is also more international and requires flexible innovation management structures. 8
  • 9. FRONTERE Noémie 3.3. Business Model Innovation in the tyre industry 28/06/2013 The need to decentralise the new MFS business unit The two activities described above emphasis the need for local responsiveness, flexibility, adaptability, entrepreneurship in the marketing, innovation and maybe even pricing of fleet services. Furthermore most of MFS’s potential customers are regional or local. For instance, in Europe MFS’s key accounts are five major road transporters (Schenker, DHL, TNT, Geodis, Norbert Dentressangle), with strong regional operational integration. However, 80% of transportation companies operate the local level (Lehrangebot 2011). In China or India domestic and local players also play a major role in road transportation (Euromonitor 2010). Most bus companies also operate at the local or national level: many MFS clients are local transportation companies like TFL (London Buses). Diversity of infrastructure conditions and specific regulations are additional pressures for the local adaptation of fleet solutions. Decentralisation of decisions and localisation of MFS services are bound to happen if teams work in close contact with clients and front-office activities become more important than back-office ones (Lasserre 2012). However the existing organisational structure of Michelin is centralized and functional: each product division has its own marketing, development, production and sales forces (Annual Report 2012). All product managers regularly report to the French HQ (Lasserre 2012). If the MFS business unit is to be separated as suggested above this structure cannot be replicated. The new unit could be divided according to geographic areas or follow a customer portfolio approach. 9
  • 10. FRONTERE Noémie Business Model Innovation in the tyre industry 28/06/2013 In any case the organisation should be given local autonomy. The best structure is probably transnational (see Figure 4). In the new decentralised organisation IT back-office functions and data processing could be outsourced to avoid trouble and costs (for instance in India). 4. Managing the key partners: integrating the distribution network The creation of a global services network will also involve a close coordination of third-party service providers: Michelin’s current distributors and maintenance contractors. The question of the management of those key partners is a principle agent problem. Michelin’s reputation is at stake if the quality of services rendered by the different partners is lower than expected. Monitoring dealerships can determine the success or failure of service activities. For instance, when Ford attempted in the 1990s to enter post-sales services, it failed because of the structure of its network of independent dealers (Economist 2001). Indeed, creating the right service network able to respond locally to customer’s needs is difficult, especially across wide geographic areas. As for Ford, creating a global service infrastructure is a challenge for Michelin due to the current situation of its fragmented dealership agreements. For instance, in Australia alone, more than 300 independent dealers sell Michelin tyres and provide end-users with MFS and traditional maintenance (Michelin Australia release 2012). 10
  • 11. FRONTERE Noémie Business Model Innovation in the tyre industry 28/06/2013 Michelin should try and integrate further its largest networks of dealerships (Figure 5), both for quality standards, reputation and information gathering purposes. This would also benefit its tyre sales activities. Standard IT systems should be provided to dealers in order to gather data that will be necessary to control maintenance costs and adapt service offers. To be able to work with the independent dealers the company should develop adapted KPI reporting and new accreditation programs. In Australia for instance, the only accreditation available to dealers today is the traditional OH&S program (Michelin Australia release 2012) which is not specific to MFS. In exchange for closer monitoring the company provides the small dealers with improved and stable revenue streams from maintenance. Finally the degree to which third-parties can customize services has to be clear: given that large customers operate regionally some services have to be transferable between geographic areas. 5. Summary: Suggested innovations represented on the Business Model Canvas © 11
  • 12. FRONTERE Noémie Business Model Innovation in the tyre industry 28/06/2013 Part 2: Evaluation of the financial and strategic impacts of BM innovation 1. Financial value of the business model innovations for Michelin 1.1. Impact on the revenue structure Based on Figure 6, business model innovations will have two different impacts on the revenue stream: direct (MFS sales), and indirect (better understanding of customer needs). The following figure presents a ten year forecast of MFS fleet and revenues. Revenues per vehicle have voluntarily been set to 2008 levels, not including the recent price increase. The indirect benefits – for the product divisions - stem from: - Deeper understanding of the needs and profile of customers of replacement tyres; Closer integration and monitoring of the network of dealers. They are difficult to monetize but could guide R&D efforts of the whole company. 1.2. Impact on the cost structure Given duplication of certain organisational functions and the forecasted increased revenues generated by MFS the number of employees and associated cost is given in the table below. 12
  • 13. FRONTERE Noémie Business Model Innovation in the tyre industry 28/06/2013 Integrating the distributor and maintenance networks through new IT and data gathering services will also affect operational expenses, especially in the short term, however there will be synergies with existing structures. As suggested previously certain IT services could be outsourced to lower cost countries. 1.3. MFS valuation after innovations Projected cash flow and NPV of MFS independent unit in € million *initial data 2012* 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 Operational parameters Revenue (€/vehicle) 933 Increase in revenue/vehicle Vehicles under contract (K) 345 Fleet growth rate 980 5% 397 15% 1029 5% 456 15% 1080 5% 525 15% 1134 5% 603 15% 1191 5% 694 15% 1251 5% 798 15% 1313 5% 918 15% 1379 5% 1055 15% 1448 5% 1214 15% 1520 5% 1396 15% 1596 5% 1605 15% Revenues 322 389 469 567 685 827 998 1205 1455 1757 2122 2562 OPEX 866 1022 1212 1434 1712 2042 290 408 493 539 616 732 Operating margin Op. margin variation EBITDA tax rate 10% -5% -5% 5% 10% 32 33% -19 33% -23 33% 28 33% 68 33% 12% 15% 95 33% 13% 15% 132 33% 15% 15% 183 33% 17% 10% 243 33% 18% 10% 323 33% 19% 5% 410 33% 20% 5% 520 33% CF 22 -19 -23 19 46 64 88 123 163 217 275 348 Discount rate (inflation deducted) NPV (€ million) 10% 557 13
  • 14. FRONTERE Noémie Business Model Innovation in the tyre industry 28/06/2013 The table above presents a rough ten year valuation of the MFS business unit, which is estimated around 500 million euros. This is non-negligible for a company which itself is valued 6.5 billion euros (market capitalisation 2013). 2. Strategic advantages of the new business model Along with the advantages already listed, by strengthening the position of MFS inside Michelin, the business model innovations will have the following effects: - - At the corporate level, balancing two activities with different risks profiles and revenue dynamics (revenues from punctual tyres sales vs. regular monthly revenues from three to six years MFS contracts) while enjoying operational synergies, Integrating – and thus better controlling – the value chain by engaging more closely with distributors and performing after-sales services (maintenance), Reducing the overall sensitivity to the price of raw materials and especially rubber, Establishing a lasting competitive advantage over other international players through an innovative business structure and new capabilities difficult to replicate. 14
  • 15. FRONTERE Noémie Business Model Innovation in the tyre industry 28/06/2013 Conclusion and challenges of the new approach The following table sums up the business model components that should be operational challenges3 the new approach involves. Business model Current Suggested Expected component management management positive impact Product performance Service at the core Larger MFS Value of the offer revenues with no proposition and at the core of the value proposition negative impact on customer Customization of the revenues from relationship Standardization of services Key activities (1) marketing MFS priced according to product availability (customer centric) ‘Culture shift’: need for entrepreneurial and pro-active attitude Better customer relationship, flexibility and adaptability Need to recruit new profiles Little contact with customer apart from sales force MFS managed as a product division inside a centralized corporate structure More contact with customer at all levels MFS managed as an independent profit centre Better MFS performance and development Internal acceptability MFS marketing team supports product marketing teams Marketing to reposition the company as a service provider Management of HR ‘product-centric’ Service as an add-on Key activities (2) R&D and innovation Key partners (distributors) Internal acceptability (by product divisions) product sales Supervision at home Key resources (2) structure Operational Challenges services MFS priced according to Michelin costs Key resources (1) HR strengthened and the Approach to innovation is technical = product R&D Fragmented dealership agreements (low monitoring) Closer customer relationship Product R&D and service and process innovation Integrated network of dealers (through accreditation programs and improved reporting systems) Information gathering Management of the interface between MFS and other units Internal fear that Michelin’s image could be ‘blurred’ Understanding of customer needs Flexibility and innovation required by new service approach Data gathering (for MFS and Michelin’s other purposes) Quality of service Acquisition of the required capabilities (internal innovation management etc) Dilution of some of Michelin’s operational ratios Time needed to diffuse knowledge and good practices 3 Because the biggest challenge is ability to accept innovation, it is worth noting with Young (2008) that Michelin is famous in the industry for continuously questioning its economic model and developing new approaches to the traditional tyre business. 15
  • 16. FRONTERE Noémie Business Model Innovation in the tyre industry 28/06/2013 References Brown, S. 2012 “Moving from Products to Services: The Six Big Challenges”, 16 February, W.P. Carey School of Business Marketing Review CEO Forum 2011, “From products to services: Interview with Alan Hyde, Managing Director of NEC Australia and New Zealand”, viewed 20 June 2013, < http://www.ceoforum.com.au/articledetail.cfm?partner=rss&cid=12405&t=/Alan-Hyde/From-products-to-services> Economist 2001, “The shake-up at Ford”, 1 November, viewed 25 June 2013, <http://www.economist.com/node/842705> Euromonitor 2010, “Regional Focus: Investments in transport infrastructures expected to grow in Asia Pacific”, 6 July, Viewed 20 June 2013 Gillai, B. and Yu, T. 2013 “B2B Managed Services: Business Value and Adoption Trends”, Stanford Global Supply Chain Management forum, March Heskett, J. Sasser, W. and Schlesinger, L.1997, The Service Profit Chain, Free Press, New York, NY Lehrangebot, 2011, “Michelin Fleet solutions, a new sales strategy”, viewed 5 June 2013 <http://www.slideserve.com/mercedes/michelin-fleet-solutions-a-new-sales-strategy> Lasserre, P. 2012, Global Strategic Management (Third Ed), Palgrave Macmillan, Hampshire Lojo, M. 1997, “Contracting of high-technology industrial services”, Sloan School of Management Cambridge, MA Michelin Australia release, 2012, “New structure for Michelin Fleet Solutions”, viewed 20 June 2013 <http://transport.michelin.com.au/Home/News-Promotions/News/TB-News/node_1746> Michelin, 2012, Annual Report, released January 2013, Paris, viewed 20 June 2013, <http://www.michelin.com/corporate/finance/documents> Michelin, 2013, “Newsletter Avril 2013: Produits et Innovations”, released 10 April, Paris Oliva R. and Kallenberg, R. 2003, “Managing the transition from products to services”, International Journal of Service Industry Management, vol. 14, no. 2, pp. 160-172 Quinn, J. 1992, Intelligent Enterprise, Free Press, New York, NY Young, L. 2008, From Products to Services: insight and experience from companies which have embraced the service economy, John Wiley & Sons, London 16