1. Whitepaper | OEM services | 2015
www.xlent.se/strategy Authored by Jonas Strömgård and Bo Johannisson
A leap across the abyss
The new imperative
for industrial OEM
services
The services operations of industrial OEMs
(Original Equipment Manufacturers) have
developed favorably during the last 10 years,
but the apparent success has been driven
mainly by growth in installed base. Look-
ing forward, companies will need to make
a leap to create monetary value from the
intangible part of their offerings. Such a
leap requires decisions on the highest level,
where the insight about value drivers in
services generally is low. To make a lasting
performance leap, industrial OEMs will there-
fore need to increase transparency about
service contribution and potential, become
truly value-focused in their business model,
allow for investments adequate for a ser-
vices business, and create financial equality
for services.g

2. 2 | A leap across the abyss www.xlent.se/strategy
Today, any industrial corporation seeking inves-
tor confidence will emphasize its focus on the
aftermarket. A review of official investor com-
munication over the last 10 years shows that
attention and space devoted to aftermarket and
services (or similar activities) for Nordic OEMs
has more than doubled over the period. Look-
ing at the financials, aftermarket revenues have
grown at an average CAGR of close to 5% since
before the financial crisis, thereby significantly
increasing their share of total OEM revenues, see
Figure 1 below. Margins have remained healthy
and less volatile than for new product sales. Also
companies selling components and consumables,
whose service activities often are embedded and
not an explicit business, have grown their service
activities considerably over the period.
But what are the dynamics behind the apparent
success and what learnings should we keep in
mind going forward? Building on a similar study
conducted ten years ago, our current study looks
behind the financials to get a long-term perspec-
tive of the Nordic industrials’ efforts within after-
market and services.
Satisfactory results, but no real trans-
formation
In 2004, the focus on aftermarket and services
had just begun. Following the then recent transfor-
mation of the IT and Telecom industries, many in-
dustrial companies were about to set up separate
profit and loss units for the services operations.
We could see a “one-size fits all” approach, where
aftermarket and services’ share of total business
was the dominant measure of success. Ambitions
were high and many new services were on the
drawing board, but services development invest-
ments and top management involvement were
still lacking.
Now, ten years later, we find that growth has been
mainly driven by growth in the installed base of
the OEM’s own equipment or vehicles. The excep-
tional growth in the first half of the period came
to a halt with the financial crisis. Since then, the
decline in Capex spending in Europe and North
America has been partly offset by growth in
emerging markets, especially in the BRIC coun-
tries (Brazil, Russia, India, China), where a large
share of capital sales adds new units to the in-
stalled base.
In addition, companies have captured some of the
“low-hanging fruits” following from the previous
lack of proactivity and professionalism. Pricing of
parts and consumables has been improved and
maintenance contracts are now proactively sold
to customers. These and other measures have in-
creased the overall market share on the installed
g
OEM Services |
Aftermarket and services’ share of total sales has increased since 2007
Figure 1: Development of aftermarket business as a share of total sales for selected Nordic OEMs
0
5
10
15
20
25
30
35
40
45
50
55
2013201220112010200920082007
Metso
Volvo
Alfa Laval2
Ericsson
Wärtsilä
ABB
Cargotec
SCANIA
Total average3
Atlas Copco
Kone
ASSA ABLOY1
Av!
31%"
Av!
35%"
%
1.Business area Entrance Systems; 2.Share based on order intake; 3.Total average also include Sandvik Mining (45% 2007, 53% 2013) and SKF
Service Technologies & Industrial Solutions (2,8% 2007, 4,0% 2013)

3. | OEM Services
www.xlent.se/strategy The new imperative for industrial OEM services | 3
base to some extent.
In contrast, the development of value-added ser-
vices, beyond standard maintenance contracts,
shows surprisingly little progress. 10 years ago,
brave ambitions were expressed in areas like
process consulting, customer training, remote
monitoring, multi-vendor maintenance, services
outsourcing and performance-based contracts.
Our study shows that very few have managed
to create any substantial business within these
areas over the period, see Figure 2.
Trapped in the services catch
Looking forward, OEMs will face increased market
pressure in the spares and consumables market,
caused by:
• Slowdown in installed base growth, as the BRIC
countries gradually mature
• Increase in average lifetime of parts, reducing
demand
• Increased global price transparency, putting
pressure on the high OEM parts margins
• Lowered entry barriers for me-too, “pirate”,
parts suppliers, as new technologies such as
3D printing trigger competition also for custom/
drawn parts with low volumes.
The OEMs’ response to this needs to somehow
include services. Some firms have chosen to work
exclusively with external service channels, but
there is a clear trend towards building in-house
service capabilities. It has proven difficult to con-
trol the service quality of external partners, and
OEMs are afraid to lose access to end-user in-
sights and relationships. Most study respondents
have also come to the conclusion that further
growth in the parts business will need tighter bun-
dling with services.
However, our study shows very modest growth
in service contract coverage, and even slower
growth in other service areas. Based on these
findings, we conclude that OEMs’ have difficulties
to add value in services to balance out their cost
disadvantage. The average hourly cost of OEM
service is often 2-3 times higher than competi-
tion, whether that is a local service provider or the
customer’s own in-house service staff.
What we find is that
the services part of
the OEM’s offering is
often not competitive
in itself, but is made
possible only through
bundling with high-
margin spares, or sometimes through regulatory
entry barriers for non-OEM service providers. This
Figure 2: Illustrative breakdown of Aftermarket and Services development 2004-2014
Aftermarket and service business
2004
Installed
base
growth
”Low-hanging
fruits” like
pricing and
proactive
service
contract
sales
New value-
added
service
2014
”What we find is that the services
part of the OEM’s offering is often
not competitive in itself, but is
made possible only through bund-
ling with high-margin spares.

4. www.xlent.se/strategy
fact is not evident in the figures, as the “intan-
gible” part of the aftermarket business is rarely
reported separately. As one study respondent
put it; “our high parts margins cloud poor service
performance”. In our view, the root cause of this
problem lies in the overall setup of an industrial
OEM. Although most companies casually use
marketing taglines like “product, service and solu-
tion provider”, they are still employing business
and operative models geared only towards prod-
uct sales. This is illustrated in Figure 3 below.
Our analysis shows that for most OEMs, there is
a negative development of the contract margin
by the increase of services (intangibles such as
labor and software) and 3rd-party products in their
customer offer. This relationship is valid for both
capital and aftermarket businesses. For instance,
large capital projects, which normally include 3rd
party products and services such as installation,
integration, start-up, training and commissioning,
will be less profitable than sales of the same
volume without the services. In the aftermarket, a
pure spare parts contract will have higher margins
than a maintenance contract including parts for
the same volume.
This means companies will only have the incen-
tive to perform services, or integrate foreign prod-
ucts, if this can boost or protect their own product
business, and they will not perform more services
than necessary. Services costs and profitability
will not be measured properly and service staff
will be seen as overhead rather than contribution
units. As a consequence, the services business
will not get sufficient investments and will not
attract the best people. Service contracts will not
add enough customer value and will continue to
be a hard sell. Value-added services will not take
off, since these offerings usually include little or
no own products, etc. It becomes a vicious circle
that we call the “services catch”.
Since many OEMs are dependent on aftermarket
and services for continued growth, we believe this
catch is the main challenge facing industrial com-
panies in the coming years. Although definitely no
quick fixes, there are still ways to overcome the
obstacles.
A leap across the abyss requires align-
ment with the investors’ perspective
To address the challenge, OEMs will need to
change the slope of the line in Figure 3, i.e. they
need to learn how to make money on intangibles.
Please note that this proposition is valid for all
companies, regardless of business model. We are
not suggesting that all industrials should charge
explicitly for intangibles. We are merely saying
that the contribution of labor and software should
not dilute profitability. Large corporations like
Ericsson and SKF have shown that industrial
OEMs can build a substantial and profitable ser-
vices business that is not dependent on bundling
with high-margin spares.
However, our experience as advisors in this field
over the last 15 years leads us to the conclusion
that there is no gradual “step-by-step” develop-
ment path to services competitiveness for indus-
trial companies. Making the necessary changes
in business and operative models is a structural
transformation that will affect many parts of the
organization, a leap that needs to replace rather
OEM Services |
4 | A leap across the abyss
Figure 3: The services catch – negative margin contribution from services
and 3rd party products
Operating
Margin
Expected
operating
margin in a
product-centric
business
Share of service and 3rd party
product included in contract
0% 100%
”There is no gradual “step-by-step”
development path to services
competitiveness for industrial firms.
Making the necessary changes in
business and operative models is a
major transformation, a “leap across
the abyss” into services.
Contract Margin

5. www.xlent.se/strategy
than complement current practices. Such a move
always means taking short-term risks for longer-
term benefits, especially when the current product-
centric practices seem to be working fairly well.
Many managers working directly with services in
OEMs share this insight and conclusion already.
However, a leap of this magnitude requires deci-
sions on the highest corporate level, where insights
about the dynamics of services value creation gen-
erally are rather shallow. Here is a gap to fill.
To better understand this gap, we interviewed
board members and institutional investors
focused on the Nordic manufacturing sector for
this study. Since the results of OEM’s aftermarket
efforts so far have been rather satisfactory, inves-
tors have had no urgent need to challenge the
progress. However, concerns are raised by inves-
tors about the lack of clarity and transparency in
the services business. These investors are used
to scrutinize the product strategies of industrial
OEMs. Bold growth targets must be backed up
by visible investments in R&D and production
capacity, both of which can be found in traditional
financial statements. A pure spares & consuma-
bles business is relatively easy to incorporate
into the valuation models, but investors are less
familiar with the dynamics of a services business,
and what indicators to look at to critically evaluate
companies’ future ambitions and growth approach
in services.
Making the leap – transparency, value-
orientation, adequate investments and
financial equality
Based on the findings from our study, along
with the additional investor perspective, we can
devise an agenda prescription for Nordic OEMs.
Four areas of change have been identified, each
contributing to the overall transformation. They
can be viewed as different enabling tools, each
challenging current practices to some extent and
all necessary to carry the organization over the
abyss and make the leap.
1. Specify the abyss - increase service business
clarity and transparency
The first step is to bridge
the transparency gap in the
contribution and potential
of services, with a focus
on intangibles. First of all,
market sizing and share estimations for services
are often very vague, especially when compared
to the main product markets. Investors are rarely
impressed by statements like “our customers
spend 10 BUSD on maintenance annually” when
everyone knows that only a small part of this
market is realistically addressable to the OEM.
Market analysis should be performed with the
same rigor as for the main product market.
| OEM Services
The new imperative for industrial OEM services | 5
Figure 4: Four enablers of change to make the leap
g
Specify the abyss
Increase service business
clarity and transparence
Make the leap
Ensure truly value-oriented
business models
A steady flight
Allow for adeguate
investments for services
Soft landing
Create financial equality
for services

6. www.xlent.se/strategy
Secondly, many services generate limited sales or
are implicit, i.e. not charged to the customer but
used in pre-sales, as brand builders or enablers
of other business. The contribution of these ser-
vices needs to be visualized and controlled, e.g.
through comparison of the overall development of
accounts with and without certain services. Such
KPIs are vital to justify investments in services
development, but very few firms use them today.
Thirdly, the true costs and profitability of services
must be properly measured. Unlike product costs,
which are mainly tangible and hard, services
costs are soft around the edges. Service offerings
are not clearly defined in the systems and service
labor, especially white-collar staff, is often seen
as cost of sales. Costs of software used in provi-
sion of services are seldom fully accounted for.
Improving clarity in this way will enable more
accurate target setting and internal control, as
well as improved communication with boards and
investors around services.
2. Make the leap - ensure truly value-oriented
business models
Most OEMs have some
kind of program for value
selling, which clearly is a
step in the right direc-
tion. Understanding the
provided value gives many advantages. A focus
on value argumentation in the sales phase will, in
the end, improve the business outcome for both
the customer and the OEM, as it puts pressure on
the service organization to perform to the quality
standards required for a premium-priced services
business.
However, our experience shows that a general
value orientation alone is not enough to impact
the slope of the “services catch” line. To succeed
on a broad scale in value argumentation for ser-
vices, companies need to somehow align the pric-
ing model. In the traditional pricing model, OEMs
make more money when their products break than
when they work, and they discount a large share
of the customer-perceived value (the intangible
part) to enable high margins on physical products
that sometimes have very low perceived value.
This sends the wrong signals to the customer and
creates distorted incentives for the own organi-
zation. Of course, not all services can be value-
priced, but most services can introduce some
sort of value-oriented price element.
In risk-averse industrial companies, linking parts
of the price to a customer outcome will face large
internal resistance. Systems and processes are
poorly configured for this type of business and
product managers will insist on knowing their
margin at the time of the sale. Making this move
will therefore require strong leadership from the
highest level and willingness to take short-term
risks for long-term benefits. In other words – it
takes a leap.
3. Make a steady flight - allow for adequate
investments to increase value and competitive-
ness of services
To enable the necessary
investments for services
competitiveness, there is
a need to understand the
dynamics of services per-
formance. To some extent,
investments in services
development can be tangi-
ble, such as engineering of
new software or erection of new workshop facili-
ties. However, the most important investments in
services do not show up as assets in the balance
sheet, since services are dependent on people
and their capabilities. Service employees are
potential profit units and must be treated accord-
ingly. The services “factory” must often be built
(hired and properly trained) before it can generate
revenues. New service offerings must be devel-
oped, packaged and deployed globally. Structural
intellectual capital must be developed to enable
scalability of knowledge services, etc.
In industrial OEMs, these types of investments
often show up as operational expenses and are
not built into investment cases that can be made
visible to boards and investors. The necessary
change of practices will challenge traditional
investment calculation principles and the prevail-
ing view on SG&A costs, and will thereby fulfill our
qualifications for a leap.
6 | A leap across the abyss
OEM Services |
g

7. www.xlent.se/strategy
4. Monitor the landing - create financial equality
for services
The final and most dif-
ficult part of the leap
towards service com-
petitiveness concerns
the firm’s basic earning
mechanism, i.e. what
KPIs are used by management to ensure overall
profitability. The negative slope of the line would
not exist if product and service were treated
equally from a controlling perspective. However,
as stated above, products are hard while services
are soft. Products are easy to define, aggregate
and control. Global targets for product margins
can be easily derived from the overall ROCE
(Return on Capital Employed) targets set by the
board. The supporting controlling mechanisms
have been refined over decades in industrial
firms. None of this tends to be true for services.
This means that even when intangible offerings
are defined, packaged and recorded correctly in
the systems, they still tend to be discounted or
given away in sales, to secure product volumes
and margins. Account managers may argue
that overall customer margins are satisfactory.
However, the decision to discount services, either
explicitly to the customer or internally through
allocation of overall contract revenues, reinforces
the view that services are less important than
products.
The first step to create financial equality is that
all services provided to customers should be
recorded and charged at internal “transfer price”
to the accounts. This price should include a small
margin to create pressure on account managers,
just as the transfer price from production units do
for physical products.
Secondly, overall account margins should be the
dominant KPI to track and control. Discounts
should be related to the overall contract volume
and distributed proportionally between products
and services.
Thirdly, financial targets should be revised to
reflect the uniqueness of services. Intangible
offerings usually do not tie up nearly as much
capital as physical products. A pure labor-based
business will make handsome returns also at
operative margins well below 10%. Furthermore,
services are hard to scale rapidly, and must often
be deployed and refined gradually in the market
to succeed. Payback requirements shorter than
12 months, which is not uncommon in industrial
firms today, effectively kills most initiatives in
services.
Just like no physical tool alone will carry you safe-
ly over the abyss, our four leap enablers should
not be seen as a menu to pick from. They need to
be interlinked in a coherent program of initiatives
to reach a sufficient combined effect.
***
Services are crucial to continued growth of Nordic
industrial OEMs, but current approaches are stall-
ing. Awareness and action must move from the
service department to the highest level. Our four
leap enablers can help companies out of the “Ser-
vices Catch” and unlock the true shareholder value
potential of industrial services.
The new imperative for industrial OEM services | 7
| OEM Services

8. XLENT Strategy is a leading Scandinavian top-line consulting firm, dedicated to defining
and realising our clients’ growth agenda.
No part of this publication may be reproduced, stored in a retrieval system, or transmit-
ted in any form or by any means - electronic, mechanical, photocopying, recording, or
otherwise - without the permission of XLENT.
XLENT Strategy
Regeringsgatan 67
111 56 Stockholm
Tel: 08-51951000
Mail: info@xlent.se
www.xlent.se/strategy
Part of:
Authors
Jonas Strömgård
Director, XLENT Strategy
Head of Industrial Practice
Mobile: +46 (0)736 88 96 31
jonas.stromgard@xlent.se
Bo Johannisson
Independent strategic advisor
Mobile: +46 (0)706 89 23 40
bo.johannisson@aslunda.se
Whitepaper | OEM services | 2015