The Challenges of Solutions Strategies

A successful solutions business is hard to implement. Whether or not it is the right competitive approach depends on a company’s relative strength in the market, how well it knows its customers and to what extent it is willing to invest in the necessary capabilities and see through the many required operational and organizational realignments. Most of all though, it depends on whether the company can integrate products and/or services in such a way that the total provides more value than the sum of its parts.

The concept of competing through “solutions” has been around for at least 30 years. Numerous manufacturers / OEMs created solutions business units to better target vertical markets or large strategic accounts. For example, industrial automation companies created customer-facing “systems” business units, which integrated various products, services, and an automation platform into a vertical market solution. However, it has not always been smooth sailing despite many claims to the contrary; It has often been the case that high product margins (arising from strong market positions and premium pricing) were negated by low or negative systems margins leading to overall profitability deterioration.

More recently OEMs have incorporated services into solutions offerings to either repulse competitive attacks from manufacturers with lower cost bases, mainly from emerging markets or to generate general differentiation. Many managers think that as (service-based) solutions place greater demands on processes (logistics systems and networks, business processes, project and risk management, pricing, software development), they are more difficult for competitors to emulate, providing competitive advantage and a means for defending market positions. Again, the evidence of the success of such strategies on the ground is thin. Undoubtedly some organizations have been good at this, many others however less so, which is indicated by the fact that numerous companies at some point or other exit solutions businesses they had deemed very promising to begin with.

To varying degrees, for market reasons, most capital equipment manufacturers now self-report some sort of solutions offering, though what they mean by that varies. But in general, a solution is (or should be) a bundle of products and services that in combination aims to solve a customer’s “problem”. Some industries and markets have naturally exhibited stronger trends towards solutions than others, ultimately driven by demands of large or very large customers with substantial buying power (and the associated industry economics) –requiring large investments by suppliers- examples being the defense, aerospace, and infrastructure industries. This has usually been followed by industry consolidation as suppliers merged to form organizations capable of delivering significant scope (usually along a customer’s supply chain) of technology, products, services, and financing over long time periods. For example, in the fossil fuel power business, most conventionally understood solutions to mean an expansion of product scope, to be able to offer turn-key power plant solutions. Accordingly, in the 1980s and ‘90s large steam turbine manufacturers acquired or merged with gas turbine and boiler makers and balance of plant companies to cover the whole steam or, more importantly, the gas and steam combined cycle, which was considered key for efficiencies (a solution) at the time. All major suppliers with one exception went down this road, but it is not at all clear that the strategy was more successful than the one of GE which at the time stuck to dominating a relatively narrow product range (gas turbines) with the extra help of significant and high-value service content (this was a separate offering). In fact, GE’s comparable profitability turned out to be consistently higher throughout that period, whereas its competitors were often plagued by technology integration, quality and project problems and cost overruns that negatively impacted profits. This example shows that simple expansion in scope of supply is not necessarily a winning strategy. In fact, it is not obviously a solutions strategy at all –because a solution surely requires tight technical and commercial integration of the elements it consists of in a way that the total creates more value than the sum of its parts. Otherwise, there is hardly any point to the solution at all and customers can rationally prefer to buy the elements individually. And once the commercial/technical rationale of a solution is broken each element is subject to normal product competition (with the additional problem that the vendor has now a higher cost base due to the investment effort to make itself capable of delivering a solution). Furthermore, as the purpose of the solution is to solve a specific problem and as customers have problems often unique to their particular circumstances, solutions need to be highly customized – though of course there are often cases where customized solutions have eventually become fairly standard (though usually complex) offerings, applicable to a wider range of customers. Solutions, therefore, require both the ability to tightly integrate products and services so as to add value in excess of the sum of the individual elements and the ability to profitably customize and place the offering in a way that the customer’s problem is solved according to metrics compatible with the outcome the customer is trying to achieve.

Given that solutions usually require upfront investment in technical and commercial/sales capabilities as well as organizational re-alignment of processes and assumption of additional risks (all of which generally translate into permanently higher overhead), it seems safe to assume that failure to provide the additional value customers are willing to pay for will result in insufficient sales, gross margin reductions and therefore in reduced profits or even losses. And this additional value must come in the form of better performance, lower lifecycle costs (by eliminating cost drivers) or both for customers -in comparison with what they would achieve by acquiring individual elements separately from different suppliers. This means effectively that the aspiring solution provider must be a technical/commercial leader in at least one, preferably more of the solution elements and must understand customer requirements better than most competitors -otherwise it is highly doubtful that the provider would be able to design and implement the right solution. This, in turn, leads to the conclusion that solutions strategies must be aggressive competitive strategies that must be pursued from a position of strength. Solution strategies as defensive strategies (from positions of technical or commercial weakness or as a remedy for weakness in product business, for example, due to market share erosion because of a too high cost base) usually end in failure -mainly because they shift management focus away from dealing with the immediate problem. Therefore, companies with such weaknesses are better advised to address them specifically and directly before pursuing solutions strategies.

The strategic logic of solutions is not dependent on whether the solution consists of an expanded product scope or services bundled with products. Just as in the former, also in the latter case, the value created through the solution must be greater than the sum of its parts for the offering to make business sense. In the same vein as product-based solutions, product-service solutions require a significant degree of integration to create winning value propositions. Rolls Royce’s “power-by-the hour” concept, where airlines essentially buy jet-engine thrust or flying time and insights on how to optimize the flying process is a case in point. The customers buy outcomes (optimized flying hours, reduced lifecycle costs) that require tightly integrated products and services to avoid disruptions, downtime or sub-optimized performance. And this logic applies to all “product-as-a-service” (or “servitized solution”) offerings in the capital equipment business. It is about offering a better outcome at a lower cost. Therefore, many companies touting “solutions” are not in effect offering solutions at all but non-integrated product-service bundles. This might be a good marketing tactic. On the other hand, it might be a genuine misconception accompanied by high solutions-type overhead which cannot be recouped through higher margins. This discrepancy is one of the major risks facing aspiring solutions providers. The other is implementation risk: either failing to correctly identify necessary changes in organization, processes or capabilities or executing them badly.

For companies organized to develop, manufacture and sell products, transitioning to solutions requires significant changes –not only in formal structures, processes, and sales approaches, but most importantly in mindset and organizational focus: From markets – the default positioning of product companies- to customers. In other words, the mental process must change from “how many uses or applications for a product”, to “what is the best combination of products/services to solve this particular customer’s problem”.

The priorities must shift from product portfolios to customer portfolios, from product margins to customer P&Ls and from metrics such as number of new products or percentage of revenue from new products to customer share within verticals, or customer retention rates. This new mindset, as well as new processes and approaches, can best be developed and sustained by somehow organizationally separating the solutions business from the product business (and even the conventional aftersales service business). Depending on the expected size of the solutions business, on where and how its elements are to be sourced and on the additional know-how required, managements may decide to create customer-facing business units with own resources or, alternatively, organizational overlays with resources seconded from product and service businesses (i.e. changing the responsibility but not the position of personnel in the organization; sharing resources in virtual teams). In each case, there are significant trade-offs and side-effects, which need to be understood and managed well.

An important issue that will quickly confront a new solutions business is whether it can source competing products or services if integrating them into the ensuing solution then offers better value. For management, this is an acid test of commitment to the solutions business. Companies that are not able or willing to take such decisions should probably refrain from entering the space, as it is unlikely that the resulting offerings will generate and sustain sufficient additional value over time. But at the same time, customer-facing, resource-owning solution businesses can themselves often create problems, including development of silo mentalities where there is insufficient communication, cooperation or coordination with the product or service units, with the disconnect potentially impacting competitiveness (costs of inter-organizational friction, resource and effort duplication, inefficient knowledge transfer, misunderstandings of necessary technology development direction, internal competition…). And, of course, it does not end here. For example, in pricing, objectives of product and solutions businesses may conflict. Product units mainly price for penetration and market share, given sufficient margin and competitor price levels. Solution businesses, however, need to price in a way as to achieve entry and an optimized result with the customer across the total solution over time (lifecycle costs). Entry-level pricing by solution businesses that make the solution upfront more attractive than the individual elements (effectively underpricing integration and customization engineering) may lead to overall margin erosion, even commoditization of the products.

Managing these issues is hard. Complexity increases substantially in a solutions business and with it the effort and time a company expends in dealing with internal rather than customer issues.  It is a key to understanding why many companies entering solution businesses (up to three out of four by some estimates) fail to achieve desired revenue and margin objectives. While the organizational setup and the transformation process need to be meticulously thought through and planned, too often they reflect intuitive management preferences rather than rational data-driven decisions. Some top managements take an off-hands approach allowing the different businesses to negotiate the operating, transaction and decision framework with each other. While this may achieve some better adjustments, it may also lead to additional inward focus, internal friction, customer neglect, and higher overhead. Others devise rules and/or incentives (e.g. through the bonus system) to impose or induce the desired collaborative behavior and eliminate internal competition. It is difficult however to make rules that make sense to all those affected and almost always they can be gamed or simply not followed. And such changes do not happen in a vacuum, but their success and ability to channel resources towards objectives depend heavily also on the personalities and behaviors of managers operating within the framework. Assertive managers, for example, may aggressively and energetically pursue business objectives, but often end up turning their organizations into silos. On the other hand, managers who support extensive collaboration and exchange of information encourage learning and development but often end up in paralysis by analysis dead-ends or shirk decisions through endless rounds of meetings.

Another major issue in implementing solutions businesses is the availability of resources with the right competencies -which tend to be scarce in the market. Any company will find that in moving from products to solutions it will lack at least some, probably many, of the needed competencies and know-how. Human resources, therefore, are a critical limiting factor in developing successful solutions businesses. Consider, for example, sales people. Both the type of people required as well as the structure and content of the sales process are quite different in solutions and product businesses: Solutions are sold on economic impact rather than features, involve a larger number of decision-makers and influencers, have far longer sales cycles and require more and more intensive interactions between customer and supplier. Sales people must have deep customer industry knowledge and are, in fact, usually recruited from those industry verticals that are targeted. The sales process involves setting up account teams around account managers or “owners” supported by industry, technical and other experts. The prevailing attitude must be listening, analyzing and finding ways to solve problems rather than pushing products or even pre-made “solutions”, which customers have usually already disaggregated to the constituent elements. Solution selling requires being able to identify and communicate areas of change and emerging demand –often even before experts at customers have formed an internal consensus as to the nature of the problem to be solved. In other words, the challenge is not only in knowing the customer’s business well but being able to redefine the customer’s needs in a way that makes technical sense and maximizes economic impact.

Implementing a solutions business model can be highly rewarding but needs to be undertaken from a position of strength with extensive knowhow on how to integrate the various elements into a whole that is more valuable than the sum of its constituent parts. Furthermore, it adds extensive complexity to organizational structures and imposes substantial additional costs on companies. If done well it can provide robust competitive advantage over long periods reflected in increased market share and margins. If not, it results in reduced profitability or losses and, most importantly, distracted management and opportunity costs. There are no textbook approaches in achieving effective transformations, other than being deeply aware of the potential problems, having clarity on strategic intent, realistic expectations on investments and resources required -and acquiring a deep understanding of the economic, technological and strategic needs and nuances of the verticals targeted. Most important of course is sustained engagement by leadership and a compelling story to achieve buy-in from those who will be carrying it out.