Capturing the Value of Supplementary Services

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The McKinsey Quarterly 2006 Number 1

Daniel Chang

The right service strategies for product companies

T he right service
strategies for product
companies
As products evolve into commodities, services become more important. But companies that play this new game must understand its rules.

Byron G. Auguste, Eric P. Harmon,
and Vivek Pandit

As relative newcomers to the service economy, many product companies

have yet to make money there. Until recently, brisk sales growth, buoyed by a rising tide of demand for services, kept trouble from view. But as the estimated $500 billion “embedded” service sector (Exhibit 1, on the next spread) becomes more competitive, too many companies find themselves grappling with strategic questions they should have resolved when first entering the market: are they offering embedded services for offensive or defensive purposes? Are they playing a skill- or a scale-based game? Confusion about fundamental issues of strategic intent and the source of competitive advantage now seriously hampers the profitable pricing and delivery of embedded services and the effective management and governance of product and service organizations alike.

That strategy must precede structure has been a tenet of good management since Alfred Chandler published his seminal studies in the field of business history, in 1962.1 But product companies in the embedded service sector lack the strategic clarity needed to make sensible decisions about how to design businesses. Some view internal service businesses as a growth platform but structure and run them as an adjunct to product businesses. Others stumble by pursuing scale-based business strategies in skill-based 1

Alfred D. Chandler Jr., S trategy and Structure: Chapters in the History of Industrial Enterprise, Cambridge, M A: MIT Press, 1962.

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The McKinsey Quarterly 2006 Number 1

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Article at a glance
Profits from service businesses have disappointed
many companies that launched them to protect
or enhance products. This embedded service sector
has grown rapidly, but the businesses are often
barely profitable.
One reason for the mixed returns is that companies
aren’t always clear about whether services
are intended to grow in their own right or to protect
products.

service markets or vice versa.
This kind of confusion leads to
organizational conflict, misguided
pricing and service delivery, and
misunderstandings about costs
and the capabilities and resources
needed to succeed in different
competitive environments.

To make existing service groups
profitable—or to succeed in
launching a new embedded service
Although executives often say they want service
businesses to expand independently, they
business—executives of product
keep services captive within the structure of product
companies must decide whether
businesses.
the primary focus of service units
should be to support existing
Understanding the direction of the business and
product businesses or to grow as
the source of competitive advantage is essential
a new and independent platform.
to determining the right structure for an embedded
service unit.
These executives must also discern
the source of competitive advantage
in the service markets in which
they choose to compete. Only with these questions answered can executives properly design an embedded service business. Getting the fundamental strategic questions right may not guarantee success, but getting them wrong is a sure route to failure.

Common mistakes
Of course, some companies fully understand the strategic intent of their own embedded services. E MC , for example, entered the skill-based business of storage-related maintenance and professional services in order to enhance a leading position in storage equipment. Johnson Controls saw the scalebased business of managing integrated facilities as a growth platform that would be more robust than its climate-control-equipment and...
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