Over the last months (actually, more like years), we’ve studied the digital transformation of several companies in the Software Center. Professor Helena Holmström Olsson and I developed a model to illustrate how they actually transition from their legacy business rooted in atoms to a digital business based on bits (see the figure). It has four dimensions: business model, data exploitation, product upgrade and AI/ML/DL. In this post, we’re focusing on the business model dimension.
Based on our research with several of the Software Center partners, we identified that companies evolve through a similar pattern when it comes to transforming their business model. Especially in the embedded systems domain, the starting point is traditional product sales, eg a car, a truck, a radar, a pump or a base station. We often refer to this as “box sales” and the business model is highly transactional: I sell you the box and I will then try to sell you a new box in a few years’ time. There may be some revenue generated from services, such as product maintenance, but this tends to be a small fraction.
The next phase is where the product is offered as a service. Here, mostly the monetization of the physical product changes from a one-time transaction to a continuous revenue stream. There are several challenges with this, including this requiring the company to, in effect, finance the product for its customers, but it can be a very effective way to grow revenue as customers that wouldn’t have bought the product in the traditional model as, for example, they don’t need it full-time, may well want to buy it as a service.
As a next step, we see that companies start to develop all kinds of services around the product. These services tend to surround the operation of the product and may range from offering accessories in a rental model to providing information and advisory services to improve efficiency or the quality of outcomes. In this phase, the product is used as a platform to generate more revenue from complementing services.
In the fourth step, the monetization model changes again and becomes more customer oriented. Rather than associating monetization with the product, it becomes associated with customer KPIs that can be influenced by the product. Examples of these customer KPIs include the number of successful deliveries without delays, the reduction in end-customer churn or the reaction time gained by earlier detection. In this case, the company focuses on the factors that influence the customer’s bottom line and links the business model to improving those factors.
Finally, the company seeks to develop a second customer base where it can monetize the data generated and captured from its primary customer base. For example, trucks have accelerometers that provide information about the quality of roads (such as the presence of potholes) and government functions responsible for road maintenance may be willing to buy this information. The result is a two-sided market where the company still sells to its primary customer base but also monetizes the data from its primary customer base to its secondary customer base. Over time, of course, the secondary customer base may become the more important one, which then fundamentally changes the incentives within the company.
Concluding, as part of your digital transformation, the business model that you employ will have to change and evolve as well. As we’ve shown, this evolution follows a pattern and jumping over intermediate stages tends to lead to failure. Although our model focuses on the embedded systems domain, I believe that all industries evolve through similar or identical patterns. As you experiment with evolving your business model, the stages presented here may provide guidance on where to focus next. As always, we’re eager to learn more about your experiences, so please reach out to us to share them.