Pathway to Servitization

Amid changing customer expectations and disruptions from the pandemic, equipment finance companies are considering new service models. 

The equipment finance industry’s long-standing reputation for flexibility, responsiveness and innovation continues with servitization, models of financing that shift from assets to services. The topic was the focus of a popular breakout session at the 60th ELFA Annual Convention that included an overview of servitization, critical operational considerations and execution opportunities and challenges. 

What is Servitization?

Cam Krueger, Managing Director, Specialty Finance, Accenture, opened the session saying, “We believe that we’re moving beyond the traditional one-asset, one-contract, one-term, one-borrower kind of traditional lease and loan financing, and moving into something a little more complex,” a key takeaway from a report he recently co-authored, “Servitization: Making the shift from assets to services.”

Of the origins of servitization, Krueger commented, “We’ve been at this for quite a while if you think back to connected copiers, which were one of the first examples of servitization. You’d plug the copier into a telephone line that would dial out and report when it was low on paper or toner.”

There are, in general, four distinct parts of what a servitization model could be, all of which present difference opportunities and challenges.

All-In Finance: The main distinction of all-in finance is the customer leases an asset and it is bundled with a service. 

Outcome Finance: In which the customer pays for specific outcomes, such as price per mile, price per page or price per gigabyte for a limited number of assets for a fixed term. For the finance company it is fixed and variable cash flows with a minimum customer commitment, which requires usage tracking that adds complexity into the model. The consumer gets the flexibility to increase or decrease as needed.

Managed Services: The customer pays for a service based on the use of multiple assets under a service level agreement for a fixed term. For a finance company the implications are fixed and variable cash flows for a fixed term.

Subscription/Utility: The customer subscribes to a service either as a commitment for a duration of time for a number of users, a specific term or other requirement, and the customer can cancel with a limited notice period. 

Getting Started

Setting up a servitization model is a very complex undertaking. Diane Croessmann, Director, The Alta Group, has compiled a 300-line checklist for servitization model implementation. She explained, “The 300-line-item checklist is the result of observing mistakes that have been made due to inadequate execution planning. I consider it a ‘best practice’ checklist because it provides guidance for newcomers to servitization to avoid similar issues.”

Krueger shared three steps for execution, the first of which is to develop a blueprint. The blueprint should have an “as-is” assessment of your capabilities, and define what the “to-be” is. During this process, redefine what your business processes and capabilities will need to be to make it work. Prioritize them to look for quick wins, and reduce complexity since it is one of the major issues of the servitization models due to the number of parties involved. “You need to simplify before you can get complex,” Krueger said. “You’ll never get to version 2.0 if you don’t get version 1.0 implemented.” 

Next, design a detailed implementation plan that will address the critical elements. It should be a short, focused list of core elements that impact your customers and your business, such as risk and credit management, syndication strategy, sales and dealer alignment, and legal considerations. 

There is a sustainability element that can be applied to servitization by moving the implementation to the cloud. This is an added benefit since the shift to the cloud is one of the major sustainability and environmental responsibility issues that is facing the financial services industry. 

The last part is to execute against it by creating a solid version 1.0 that works. Consider technologies like robotics to automate repetitive processes, and artificial intelligence and analytics to deploy the system. Continue to redesign and consider the strategic imperative of the project. Finally, a good maintenance and governance component should be included. 

Critical Operational Readiness Activities

Panelists presented critical operational readiness activities for guidance in moving from conceptualizing the offering all the way through to execution. Croessmann said, “My personal observation is that oftentimes service providers or OEMs who have services organizations try to move a little too quickly because they are eager to launch these programs. They skip over critical activities which sets them up for either a lot of redo later on or potentially even failure in the program.”

Joseph Pulicano, Managing Director, Specialty Finance, Accenture, said, “Moving to as-a-service is developing new capabilities and increasing the level of maturity in those capabilities in everything from credit and pricing to asset management. It is really a journey where basically the players are moving from Products to Services sales by developing new capabilities that they did not have when they started.”  

At a minimum, a thorough understanding of traditional leasing is required in order to think about addressing a services type of process or program. The following are key areas of consideration: 

Market analysis: Performing critical assessments for product offering development. Activities include identifying what the addressable market is from a financial standpoint, whether you will focus on enterprise accounts, general markets or specific verticals, or all of the above. This is an iterative process that starts broadly and narrows.






Value proposition: Aligning market needs to essential product development. You will need to solicit feedback from end users, sales resources and channel partners to ensure that they are comfortable with the concept. That feedback can be turned into a preliminary offering. This is where developing communications starts: with end users to demonstrate the economic value, with channel partners to overcome any objections they might have to potential interference in their business, with sales resources to motivate them to learn something new, and internally with executives and the rest of the organization to understand the strategic value. 

Alliances: Developing successful organizational and other go-to-market strategies. There can be a lot of parties to these contracts. There may be subcontracted services and go-to-market relationships, so focal points are needed to interact between the organizations. Define the roles and responsibilities especially as they relate to services, because in the event of a default the failure to do so can be a critical alliance risk. Finally, objectives must be aligned between all alliance partners, especially if there is a go-to-market capability.

Legal issues: Weaving end user, funder and service provider requirements into key documents. All of the relationships being combined to present the end user with a contract have requirements and potential for risk. These intricate relationships must be well managed to avoid inadvertently subordinating one party’s risk to another, in the template you create, as well as in any changes that are made.

 
Funding: Monetizing payment solutions with traditional and non-traditional contract flexibilities. Whether funding internally or with a third party, ensure that funder has the capacity to handle the nuances of services contracts such as usage billing. These contracts are services contracts, not leases, which are owned by the services provider, not the funder. This is a shift in roles and responsibilities, which may find the service provider in a delicate position in terms of its ability to monetize the transaction or impact the sale revenue. 

Managing risk: Mitigating data security, performance, credit, residual, usage and flexibility risk. Thorough risk evaluation for managed services transactions ensures critical risk areas stay within defined tolerance levels for all parties to the contract. Service contract risks extend beyond traditional leases and include the following:

• Credit – Requires a scalable and comprehensive internal, or if monetized, a third-party underwriting process.
• Residual – Secondary market opportunities need to balance with balance sheet implications of retaining residual ownership.
• Performance – Ensuring performance continuity from service providers is a key preventative to the risk of early contract termination.
• Usage – Risks to recovery of asset values due to usage flexibility or cancellation requires strong secondary use programs.
• Data Security – With IoT connectivity, security and privacy risks increase. Any access or use of data requires regulatory compliance.
• Accounting – Service provider sale revenue recognition and off-balance sheet treatment requires paying attention to recourse risk. 

Accounting: Optimizing revenue and balance sheet strategies. Service contracts are often incorrectly positioned as “off balance sheet” for end users. Under most conditions, a contract with “embedded lease” content is not “off balance sheet.” 







Croessmann cautioned, “These things can sometimes be so complicated that it doesn’t take a lot to have a potentially flawed accounting classification.” 

Pricing: Incorporating predictive behaviors into pricing for performance and usage flexibilities. Thorough configuration and pricing evaluation and performance management for as-a-service solutions ensure deal profitability meets expectations throughout the contract. As-a-service contract pricing extends far beyond traditional leases. Pricing covers multiple dimensions linked to the various components and the structure of the deal, and needs to include financial performance management.

Asset management: Identifying opportunities to improve asset tracking and usage optimization. An asset management platform is required to track each asset individually as well as customer consumption, and link it to the customer portal and the contract, billing and tax management systems.


“These deals usually include tens, if not hundreds, and sometimes thousands of assets,” Pulicano noted. “These assets are very often distributed and you really need to understand the assets that are involved in the deal. You also need to have the capability to track all these assets, and more importantly, to track all the events related to these assets. For example, the replacement of an asset that has technical issues, or removing an asset from the contract needs to be tracked and shared with the asset accounting system. To that extent, the AAS provider needs a pretty solid asset tracking platform closely integrated with the accounting system.”  

Administrative: Identifying requirements for new tools and processes to support usage models. The administrative management of AAS contracts comes with an increased complexity due to the increased number of parties involved in the deal, the variable nature of the contract, and the more complex revenue recognition/accounting rules.

Successfully coordinating all these functions is quite an undertaking. As Pulicano noted, “All the departments will need to work together in order to not only design the solution, but also validate and ensure that it can be delivered and that the whole thing will work from an accounting, tax and operational perspective. So, there is a need to involve multiple experts in designing the deal.” 

Real World Implementations

Despite the tremendous complexity of servitization models, equipment finance companies are working successfully in this space. Stryker Flex Financial uses servitization options, particularly in the healthcare space. “Our goal is to meet the customer where they are, and create solutions and programs that help them meet not just their clinical goals, but also their financial goals,” said Stryker Flex Financial VP and GM James Cress. “As a result, our customers are demanding more flexible solutions, more risk sharing, and more outcome-based results. This leads us to solutions that combine the breadth and depth of Stryker products and services in a way that drives hospital outcomes.” 

GreatAmerica Financial Service Corporation has roughly 130,000 contracts that they are administering per month that have a bundled component. Most of them are office equipment, MFP imaging and printers, and all have a minimum payment and a set term. 

Brian Bjella, SVP and GM, GreatAmerica Financial Services Corporation, said of the company’s servitization strategy, “We’re working hard to pick our lanes—two or three lanes that can encompass 80 or 90 percent of the opportunities that we want, build our processes and technologies around those, and perhaps steer other opportunities in that direction as well.” 

He added, “We’re not going to out-bank a bank as an independent, so being astute in our ability to manage these types of programs and processes are where we see the future going for our organization. I would strongly encourage others who are trying to do this not to try to be everything to everybody. Figure out where you can provide value.” 

Customers Driving Change

Expectations of equipment finance end users are continuously evolving. They are demanding flexibility in agreements, more risk sharing with their partners, and more outcome-based models. Given this and the disruption from the pandemic, the demand for change and more balanced agreements is becoming more urgent and more frequent. Equipment finance companies that want to be competitive and responsive to their customers need to consider if servitization models are an option for future growth.

As Cress commented, “When you think about customers and how [the way] they are consuming capital is changing, whether we want to move to these models or not, they’re going to force us there.”