May 1, 2014

Why Manufacturing is the New Service Economy

Integrating growth and profit strategies to create more satisfied customers

It started with a saw blade. In 1837, blacksmith John Deere fashioned the polished steel into a plow that could cleanly cut through the sticky soil of the Midwest. Five years later, he was making 100 plows a year. By 1849, Deere’s Illinois manufacturing operation produced 2,136 plows and employed a team of 16.

Today, plows, tractors and other farm equipment are still the foundation of Deere & Company (commonly referred to by its brand name, John Deere). The global manufacturer’s equipment operations generated sales of $35 billion last year. But Deere, like a growing number of manufacturers, has expanded its portfolio to include service-minded solutions that extend the relationship with its customers well beyond the sale of fabricated products.

This is not old-fashioned customer service with a smile: Using Big Data and new technology, John Deere provides advice to customers about crops, irrigation, feed, the weather and more, as well as continuous updates on equipment. This valuable support creates an integrated, ongoing relationship with customers. With an eye to the future, a recent Deere video featured a farmer triggering the day’s plans with a swipe of his hand across a flat screen, then receiving a wireless alert that a technician was on the way to fix a tractor malfunction—well before the farmer even finished his first cup of coffee and ventured outside.

Deere is not the only iconic brand to recognize that its fortunes are tied to expanding itself beyond its core manufacturing and product sales. For most of the last century, Rolls-Royce has sold finely tooled cars and aircraft engines made for civilian and military purposes. British engineer Henry Royce and businessman Charles Rolls formalized their partnership in 1906, less than two years after Royce designed his first car and the same year they released the Silver Ghost, hailed then as “the best car in the world.”

But Rolls-Royce has increasingly shifted the line between making things and selling services. Rather than simply making and selling an engine, the company leases it instead, contracting with many of its customers to pay for each hour of engine operation. In turn, the company agrees to maintain it and replace it if it breaks down. That allows the company to stay close to its customers and better understand the strengths and weaknesses of its products. As The Economist has noted, Rolls-Royce “continuously assesses the performance of 3,500 jet engines around the world, raising an almost insurmountable barrier to any rival that hopes to grab the work of servicing them.”

The OEMs don’t see us as just another service center,” Brenneis says. “We have become an extension of their manufacturing operation.”


Metal service centers that are alert and on top of their markets are developing in much the same way. To grow, stay strong and be increasingly profitable, they have steadily moved away from just warehousing and distribution to customizing products for their customers. They recognize that high-quality, value-added service generally offers fatter margins than storing and shipping metal. Cutting, shaping, forming and fabricating, responding to clients’ demand for more metal processing—service centers are following John Deere and Rolls-Royce in a trend that increasingly blends manufacturing and service. More and more, the distinction between the manufacturing and service economies is diminishing.

Keeping Up With What Customers Wanted

Back in 1997, Marmon/Keystone, in Butler, Pa., recognized an opportunity to expand beyond its core distribution business of pipe and tubing by offering customers finished or semi-finished parts produced by outside machine shops and other vendors. To make it work, the company initiated a value-added services group that not only offered this service to customers, but also identified vendors to perform the processing from among its own customer base. “We were keeping up with what our manufacturing customers wanted,” says Kenneth Sichelski, VP of sales and marketing. “We got so sophisticated, learned so much about our manufacturing customers’ business, we became an extension of their business.”

Three years ago, this value-added services operation was set up as a separate profit center, and it now represents 25 to 30% of Marmon/Keystone’s total revenues, according to Sichelski. Both Sichelski and Tom Brenneis, director of value-added services, envision continued growth for the unit—a vivid sign of the rich wellspring that Marmon/Keystone tapped and an illustration of what can happen when a company successfully identifies customer needs and figures out how to service them. “We go in and ask a customer, ‘Where do you have bottlenecks? What are your pinch points in processing?’” Brenneis explains. “We try to go after parts and assemblies that have never been outsourced. I want a part or assembly that is a nuisance, a bottleneck, and [has been] manufactured forever in-house.”

The goal is to set up repeat production contracts, link equipment manufacturers with vendors and take advantage of the Marmon/Keystone team’s expanding expertise to manage the process. “We put a program together—we are not a job shop,” says Brenneis, noting that this both expands the company’s relationship with customers who get a “nuisance” solved and enriches its relationship with its current base of about 800 vendor-customers (most of which are small and independently owned). “Most larger OEMs [original equipment manufacturers] have been reluctant to trust anyone to do what they thought they could do themselves. But when it comes to producing nuisance pieces, they are terrible at it. It’s their Achilles’ heel.”

Pursuing this business has not only created a significant and growing profit center, but also has established Marmon/Keystone as an integral partner for its customers. “The OEMs don’t see us as just another service center,” Brenneis says. “We have become an extension of their manufacturing operation.”

Sichelski says that services could grow to 50% of revenues within five to seven years. It’s hard to miss Brenneis’ enthusiasm: “Right now, in my opinion, value-added is in its infancy.”

Creating a Bundle

While every manufacturer and distributor—indeed, every company—may offer anecdotal evidence of its attempts to provide customer service, Suzanne Berger of the Massachusetts Institute of Technology (MIT) believes that many companies aren’t aware of the extent to which they already are involved in providing services. As co-chair of MIT’s Production in the Innovation Economy project and author of the 2013 book Making in America: From Innovation to Market, Berger and her research team interviewed more than 250 companies, ranging from small startups to General Electric. “Almost all of the manufacturing companies doing well—they were doing bundles of products and services,” Berger says. “I think our ideas have misled us that there is a steep distinction between making things and the service component.” 

Berger describes visiting a 100-employee company in Ohio that fabricates half sleeves to repair oil pipes. Exporting about 70% of its product, the company sends out technicians along with its customized half sleeves. “If you ask what they are selling, it really is a combination of [manufactured] product along with customization and service,” she says, adding that many manufacturers “are not recognizing what they are doing and not recognizing the potential to expand that service piece of the business.”

A 2012 report from the McKinsey Global Institute, “Manufacturing the Future: The Next Era of Global Growth and Innovation,” estimated that more than 34% of U.S. manufacturing jobs involve service functions—such as R&D, marketing and sales, and customer support—and that number will continue to grow. But the presence of service activity extends beyond these usual roles.

“The intangible results of the continuing IT revolution, in the form of reshaping entire economic sectors and business models, may prove to be even more consequential than innovation on the factory floor,” write Michael Lind and Joshua Freedman in “Value Added: America’s Manufacturing Future,” a 2012 report by the public policy institute New America Foundation. “One of the most important trends is the blurring of distinctions between the manufacturing sector and the service sector.” While traditional manufacturers focused on converting raw materials into finished goods, the researchers note, they often ignored the opportunity to provide maintenance, repair and other related services connected to the installed products. The authors assert that “the integration of services with manufacturing provides manufacturing firms with a method of competing by providing services along with products, rather than competing merely on the basis of price.”

The Challenge of “Servitization”

This transformative shift is what Andy Neely calls “servitization.” Neely, director of the Cambridge Service Alliance at the University of Cambridge and one of the leading researchers in the field, describes this simply as “firms developing the capabilities they need to provide services and solutions that supplement their traditional product offerings.” Based on public company data, he estimates that the majority of U.S. manufacturing firms, about 55%, are engaged in servitization. This is the highest level in the world (followed by Finland, Norway, Malaysia and Belgium), according to Neely’s findings.

Neely acknowledges that making the shift is challenging for all businesses. “They have developed really strong technical and product capabilities,” he says. “Services are different—they require closer customer engagement and cooperation. Making the cultural shift is inevitably challenging and takes time and dedication.” In his global study of servitization in manufacturing, Neely summarized the challenges like this:

  • Shifting mindsets of sales, from selling multimillion-dollar products to selling service contracts and capabilities, and of customers, from wanting to own the product to being happy with the service.
  • Rethinking “timescale.” That may include managing and delivering multi-year partnerships; managing and controlling long-term risk and exposure; and modeling and understanding the costs and profit impact of long-term partnerships.
  • Revising the business model to understand what value means to customers; to develop the capability to design and deliver services rather than products; and to shape a service culture internally. “Start by being really clear about the outcomes your customers value—what is it they really want,” Neely says. “Then consider how you can revise your business model to deliver the outcomes they want. Often this shift involves the customer shifting responsibility for outcomes from them to you. So it is also crucial that you understand the risks that you will be taking on as a consequence.”
Despite the challenges, Neely’s research suggests that companies are recognizing the strategic benefits of locking in customers, locking out competitors and finding new ways to differentiate themselves. As he explains, this movement into service becomes increasingly necessary as manufacturers in developed economies struggle to compete on cost. Certainly, alert companies in developing economies have gotten the message. While less than 2% of Chinese firms offered services in 2007, according to Neely’s data, by 2011 the percentage had risen to nearly 20%.

Complexities aside, MIT’s Berger may have identified the most important factor for not only pursuing service business in the first place, but also expanding and sustaining it over time. “It’s surprising to see how often the companies mentioned the profitability of the service components,” she says. Neely noted that, while precise numbers are problematic, a “rough rule of thumb” is that revenues on parts and support are around four times the original purchase price of equipment, and margins can be as much as 10 times the margin on an original purchase.

“Almost all of the manufacturing companies doing well—they were doing bundles of products and services. I think our ideas have misled us that there is a steep distinction between making things and the service component.”

Your Inventory Is Our Inventory

Metals distributor EMJ, named for its founder Earle M. Jorgensen and a subsidiary of Reliance Steel & Aluminum Co., offers a classic picture of service. It still uses slogans created by its founder in the 1920s: “Hustle, That’s All” and “Only customers pay our wages.” (No, it doesn’t use “service with a smile,” although it does tell visitors to its website that EMJ has an “excellent reputation for quality and service.”)

But EMJ, headquartered in Lynwood, Calif., is not living in the past. Rather, in addition to 38 service centers in the United States and Canada, it has put in place what it calls “the largest automated inventory storage/retrieval system under one roof in the world”—a 10-story robotic operation in the Chicago area that picks, packs and labels with bar codes every order that leaves the building, providing managers with real-time production data. The resulting accuracy and speed—matched with a delivery system that includes truck sensors and other data tracking—allows EMJ to boast this catchy customer guarantee: “On Time, Or Free.” According to James Desmond, EMJ president and CEO, 80% of orders are shipped the next day.

The combination of expanded storage capacity and ability to achieve on-time delivery also has enabled EMJ to take over the responsibility of housing inventory for some of its customers. “Some of the manufacturers we sell to would much rather have the inventory on the floor and have always done it one way,” Desmond says. But in other cases, “we can help them implement a different system for inventory.” This can include stocking specialty materials based on their history of usage and forecasting when customers will need to reorder.

As a result of EMJ’s automated process, “we already have the stuff ready to ship,” Desmond says, noting that sometimes EMJ staff participate in customer production meetings to identify other potential efficiencies. “Our business,” he adds, “is servicing inventories, making their inventories lean and on time.”


Thinking Outside the Tank

Mass Tank is one of the last remaining manufacturers of steel tanks in New England. It operates out of a 60,000-foot facility in Middleborough, Mass., that formerly was the manufacturing plant of Maxim Fire Trucks. When Carl Horstmann bought the 90-year-old company 15 years ago, he counted about a dozen competitors in the region. A former banker who had returned to the United States from overseas, Horstmann has been determined to make the business succeed, even as others faded away. “We’ve been able to survive and thrive by diversifying our product base and revenue stream,” he says.

That includes not only making about 2,000 tanks of various sizes each year—some as large as 80,000 gallons or even larger when assembled on-site—but also venturing into parallel service work such as inspecting and repairing tanks. What Horstmann has discovered in the last few years is that he can dramatically expand his customer base by making use of his company’s engineering and related technical knowledge. While he continues to pursue new markets to sell standard and custom tanks, he is excited by the potential of the service side. It currently makes up about one-fourth of Mass Tank’s total revenues. “We are really focusing on growing this business,” he says. “We have a distinct advantage because we have so much expertise on the fabrication side.”

Horstmann’s certified inspectors have been sent to jobs around the United States and such places as Panama, Puerto Rico and Italy. (“It’s a lot easier to send an inspector than a tank,” he says, and “the margins are better.”) In many cases, they may simply perform the inspection and report the findings. But when they find problems, they often are asked to write up a scope of work and quote the cost of repairing or replacing the tank. “The two businesses are feeding each other,” Horstmann says. “Every tank needs to be inspected. There’s a lot of business out there. A lot of it.”

To date, Mass Tank has handled inspections of above-ground and underground tanks for such diverse customers as the U.S. Navy, Harvard University, Ocean Spray Cranberries, Eastman Kodak, Liberty Mutual Insurance, The Boston Globe, Bank of America data centers, and various power and energy companies. Horstmann envisions opening offices in other parts of the United States and internationally to drive growth in sectors as varied as petroleum, pharmaceuticals and power.

“It’s really unlimited where we can go,” he says. Still, he is treading carefully, trying to find the most capable staff, armed with the necessary certifications and prepared to work hard. “We have to be smart about this. We are forced to do this to survive … to think outside the box. We are competitive. We want to grow.”

Steven Beschloss is an award-winning editor, journalist and filmmaker. His work has been published in The New York Times, New Republic, Chicago Tribune, Village Voice, Wall Street Journal and Parade Magazine.