When the topic of Equipment-as-a-Service (EaaS) comes up in conversation, often leaders view this as another means to define a subscription model. After all, EaaS is based on the concept of Software-as-a-Service (SaaS) which at the end of the day is a subscription model, right?
EaaS is a bit more complex since there is a large, physical value that is associated with the business model – the asset. In a SaaS model, there is no physical asset, and the value (and risk) is tied to the software platform and its associated maintenance requirements. The margin for SaaS companies is largely an equation between the cost of selling the subscription and the cost of maintenance/support for the platform vs. the subscription revenue associated with the contract. As most of you are aware, margins are quite high for SaaS companies and with high margins come high valuations.
The Technology & Services Industry Association eloquently defines EaaS as the following:
“Equipment-as-a-Service is about the value-added service around the piece of equipment that happens to be on your customer’s premises. In its purest form, it is a piece of equipment on premise where you provide the technology-as-a-service and help your customer achieve THEIR outcomes. They want outcome-based services.”
There you have it. A service where the asset – while not owned by the customer – is located on the customer premise with the mission of achieving a specific outcome. Sounds pretty good if I’m a customer, right? I can run my business, achieving the outcomes I desire, without the upfront capital of purchasing the asset or risk unknown maintenance costs.
Why is the Customer Shifting?
While EaaS has been around for years, really taking hold in the 1960s with Rolls Royce and their Power-by-the-Hour business model, why are we seeing a stronger shift in customer demand in recent years? Let’s break down some of the recent events that have unfolded:
- COVID-19: Imagine running a manufacturing business where the production line requires a dozen CNC machines, costing roughly $250,000 The machines are financed over five years, and the cash flow from production sales easily covers payments. Fast-forward to a natural disaster like a pandemic, where the entire production line halts for an extended period and demand plummets. Unfortunately, payment obligations on the $3,000,000 investment don’t disappear with demand and now the risk of defaulting becomes a reality. With an EaaS model, my payments may decrease due to a change in the outcome as defined by production rates. Sure, there will likely be a force majeure clause in the contract, but liability won’t fall 100% on the shoulders of the customer.
- Economic and monetary policy: Let’s be honest with ourselves for a moment and establish that for the past 40 years economic and monetary conditions have been very supportive of industrial growth. Following the excessive amounts of liquidity funneled into the economy during the COVID-19 pandemic, the world is now faced with the tumultuous situation of record inflation, energy supply/demand imbalances, labor shortages, and more. To tame the beast that is inflation, quantitative tightening via interest rate hikes and balance sheet reductions has been occurring at a record pace. So, what does this mean for the average business owner or service leader? Money is now expensive. Times of borrowing money at low-interest rates to purchase manufacturing or industrial equipment are in the rear-view mirror. EaaS contracts allow for cash flow with less investment upfront since the business is no longer purchasing the assets.
- Acceleration of technology: We are currently living through an incredible period of technological advancement. Just look at how far computers have advanced in line with Moore’s Law since the 1970s, essentially doubling the number of transistors on a microchip approximately every 2 years. No one wants to be locked into owning a 10-year-old computer anymore, yet buying a new computer every 2-3 years can build quite the tab. The same philosophy applies to larger-scale assets such as manufacturing or industrial equipment. The customer is now focused on how to maximize the output with their current asset in hand, while not pigeonholing themselves to be forced to work with obsolete technology.
Needless to say, the shift to EaaS for the customer seems quite appealing given the reasons above – most of which highlight the benefit of moving equipment from capital expenditures to operating expenditures as an equipment purchaser. However, is it appealing to the manufacturer to provide the contract and outcome to the customer?
Evaluating the Shift to EaaS
To quote a service leader I had the opportunity to speak with recently, “We’re all moving Mach 4 about 20 feet off the ground.” Given the state of the economy, supply chains, inflation, and consumer, I thought this summed up very well what service leaders are trying to navigate today. A shift to EaaS is a massive transformation for any company to undertake, regardless of the situation around them. I’m not saying it’s right or wrong to go down this path, but it’s good to understand all the variables, risks, and return on investment before jumping two feet in. Let’s look at some of the pros and cons of taking on this transformation.
Pros:
- Profitability and valuation: The consistently high margins secured revenue through subscription contracts make these types of investments very appealing to institutional funds. While the customer comes first in service organizations, appealing to shareholders or investors isn’t exactly the bottom of the priority list for businesses.
- Customer and asset engagement: With the asset now being owned by the OEM and utilized by the customer, the rules of engagement pivot to favor data sharing and consistent health assessments of the contract. The data provides greater insight into maintenance requirements for the OEM leading to efficiency and profitability improvements while customer engagement ideally results in continued renewals and upsell opportunities.
Cons:
- Investment in transformation: The pivot to operating as an EaaS business model is not one that happens overnight or with a single IT system change. While I haven’t personally run a large-scale manufacturing company, it’s safe to say that given the significance of the shift to an EaaS operating expenditure business model, extensive review, and approval from the board of directors and investors would without a doubt be required. Once approved, this type of transformation takes years of planning, executing, and continuous improvement for systems, people, and processes across an organization. Additionally, the financial journey will be highly scrutinized the entire way with investors constantly questioning if the return on investment is tracking.
- “With great power comes great responsibility.”: Yes, I did just quote Spiderman, but bear with me as it’s rather applicable in this situation. With EaaS you can reap the rewards of an incredible valuation if the transformation comes out profitable; however, the risk is now fully on your shoulders. The customer focuses on achieving their outcome while the OEM mitigates the risk to the contract and asset. Risk in this situation is defined as asset value, maintenance requirements, quality defects, and more. Remember the amount of debt that companies had to take on when COVID-19 occurred? That force majeure clause in the contract better be thoroughly analyzed before signing.
The great thing about EaaS is it’s a long journey with plenty of stops along the way. OEMs may begin the transformation by offering service contracts to complement their asset sales and stop right there.
Where to Begin?
Regardless of what other industries or peers may be doing, it’s critical to understand the full scope of your Service Lifecycle Management (SLM) and make the best decisions for your company based on evaluating your products, data, systems, people, and processes at hand. In today’s world where digital transformation is more prevalent than ever, leaders are constantly changing individual pieces of SLM including inventory planning, pricing, contract management, and more. The decision to shift to EaaS will require analysis of all SLM components holistically in order to make the most informed decision for your business and customers.