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29-11-2021 09:00

An EaaS-y answer to reducing capital expenditure?

At Nordea's Offline to Online event, the topic of service based business models was on the agenda. Equipment-as-a-Service (EaaS) relates to a whole range of equipment that is used on a “pay as you go” basis rather than by purchasing and owning the machine itself. As technology and the ability to monitor equipment usage rapidly evolves, EaaS presents opportunities and challenges for customers, manufacturers, banks and insurers alike.
Driverless Digger

Payment models have changed a lot over the years. In the past, the growth of credit cards displaced hire purchase agreements; more recently post-purchase payments such as BNPL (Buy Now Pay Later), which enable consumers to pay in instalments, are becoming increasingly popular as shoppers seek alternative ways of financing purchases. Another fundamental shift has been the emergence of subscription-based services, from Netflix to business applications like Slack and Microsoft Office.

It’s not just software where “as a Service” models are replacing traditional upfront purchases. Equipment-as-a- Service (EaaS) isn’t new, many manufacturers have been offering it for years; for example, companies that make jet engines make the bulk of their profits on the maintenance contracts that are based on hours of use. But with companies looking to free up capital and become more agile, this model is attracting renewed attention. The potential benefits for companies that are reliant on expensive equipment are huge, and it can help the equipment manufacturers build relationships with its customers, but there can be downsides.

“Well-executed services businesses can increase customer satisfaction by 10 to 20 percentage points and reduce costs by 15% to 25%.”

McKinsey, Introduction: The services solution for unlocking industry’s next growth opportunity, January 2019

What is Equipment-as-a-Service?

EaaS, as the name suggests, is the option to use equipment, which can be almost anything, on a “pay as you go” basis rather than by buying it. But this is much, much more than just switching from buying to leasing. Sometimes there will be an upfront cost with EaaS, such as with jet engines. The key difference is that EaaS contracts are typically focused on the maintenance of the equipment. There’s an old marketing adage about people wanting holes rather than drill bits. And that’s what EaaS can deliver — companies like Rolls Royce now talk about selling thrust, not jet engines.

“People don’t want to buy a quarter-inch drill. They want a quarter-inch hole!”

Professor Theodore Levitt, Harvard Business School

New technology, specifically Internet of Things (IoT), is making EaaS an option for more manufacturers and more products. It’s now relatively easy to add sensors to equipment that enables you to remotely track where it is, how it is being used and its condition. The sensors are getting smaller, cheaper and more robust and connectivity contracts can be less than $1/month.

Being able to gather data on miles travelled, hours of operation, use of consumables and what loads are placed on equipment is incredibly powerful for manufacturers. Not only does it enable them to embrace this new business model, it can help shape new product development and build stronger ties to their customers.

Why now?

At the Nordea “Offline to Online” event in November 2021, Greger Svanström from Volvo Construction Equipment talked about why Volvo is embracing the EaaS model, “You have machines that are only going to work properly at a 95% availability. From the customer side, you also want to align your production and your costs. So if you have a situation where you can’t produce so much, you don’t want to pay so much either.”

Business agility has become a familiar buzzword over the last decade. It has become a key topic around the boardroom table, or conference call, partly due to the effects of the COVID-19 pandemic. The last couple of years demonstrated just how quickly things can change. Businesses that were not able to adapt at speed suffered more than those that could adopt new models and change cost structures quickly. As a result, companies are changing strategy and no longer want to be tied into fixed, long-term contracts that could constrain their ability to change strategy and shift focus—even if they mean some short-term savings.

Additionally, many manufacturing industries are seeing unprecedented change as market requirements change, including the rising demand for personalisation. There is also growing pressure from consumers to improve sustainability. All these factors are driving manufacturers to look at updating their equipment. And for those with large investments in legacy technology this could be a huge cost.

However, with new competitors springing up, doing nothing is not an option. Many new entrants don’t have the same “technology debt” and can leverage EaaS to enter a new market; and then in some cases offer EaaS themselves.

What are the challenges?

The potential benefits to customers are clear: reduced capex requirement, increased flexibility, improved agility and the ability to align costs with use. This can help companies to enter new markets and expand with less financial risk. It can also help them deal with fluctuations in demand, like seasonal peaks and troughs.

For the providers of EaaS the picture is more complicated, especially if they are an established manufacturer. Although the upsides are quite clear — EaaS offers the opportunity to develop closer relationships with clients and gather more data — there are many other things to consider from impacts to cash flow to changes in insurance.

Moving from large upfront purchases to smaller regular payments can have a huge impact on short-term cash flow. It can also change the company’s payment processing needs — instead of one six-figure payment there might be hundreds of four-figure payments. Ensuring smooth operations during the transition period requires strong planning, cash management and reporting. Especially if you operate internationally, as many manufacturers do, as the ongoing nature of the purchase increases the likelihood of significant currency variations. Manufacturers must also consider the impact of inflation, which is at a decades-long high in many countries. Getting contracts right will be critical to success.

Introducing EaaS can also dramatically change a company’s cost and risk model. Previously a company might sell a piece of equipment covered with a one-year warranty. But now the manufacturer is selling holes not drills, so it is up to them to make sure that the equipment is operational throughout its lifecycle. The theory is that the manufacturer is able to maintain the equipment more efficiently and effectively than the user. Implementing predictive maintenance, using all the data that can now be gathered, can help. This should create a gap, profit, between what the customer pays and what it costs the manufacturer to deliver the maintenance. But pricing this relies on getting the pricing right.

If a company starts offering EaaS it could also be liable if the equipment is out of action, i.e., if the service is not available. Should this downtime go on to affect other parts of the business — such as an excavator failure holding up an entire construction project — the customer may expect compensation. The equipment users may also expect financial restitution if the equipment causes damage due to maintenance issues. Choosing the right insurance, agreeing policy conditions and ensuring that conditions of cover are followed could be critical.

The high level of customisation and personalisation required in modern equipment also makes it challenging to apply generic prediction models to assess the required level of equipment financing risk. Making the predictive modeling accurate is a fast developing area as banks and leasing companies gain more and more insights from increasingly connected equipment being deployed.

“Old habits and culture take some time to change. When you're working with something new, it can be problematic if it’s always expected to be a revolution and not an evolution. And maybe moving over to service contracts, having electrified machines and autonomous machines is more on an evolutional side.”

Greger Svanström, Head of Trade and Customer Finance, Volvo Construction Equipment

How to adopt EaaS

Any major change comes with risk, and EaaS is no exception. Moving from an established business model to a radically different one is a major decision. It can affect capital requirements, cash management, borrowing requirements, FX management, credit checking needs and more. That’s why companies like Volvo CE are working with Nordea to co-innovate.

“New technology is a risk. It’s a risk for us but it’s also a risk for the bank. But it is there today, and we need to address that risk. We need to be able to finance it and insure it. So let's work together on this one.”

Greger Svanström, Head of Trade and Customer Finance, Volvo Construction Equipment

Banks are seeking to provide manufacturers with critical EaaS components like funding, cash management, flexible billing systems and scalable payment processing. Beyond the sort of services customers might traditionally expect from their bank, they also beginning to provide advice on things like advanced data analytics and the artificial intelligence (AI) models required to forecast risk and optimise the pricing of new business models like EaaS.

Ville Sointu, Head of Emerging Technology at Nordea, says: “Our customers are changing and the way we all do business is constantly adapting. EaaS offers both manufacturers and consumers huge potential benefits. Over the past few years we have invested heavily in building systems and updating our processes so that we can keep ahead and offer our clients enhanced experiences and more flexible options. Because we have embraced change, we are in a strong position to help our customers to do the same.”

For more information on machines as a service at Nordea or the topics raised in this article, please write to Ville at ville.sointu [at] (ville[dot]sointu[at]nordea[dot]com).

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