Jeff Kavanaugh, head of the Infosys Knowledge Institute, explains why manufacturers are moving toward a more service-style strategy to build a longer relationship with consumers.

Manufacturing contributes more than $2.3 trillion to the U.S. economy, with upwards of 12.8 million workers in the sector, according to the National Association of Manufacturers. But like all industries, manufacturing is not immune to disruption. Digital transformation has changed daily operations and also pushed companies to pivot from a product-driven strategy to one focused on building a longer relationship with the end-users of those products.

Jeff Kavanaugh believes this strategy, known as servitization, is critical to a company’s success. His work as a vice president at Infosys and global head of the Infosys Knowledge Institute helps firms make the transition. Kavanaugh appeared on the Knowledge at Wharton radio show on SiriusXM to discuss the future of manufacturing. (Listen to the podcast at the top of this page.)

 An edited transcript of the conversation follows.

Knowledge at Wharton:  Let’s start with the term “servitization.” Where has it come from and what does it mean?

Jeff Kavanaugh: The term was coined several years ago in Cambridge, England. The idea is that manufacturing isn’t just about products. We know there are services around it. The transition to services — especially with the technologies and the things that are driving it — is thinking about things more as a longer-term relationship with a customer and not so much a one-time transaction. It’s as simple as it sounds. It’s more about services than about the product itself.

Knowledge at Wharton: How is manufacturing being disrupted? How does servitization factor into that?

Kavanaugh: When the first wave of the Internet hit, mostly consumers were affected. Yes, manufacturers wanted to put up a webpage or needed to. But for the most part, it was the retailers and the folks facing the consumer. What has changed today is that this next wave is really the Internet for industry, or “the industrial Internet” and the things that surround that. It’s no longer a novelty to do the things we take for granted on our smartphones and other things electronically. It’s an expectation, and it’s built into the business model. There are organizations from garages to large companies you’ve never heard of around the world that are doing these things that can now reach into previously protected economic modes or other markets.

Manufacturing is no longer just about putting a bunch of sneakers or sheets of metal on a barge or a boat and going across oceans. It’s about being able to 3D-print a product somewhere. It’s about being able to design something and test it before you ever go through that process. The people who had all this experience, and plants and assets that protected them from others entering — all of a sudden those are no longer an asset. In some cases, they’re a liability.

“Manufacturing isn’t just about products. We always know that there are services around it.”

It’s also about speed. In a world where it takes a long time to build a plant or a factory and set up these supply chains, you’ve got these factors or disruptors that are happening much more quickly. That gap between the amount of time it takes to do something and the need to do so is forcing manufacturers to deal with problems they never had to before. They’ve got to find new ways of addressing them.

Knowledge at Wharton: Could you offer examples of manufacturing companies that are doing some of the things you just described?

Kavanaugh: There are the obvious ones like in the automotive industry, where you’d sell through a dealer and, except maybe through warranty, you wouldn’t know who that customer was. Now, spurred by companies like Tesla and others, they’re considering selling directly to a customer and having a relationship with that customer and downloading software, of all things, and charging you for services like OnStar. That’s one example.

Another company I worked with several years ago produces automotive seating. It is a similar industry, but they’re even farther removed. Yet they need to know the customer. Do you even know the manufacturer of that seat you sit on every day in your vehicle? Probably not, and yet it may be something that you interact with more than almost any other product because every single day you use it. If that’s the case, even though that probably was several hundred dollars worth of value in that vehicle, they risk being a commodity. How can that manufacturer, with its hundreds of plants around the world, make it in a world where maybe that seat gets 3D printed in foam in some small office complex somewhere? Those are two examples.

Knowledge at Wharton: How will manufacturing be affected by this trend?

Kavanaugh: Like most challenges, there’s an opportunity in there somewhere, for someone. First, companies have to not let go of their past, but embrace fresh thinking. It isn’t just, “Let’s build more plants. Let’s modernize the plants we have.” It’s also, “Think about the fundamental relationship with the customer.”

There is this thing called information asymmetry that companies have had where if you buy a product, you own it. It could be a bulldozer from Caterpillar. It could be some household appliance like a stove. You have this information, and the manufacturer doesn’t. What if, through low-cost sensors and Internet and integration, now the manufacturer knows about it? It can let you know when something might fail. It can let you know when maybe there’s a change in regulation or compliance or safety. That’s one example where, if it’s valuable, they can keep that tether of a relationship much longer. You’ve had this appliance for two years or three or five. Maybe it’s time to upgrade. Here’s a coupon. Maybe they serve up ads on the face of your refrigerator. These are all ways that manufacturers can change the definition of what a product is, change the nature of their relationship and even start to have value from the information that the product is generating.

Knowledge at Wharton: You gave a couple of examples from the automotive industry. Are there other manufacturing lines that have seen similar transformation by embedding services as part of their product strategies? What benefits have they experienced by changing to the servitization model?

Kavanaugh: Possibly the first and certainly the classic example that must be in any discussion is Rolls-Royce in aviation. “Selling power by the hour,” I think was the phrase. And Boeing, where not only are you changing the economic model, you’re also trying to measure things much more diagnostically and prescriptively so that you aren’t just addressing problems or operating, you’re also trying to prevent them. I think that the phrase was, “There’s a terabyte of data a day per engine now being collected from the many sensors embedded.” Think about the sheer amount of information where safety is an issue or where it’s a big asset.

“Companies have to not let go of their past, but embrace fresh thinking.”

It also is something as ubiquitous as a building – a good example is Johnson Controls and smart buildings and air conditioning, all of that equipment that you see on the top of your buildings and all the electronics within it. There’s physical security. There’s comfort. There’s the environment, making sure that you have the employees comfortable but also don’t waste. There are all kinds of data that you can collect, that could be fed back. This is just in manufacturing. Manufacturing now is touching many other industries where humans walk around and people interact.

Knowledge at Wharton: We have spoken about the benefits of servitization. What are the risks?

Kavanaugh: I can think of two in particular, and maybe a third one. The first one I call “the dark side of servitization,” where taking advantage of technology, instrumenting, embedding, making all of these wonderful things we just mentioned, doesn’t guarantee you’ll make any money. Let me repeat that: It doesn’t guarantee you’ll make any money. Just because you can do something doesn’t mean someone is willing to pay for it. One of the reasons why consumer apps are so popular on phones is that usually they’re free, at least to pull you in, and then you pay for something.

Think about a company that has all these plants — one, 10, a dozen, or more. One of our clients had 200 plants. How do you introduce these new manufacturing and service models and yet make money in the process? Or if you make a lot of money selling a product or a certain amount, how do you ensure you don’t cannibalize that so fast that the incremental subscription revenue or the revenue over time isn’t enough. That’s one issue.

The other is when these products — whether they’re household or commercial or industrial — generate data, who owns it? As an aside, I’ve got a family farm, and as I work with the farmers, they generate all kinds of information. The agri-manufacturers — the John Deeres of the world, the seed companies, and others — they want to get their hands on data about soil and about the plants and the equipment and what’s going through the combines. They want that information from the farmers. The farmers say, “It’s ours.” How do you evaluate or identify value for that?

It’s the same thing with personal data and the life sciences companies, the pharma companies. It’s the same thing if you have data at your house, the way you use a product. What data do you actually own? I think that’s a challenge in this brave new world of connectivity. What are the boundaries, what are the responsibilities, and what are the legal ramifications?

“Think hard about how to get on that same side of the table as your customer.”

Knowledge at Wharton: What can manufacturers do to mitigate some of these risks so that they don’t have to remain on the dark side?

Kavanaugh: First, don’t abandon traditional economic or customer models as you race after the newest technological wonders. Embedded sensors and connectivity and cloud and AI aren’t by themselves making this happen or will make you money. They’re tools. Know your customer. Have transparency. That’s an overused word, but have transparency and let people know there’s not some nefarious agenda, which is why the social media companies have run into some trouble recently. Even if what they’re doing overall is net-positive, it can come across in a negative way. Who owns the information? Why are you collecting this?

Also, think hard about how to get on the same side of the table as your customer, so it’s shared value. And the last thing is, be creative and find new ways to excite people. I think that’s what’s important. Turn it into an experience.

Knowledge at Wharton: How do these ideas relate to Boeing and the problem it’s having right now with the grounded 737 MAX?

Kavanaugh: It’s unfortunate that this happened to a proud company with more than 100 years of a strong track record. This was possibly because an expedient decision, a problem they thought they could mitigate through a piece of technology, came back to haunt them. Two situations, maybe more, could happen — and it wasn’t just the first occurrence, it was the follow-up ones that made it worse. Whether it’s a failure of public relations or of systems thinking, let’s face it, we live in a world that is so complex that few of us really know what these systems are or how complex they are.

Ultimately, it comes down to trust and credibility. When you work with a company that does a complex thing that affects your life in some way, whether it’s a vehicle or an aircraft or medicine, ultimately you’ve got to trust them. And I think it was probably a matter of customer and market trust that wasn’t considered as top priority.

Knowledge at Wharton: What are some of the most common mistakes you’ve seen companies make with servitization? What lessons can be learned from the way in which they dealt with those mistakes?

Kavanaugh: One of the mistakes is a reluctance to jump in, thinking it will be premature, and that it was better to just wait until [the situation becomes] more mature. The companies that early on experimented and experimented frequently, they developed the scar tissue. They learned [through] small mistakes and small wins. They understood what worked for them, what worked in the factory, what worked on the shipping dock, what worked in the retail showroom. Then they could build on that learning while the cautious ones never got out of the gate.

“Don’t abandon traditional economic or customer models as you race after the newest technological wonders.”

The second mistake I see companies making is after they experimented, sometimes leaders would highlight these proofs of concept to their leadership as victories unto themselves. Well, that was the initial victory, but it didn’t scale. I’ve interviewed many industry leaders in interviews and at conferences, and that’s consistently the thing they struggled with. How do you scale the experiments and the proofs of concept, because then you’re dealing with things that aren’t just technical. They’re cultural. They cross organizational boundaries. And unless the very most senior people in the company address it, you’re down to silos. You’re down to people competing, maybe the different vice presidents or at different organizational levels.

I think the last thing is to make sure your company continues to evolve, making refinements and keeping your eye both on the customer and the economic model. Those are the three things that I’m seeing.

Knowledge at Wharton: I was struck by the fact that you say that this approach to bundling products and services ties in with the United Nations’ Sustainable Development Goals. Can you explain that connection?

Kavanaugh: I’m glad you brought that up because it’s something near and dear to my heart. Beyond the profits and beyond the people, which are very important, is the broader planetary aspect, embodied in the UN’s 17 Sustainable Development Goals, I think SDG No. 12 is on responsible consumption and production, and it relates to the circular economy. It’s about not starving yourself or doing without, but creating and consuming responsibly. The implication of servitization, the implication of having a longer-lasting asset that’s updated through software or other means, means that we don’t have to make and throw things away. That holistic thinking not only will help our planet and help broader goals that everyone can and should get behind — must get behind — it also can help companies become more profitable through having less inputs and yet driving more outputs. I also think it’s sustainable as a company because you just can’t afford in these supply chains to have all the waste.

Knowledge at Wharton: I would think sustainability would help not only with the manufacturing processes, but also with the employees and consumers who want to support a company that is being environmentally responsible. It works from different angles.

“Manufacturing now is touching many other industries where humans walk around and people interact.”

Kavanaugh:  You’re already starting to see it in Europe where, over time, the annual reports and the requirements of companies by their governments will include, besides the profitability and the accounting standards, the impact on their employees and working conditions. And it will also include the environment and social and governance aspects. That will be embedded. It won’t be ancillary. Now, most companies have a social and governance and environmental sustainability report. What’s going to happen is they’ll all be together, that triple bottom line — people, profits and planet. It’s like an income statement. You’ll have those metrics. And the sooner companies understand these, I think that’s going to be something that positions them to be successful in a future where people will decide who they do business with based upon these other factors.

Knowledge at Wharton: How close are we are to having all three of those elements in sync, not just in certain countries but around the world?

Kavanaugh: Incrementally, it has already begun. The U.N. has taken the lead with it. The World Economic Forum is starting to adopt them. At Davos last year, I saw that it was more prominent. I think there will be a few northern European and western European countries that will take the lead on this.

It will probably be five years before it filters to other countries as requirements, but sometime in the late 2020s, you’ll even see it in the U.S. There will be a tipping point, but I believe the companies that do business globally have to be thinking about it now or else they’ll have this two-tiered model they’ll have to have in the future.

Knowledge at Wharton: For manufacturers that have not yet begun this journey, where should they start?

Kavanaugh: I think there’s a bifurcated approach. On the one hand, take a fresh look at their relationship with their customers and products and what can they do? They already will have services, warranties, maintenance, training and installation. They have these things, so just think about taking the baby step. Think about that next step, formalizing a framework.

The other is make sure that the foundational elements are in place so that when they try doing these interconnected digital transformative initiatives, they have the basics in place. Do the systems talk to one another? Are they going down a path where they embed the sensors in their plants and equipment and they can talk to their trading partners? If you don’t have that, when you do make the bigger decisions it won’t matter because you’ll be dead in the water until the foundation’s in place. I think those two things will get them started.