XaaS and subscription business models: How business model innovation is driving growth strategies
Today we live in a digital world with an estimated 2.5 quintillion bytes of data generated every day, transforming how we live, work, and do business. For organizations, this influx of data – coupled with a global shift to cloud-based technology – is fueling business model innovation that’s resulting in greater resiliency, competitiveness, and growth for companies.
In the past 50 years, the average business model life span has fallen from about 15 years to less than five. And to survive in such a fast-paced environment, organizations must be agile, quickly adapting to changes in technology, market trends, and customer expectations.
Implementing new business models in response to these changes is critical to the success of the organization. Business model innovation can open up additional lines of revenue, expand market share, and increase profitability. There are also some surprising, and unexpected, benefits emerging as well.
What is a business model? What is business model innovation?
A business model defines how a company creates, delivers, and captures value. Business models vary based on numerous dimensions – such as key offerings, target market, company resources, and business value chain – and are a critical component in driving a company’s business growth strategy.
Business model innovation occurs when existing models are modified, or new models are constructed. Often triggered by advances in technology and digitization, new business models such as “everything-as-a-service” or “anything-as-a-service” (XaaS) and subscription-based and are undergoing rapid adoption to help support the business’ strategic vision and ultimate success.
A classic example of business model innovation is Amazon. Shortly after launching as an online bookseller in 1995, the company began to offer new services beyond books such as Free Super Savers Shipping. Over 10 years (2005-2015), the company’s expansion included cloud computing (Amazon AWS), eBooks, and streaming services (Amazon Music, Amazon Video). By 2015, its market capitalization surpassed that of Walmart.
Each time Amazon expanded to incorporate new products or services, it adjusted or created new business models to support its strategy.
Business model innovation today: XaaS and the rise of subscription-based business models
Business models and the kind of innovation that’s happening vary greatly based on industry and business strategy. From consumer products to high tech, businesses are constantly innovating to find new ways to serve customers and grow revenues. Examples include new parents who subscribe to reusable diaper services instead of buying disposables, Rolls-Royce provides engine maintenance and replacement services for their business jets, and automotive companies are providing car subscriptions and even parcel as a service.
The examples above reflect the growing trend towards implementing “everything-as-a-service” – or XaaS – and subscription business models, a popular type or form of XaaS. These types of digital business models are the result of product/service digitization and the global shift to cloud-based technologies.
Here are some basic definitions of these important terms:
- What is everything as a service? XaaS is a broad category of business models in which users access products, tools, technologies, and/or services “as a service.” More traditionally and commonly, in the software industry, XaaS examples include software as a service (SaaS), platform as a service (Paas), and infrastructure as a service (IaaS), but XaaS is not limited to the tech space. Today almost everything is available “as a service.”
- What is a subscription business model? Subscription-based models are a type of XaaS, where a customer subscribes to services or products – similar to renting – on an ongoing basis. This approach generates monthly or annual recurring subscription revenue for the business. The focus of this model is on retention of a customer versus acquisition to increase the lifetime value (LTV) of each customer.
Other forms of XaaS include monetization based on volume of usage – or the outcome – as well as fixed price or variable price approaches.
Why are subscription business models so popular today?
Aside from cloud and digital technology advances, there are several important reasons why subscription-based models are increasing in popularity. First, selling as a service is more profitable. For example, Apple entered the market in the 1970s as a hardware vendor. In 2008, the company offered its first service, the App Store, selling third-party applications for its iPhone and iPod Touch. By 2019, its services business posted gross margins of 63.7%, almost doubling that of its product division, which posted a 32.2% gross margin.
Second, a subscription-based model is also a predictable and stable source of revenue for companies, which is especially critical during times of uncertainty – like a pandemic.
And third, from the customer perspective, it’s beneficial for anyone sensitive or reluctant to invest in large capital expenditures. A service-based model removes the need for companies to make significant investments in turbulent times while opening the door to new products and services at a reasonable cost that were previously out of reach. For smaller and mid-sized businesses this can make a world of difference – giving them access to new tools to compete and grow.
A subscription-based business model allows companies to deliver meaningful services quickly to customers, bring new offerings to market in less time, accelerate cash collection, and define and modify pricing models.
Examples of business model innovation and XaaS
A good example of the shift to XaaS (more broadly referred to as “servitization”) is within the manufacturing industry. Manufacturers can now provide access to their products versus selling them (XaaS), bundled with associated services such as maintenance and repair (subscription-based).
Today, manufacturing companies around the world are adopting XaaS business models. Examples include:
- Hewlett Packard Enterprise (HPE) transformed its traditional product offerings into high-value solutions to generate lifetime customer loyalty and recurring revenue streams.
- MOSCA, manufacturer of some of the world’s most advanced strapping machines and materials, is laying the foundation for new business models with a central ERP system and IoT technology.
The benefits of XaaS
The importance of diversifying and adjusting business models to adapt in current market conditions is critical. There are many obvious benefits to businesses, but also some surprising advantages of XaaS that could have a broader impact on how business make things, how consumers use products and services, and the product/service life cycle.
Here are the key benefits of XaaS and subscription models from a business’ point of view:
- Growth through new revenue streams and markets
- Greater predictability and profitability
- Improved resiliency and competitiveness
From a customer perspective, the benefits include:
- Greater range and improved quality of products and services
- Lower costs for customer and consumers
- Lower risk as shared with service provider
- More predictability in operations and guaranteed performance
From a broader perspective, the move to XaaS and the servitization of products can promote a circular economy – especially in the manufacturing industry. In this sector, there is a shifting focus from creating a product at a specific point in time to the continued use of that product over an extended period. With this change comes a greater emphasis on the quality, use, longevity, maintenance, and disposal or recycling of the product.
With greater ownership of the assets across their entire life, ensuring compliance and minimizing waste, energy usage, or carbon emissions makes sense for manufacturers; it also encourages product, material, and waste reuse of recycling. This may even generate new opportunities. In the electric vehicle industry, used or “second-life” batteries, for example, are having an effect on the power and energy storage sector – a great example of how sustainability makes business sense.
Choosing a suitable business model strategy
Since business models vary based on industry and business strategy, there’s no “one-size-fits-all.” Instead, you should consider the unique needs of your company and the specific growth strategies you intend to implement.
Common factors for consideration include:
- Technology: Is your existing infrastructure able to support the strategic vision of the company? Business model innovation will require connected products that are networkable, digital, and even sensor-equipped – and the ability to use the data from the connected products and equipment within new processes.
- Data: Is your data centralized or siloed? Business model innovation relies on advanced data modelling and predictive capabilities to support analytics and forecasting.
- IT infrastructure: Is your IT core robust and flexible enough to share data across the value chain to support a range of models such as information technology/operational technology (IT/OT) collaboration?
- Pricing and packaging: How sophisticated is your pricing and packaging models? Will these need to be adjusted to support a new business model?
You must also consider organizational support. Business model innovation often requires that the company and individual stakeholders shift what may be long-held business perspectives. How easily will the company adjust to a customer-centric versus product-centric business model?
The business will also have to shift from one-time (usually capex sales) to a recurring (usually opex) financial model. This impacts compensation, margins, and reporting – a big change, especially for sales. Will these changes be supported across all teams or will additional effort be required to bring everyone onboard? And, do you have a strong business network of partners that are open to collaboration?
Technology and business model innovation – where to start
Understanding where to start on the path to business model innovation is challenging, especially when you have an established business with various customer bases, revenue streams, and stakeholders.
Starting with a strong foundation using an intelligent cloud-based ERP system with embedded artificial intelligence (AI) and machine learning is essential. Look for a system that can:
- Seamlessly manage a variety of contracts that include different types of products, services, and pricing
- Build and execute subscription and/or recurring billing models easily
- Manage revenue recognition and partner settlement
The system must be flexible and adaptable, supporting contract changes, such as price, contract duration, and other details. A good ERP system will include these billing capabilities or can be purchased as an add-on to your existing ERP system and licensed separately.
As your business model strategy matures and you gain access to usage and other data intelligence, such as Internet of Things (IoT) data from equipment and products, you can develop additional revenue models such as bill-based metering. This requires smart, connected products that support the flow and sharing of data. It also requires a collaborative asset network where data and processes are shared.
Digital business model FAQs
Servitization refers to the trend away from a single sale, towards using products to sell additional services. These can be service and maintenance contracts, everything as a service (Xaas), or “outcome as a service.”
This is a common trend in the manufacturing industry, where manufacturers move from simply building and selling a product. They start adding additional services and products and may sell direct to consumers. In this approach manufacturers get closer to customers, provide more value to them, and retain them by providing different levels of service differentiation.
There are four levels of servitization within manufacturing:
- Distinct products and services: This is the basics of manufacturing businesses in which products and equipment are built and then sold to customers. There is very limited customer involvement once products are sold, and also limited revenue.
- Bundles of products: Similar to the above, but the products are more personalized.
- Aftersales and subscription servicing, repairs, and condition monitoring: In this level, the maintenance of a product provides an ongoing source of revenue for manufacturers.
- Advanced services: Taking aftersales to the next level, advanced services are more relationship focused and customer-centric than just selling and maintaining a product. In many cases, advanced services are delivered on a subscription model in which the consumer pays for the outcome.
An outcome-based business model is a type of XaaS in which customers are charged for services based on the amount or volume of usage of a service. This model requires that you collect and monitor, and bill, against the amount the service is used.
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