Industrial’s shift to software-centric business: A key ingredient to digital transformation

August 29, 2017

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By Barry Jaruzelski and Steve Eddy

Industrial companies are facing a future that requires them to transform themselves into digital companies with critical capabilities in designing, developing and delivering software. The shift to a software-centric model is inevitable and irreversible and is significantly disrupting traditional industrial markets and companies.

In our recent white paper, “Software disruption accelerates,” PwC consultants and clients in manufacturing, healthcare and financial services discussed how companies across industries are tackling the challenge of software-led transformation – the convergence of digital technologies with operations to change the way companies conduct business. Leveraging emerging technologies such as the Internet of Things (IoT), artificial intelligence, robotics and 3D printing, many industrial companies anticipate an increasing percentage of revenues will come from their digital transformation efforts.

As revealed in the 12th Annual Global Innovation 1000 study conducted by PwC’s Strategy&, across all industries, companies growing faster than their competitors invested 25% more of their R&D into software than their slowing growing competitors. In the study, executives said the main reason for accelerating the rate of software R&D faster than hardware R&D was to stay competitive.

As explored in another PwC white paper, “Manufacturing’s next big act: Building an industrial digital ecosystem,” many manufacturers are starting on a path to fundamentally transform their business models and cultures by forging digital connections with suppliers, customers and other manufacturers, and also by creating digital-based products and services that deliver business outcomes.

As industrial companies embrace new technologies and innovate to improve operations and solve customer problems, the move to a software-centric model is likely the most unnatural act in driving a digital transformation – and maybe the most pervasive for companies with legacies in traditional manufacturing. In this light, what are the key decisions industrials must make that will impact the companies they will become? What are the challenges that will impact future success? Let’s explore further.

Strategic decisions

To succeed as a software-based company, an industrial company needs to make several strategic decisions that may fundamentally shift its market position. As we see it, these decisions are in four areas:

Products/markets: At the risk of market disruption, many industrials are recognizing that their growth agenda cannot only be product focused, but should also aspire to deliver business outcomes consistent with customers’ needs. In many cases this means offering products enabled by software that accomplish outcomes that benefit the customer.

But software that does what exactly and resides where? Software is generally active in three ways:

  • embedded in and indistinguishable from the hardware – also known as digitizing the physical product (digitized pacemakers);
  • on top of and independent from but connected to the physical product (facility management solutions); and
  • standalone (hospital information systems).

Another issue is whether the industrial company will continue to focus on its current vertical or expand to include others. For example, some jet engine manufacturers embed software in their engines to monitor and trigger pre-emptive maintenance. Do they stick to the vertical, or expand their predictive maintenance capabilities through software into other verticals either by directly entering other markets or through partnerships?

A third consideration: Does the industrial company build its own IoT platform, or license and concentrate on developing applications on another’s platform? Such decisions will take a keen understanding of how their ecosystem is evolving and where it is going.

Each of these areas will cause the traditional industrial company to think about markets and products differently.

Business models: The industrial company needs to decide how to monetize the new value chain it has created. For example, in the embedded software model the real differentiator now is software, which is all but hidden within the product; how does this change the value the product delivers and how does that factor into pricing?

Does that jet engine manufacturer simply increase the price of its base product because it now has the pre-emptive maintenance capability? Or does it charge extra for that capability for customers who want it? Or does it overhaul the entire model and move to a leasing/subscription model for the entire product?

Some key points companies need to consider: Which pricing strategy will maximize revenue? What internal sales structure will best support the chosen pricing strategy? There’s not much room for mistakes. They will be costly to revenues, sales staff morale, brand equity and customer retention.

We’ve seen traditional industrials begin to pilot software models, and start to consider new business models, only to realize they don’t fully understand their legacy business models. This is especially true of large industrials with multiple business units. Companies like these first need to understand the business models they have before they can determine how digital transformation will change their business models.

Capabilities: Decisions about new capabilities the industrial company needs will evolve directly from decisions about products, markets and business models. Staffing needs, especially for software design and development, is a big piece of this puzzle. Leadership and the physical product engineers for digitized products are also issues.

Co-development of software and physical products will be new terrain to most industrials. What they will need comes back to the software model they choose. Embedded software demands closer synchronization between both pieces; a standalone software model less so. Other issues include whether and what kind of partners are needed, and how to develop ecosystem management.

Transformation: “Transformation” is the key word in “digital transformation” because the future it portends will require vast changes throughout the industrial enterprise from culture to financial management to the kind of employees needed. Software as value is a fundamentally different way of thinking for most industrials; financial aspects such as key performance indicators and investment models must change, and the enterprise must view its brand differently and work to establish a new kind of credibility.

In our experience, the BXT method – working at the intersection of business, experience and technology – is the transformation approach that delivers success by breaking down silos, unearthing value and making tomorrow.

Key challenges in moving to a software model

Strategic thinking is clearly important to this convergence, but industrial companies that undertake a hardware-to-software transition also typically struggle just to acquire and grow the necessary software design and development competencies. Top challenges we see include:

Development: The need to master agile software development, including shorter, more dynamic release cycles; dealing with end-of-life and compatibility issues, and disruptive trends including service-oriented architecture, cloud and open source options.

Shifting value: Value and value creation shift from the physical product to software with impact on the traditional R&D funding split between the two.

Sales: The sales force needs to undergo talent and cultural changes to sell software-enabled solutions – different than product-sales – which focuses on value propositions centered on delivering specific business outcomes.

Organizational DNA: Inherent in the need to achieve shorter time to market and time in market is a potential culture clash between proven engineers and younger software specialists. Agile development requires a different kind of culture than most industrials have today.

Capability gap: The ability to integrate vertically and build complete solutions, including specific software skills: quick development, design and tailoring to avoid reengineering, alignment, maintenance, etc.

For a more in-depth look at how one industrial company is handling these kinds of challenges, read our recent interview with Honeywell.

 Conclusion

 As industrial companies face the future, they must come to terms with the need to transform themselves into digital companies. This requires a big shift to a software-centric model that is foreign to most traditional industrial companies and markets.

The payoffs will be vast for industrial companies that successfully make the right decisions, meet the challenges of the software model and transform themselves.

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