- Email: [email protected]
A Proposal to Support the Value Proposition in Product Oriented Service Business Model of Product Service Systems
Available online at www.sciencedirect.com
ScienceDirect Procedia CIRP 16 (2014) 211 – 216
Product Services Systems and Value Creation. Proceedings of the 6th CIRP Conference on Industrial Product-Service Systems
A proposal to support the value proposition in Product Oriented Service business model of Product Service Systems Kênia Fernandes de Castro Rodriguesª*, Vanessa Nappiª, Henrique Rozenfeldª ª University of São Paulo, Av. Trabalhador São Carlense 400,Postcode 13566-590; São Carlos, Brazil * Corresponding author. Tel.: +55 (16) 33739433; E-mail address: kenia @sc.usp.br
Abstract The product service system offers opportunities for companies by introducing new ways of offering value to the customer. Thus, the value proposition needs to take into account uncertainties and tangible and intangible assets in an integrated way leading to more complex decisions. To address these decisions, the study proposes the application of scenarios with real options considering the most suitable financial performance indicators. This research followed the design research methodology. As a result, the proposal considers three scenarios: optimistic, moderate and pessimistic, each showing three possible real options: to expand, to abandon and to defer the incorporation of the service. © Authors. Elsevier © 2014 2014 The Elsevier B.V. Published This is an by open accessB.V. article under the CC BY-NC-ND license Selection and peer-review under responsibility of the International Scientific Committee of “The 6th CIRP Conference on Industrial Product(http://creativecommons.org/licenses/by-nc-nd/3.0/). Selection and peer-review underofresponsibility of the International Scientifi c Committee of “The 6th CIRP Conference on Industrial Service Systems” in the person the Conference Chair Professor Hoda ElMaraghy. Product-Service Systems” in the person of the Conference Chair Professor Hoda ElMaraghy” Keywords: Product service systems; value proposition; scenarios; real options; financial performance indicators.
1. Decision making to support the PSS value proposition The product service system (PSS) offers opportunities for companies interested in gaining a competitive advantage in the current marketplace by the introduction of new ways of dealing with businesses, customers and with the value chain [1]. A PSS can be defined as an innovation strategy, shifting the business focus from merely designing and selling physical products, to designing and selling a system of products and services which are jointly capable of fulfilling specific customers’ needs [2]. There are three types of PSS: in the first category called product-oriented, the business model is geared primarily to the sale of products, the traditional way, including some extra services. In the second category use-oriented, the sale of traditional product still plays a central role, but the business model is not geared by selling products. The ownership of the product remains with the provider and is made available in a different form, like services of renting, sharing or pooling to use the product. In the third category, result oriented, the supplier offers a mix of services. The result is delivered
through a product, while the PSS suppliers maintain its ownership, the customer pays only for the results [3]. In this way, the PSS by considering tangible and intangible assets in an integrated way leads to completely modified requirements towards the service provision process [4]. A service is any act or performance that one party can offer to another that is essentially intangible and does not result in ownership of anything. Its production may or may not be tied to a physical product [5]. Thus, the service part in the PSS concept comprises services that make products available to the consumer (marketing, sales-service, sharing, leasing, etc.) and services that service products in the use and end-of-life stage (maintenance, upgrading, take back, closed loop or safe product disposal) [6]. In any case, the ability to react to changing conditions in the future gains importance as new information arrives all the time and current business environments are characterized by dynamic growth and uncertainties. Hence, the company should be flexible enough to reconsider the decision impacted by additional information in the succeeding stages [7]. The uncertainties are more prevalent at the beginning of the new product service system development process (NPSSD), in the
2212-8271 © 2014 Elsevier B.V. This is an open access article under the CC BY-NC-ND license (http://creativecommons.org/licenses/by-nc-nd/3.0/). Selection and peer-review under responsibility of the International Scientific Committee of “The 6th CIRP Conference on Industrial Product-Service Systems” in the person of the Conference Chair Professor Hoda ElMaraghy” doi:10.1016/j.procir.2014.02.009
212
Kênia Fernandes de Castro Rodrigues et al. / Procedia CIRP 16 (2014) 211 – 216
front end [7,8,9]. However, they also continue to appear during the entire NPSSD [10]. Thus, it is important to manage these uncertainties through the process because each stage entails increasingly investments and resource allocation as the project evolves [10,11, 12]. In order to enable the flexibility in the PSS value proposition, several studies suggest that real options approach addresses the uncertainties [7,11,12,13,14,15,16]. A sound proposal is to combine real options approach with scenarios method. By integrating the two, real options approach and scenarios method, it is possible to seek the best of both and show how they complement each other [12,1718]. The opportunity to integrate has a significant impact in other organizational processes, for instance, the performance measurement as they both share the perspective of future cash flows. In this way, performance indicators should assist the integration of the real options approach and scenarios method [18]. The real options “are perhaps the most promising area for valuation of intangible assets” and are especially useful in estimating the value of intangible assets [19].The traditional methods to evaluate intangibles are limited in capturing the value of intangible assets, because ignore the flexibility. However, the option pricing method, one way to apply real options approach, represents a new direction for evaluating intangible [20]. Despite these suggestions, systematic methods and tools from the scientific point of view need to be developed to design PSS. This development requires a holistic solution [4,10]. Such a solution should address the real options approach and scenarios method integration along with performance indicators. So, the research question is how real options approach and scenarios method can be integrated and, later, be assisted by performance indicators to support the definition of PSS value proposition? Therefore, this study aims to propose the application of scenarios with real options considering the most suitable financial performance indicators to support the PSS value proposition. This application should take place during the formal assessments, gates, through the NPSSD. The remaining discussions are structured into four main sections: 0 treats the main concepts; 3 illustrates the research method; 4 describes the proposal and 0 reasons implications of the findings and directions of future research. 2. Research background This section describes the main concepts of: uncertainties, real options approach, financial indicators, scenarios method and performance indicators. 2.1. Uncertainties and real options approach Uncertainty can be defined as the missing and the imprecision of information and knowledge, which consequently jeopardize the forecast of the future [11]. Generally, there are four types of uncertainty that can be
distinguished: market, technological, environmental and resource allocation uncertainty [16][4]. Besides, a great deal of literature has been dedicated to the problem of market uncertainty in the NPSSD of innovative products [12, 17,21]. There may be situations in which uncertainty over future market conditions should prompt a company to delay certain investments. In these situations, the traditional investment evaluation ignores the value of creating options because is built on faulty assumptions that the investment is irreversible and it is a now or never proposition. Thus, the value of waiting for more information is not reflected in the conventional Net Present Value (NPV) [21]. By contrast, real options approach recognizes that managers can kill the project after each incremental investment is made, so it provides to managers options along the way. The argument is that real options approach rather than NPV is the appropriate way to evaluate the worth of a new product project at each gate [11]. The classical definition states that a real option is “the right but not the obligation to take an action at the future” [14,16,22,23]. There are different ways of applying real options approach: Black-Scholes model; binomial lattice valuation; options pricing theory and its variant options thinking [17,22,24]. The Black-Scholes and binomial lattice models require sophisticated data like historical series and complex calculations such as Monte Carlo simulation respectively; however in the NPSSD these data are not available especially regarding innovative products. In contrast, the option pricing and options thinking principles can be used in a more flexible and strategic way to deal with uncertainty. In addition, they two provide the concepts of real options value (ROV) (1) and premium (PR) (2) to assess the worth of options [16]:
ROV
Strategic NPV Passive NPV
Premium
Investiment with the option Investiment without the option
(1)
(2)
The ROV characterizes the managerial flexibility which corresponds to the strategic NPV (NPV of the option) decreased of the passive NPV (NPV without the option). The PR, in turn, represents the amount that must be invested to acquire the option [16]. Indeed, flexibility might add to any asset, intangible or not, an “intangible value”, as long as the premium of the real option is lower than the benefits that it should provide [20]. So, at each gate managers are, in effect, buying options on the project by considering these concepts. Moreover, the use of financial indicators is also suggested as they can complement the differentiation of between options [11]. 2.2. Scenarios method As mentioned before, scenarios method and real options approach have complementary strengths for managers to make strategic investment decisions under uncertainty [18]. A scenario can be defined as a generally understandable description of a possible situation in the future [25,26].
213
Kênia Fernandes de Castro Rodrigues et al. / Procedia CIRP 16 (2014) 211 – 216
Whereas most methods focus on quantitative projections, the scenarios method provides a simple step by step procedure. These steps are: preparation, field analysis, prognostic, development and transfer [26]. The scenario preparation encompasses the definition of the objectives as well as the definition of the field of conception which is the object of scenario e.g. the development of a product. Subsequently, the goal of scenario field analysis is the identification of the most relevant and key factors that influence the future development of the scenario field [26]. The scenario prognostic forms the core of the scenarios method. Alternative development possibilities (projections) of key factors are worked out according to the principal of the multiple futures. In the scenario development, in turn, scenarios are created based on the formulated future projection of each key factor. Finally, in the scenario transfer the impact of the scenarios on the field of conception is analyzed. As a result, a strategic direction can be derived for a company [26]. 2.3. Performance indicators In terms of decision making, one of the major influences that affects managers is the perception of the actions they take, especially from a future cash flow perspective. The analysis of future alternatives promoted by real options approach and scenarios method should be aligned with the measurement system. Otherwise, it can create confusion and jeopardize the planning and management of projects. Thus, performance indicators should be also incorporated with real options and scenarios proposal, with the purpose of following the project throughout the stages [27]. Performance indicators are the metrics used to quantify the efficiency and/or effectiveness of actions of part or of an entire process or a system in relation to a pattern or a target. Good performance indicators should be straightforward and easy to understand in order to enable a rapid identification of what is being measured and how it is being measured [27]. Therefore, the financial performance indicators are the most established in the literature and consequently, more suitable for supporting the use of real options approach and scenarios method. There are few works concerning PSS performance indicators. In addition, they can only measure PSS very abstractly and cannot be used to measure and monitor PSS [28]. In this way, the performance indicators should be systematically measured during the gates, through the stages of NPSSD. 3. Research method The research method consists of an adaptation of design research methodology, which presents four stages: Research Clarification, Descriptive Study I, Study Prescriptive and Descriptive Study II [29]. However, this work only carries out the research method until Prescriptive Study, as highlighted in Fig.1. In the Research Clarification stage, some evidence and suggestions that support the initials assumptions were found
in order to formulate realistic and worthwhile research objective as established in section 1. Based on the findings, an initial description of the existing situation was developed, as well as a description of the desired situation, written in terms of objective, in order to make assumptions underlying each of the descriptions explicit. The remarks and findings are shown at section 2, “research background”, presenting three main subjects: uncertainty and real options approach, scenarios method and performance indicators. Afterwards, these subjects were studied with the intention of making a description detailed enough to determine which features should be addressed to execute the next stage. Research Clarification Define objective Descriptive Study I Conduct research backgound
Study these subjects
Prescriptive Study Build scenarios
Determine FI
Customize types of real options
Select PSS PI
Elaborate proposal
Descriptive Study II Conduct case study
Future
Fig. 1. Research method.
In the Prescriptive Study stage, the knowledge about these subjects allowed the elaboration of the proposal by building scenarios, customizing types of real options, determining financial indicators and selecting PSS performance indicators. Using the procedure of a scenarios method by [26] the real options method will take place as the strategies while the performance indicators are going to be used to monitor the options during the gates (section 4). This proposal represents a conception on how addressing the existing situation would lead to the realization of the desired situation. Finally, the Descriptive Study II stage aims at investigate the impact of the proposal and its ability to realize the desired situation. An empirical study must be done to gain an understanding of the actual use of the proposal. This stage is not part of the scope of this research and as a technical procedure will be conducted in the future, a case study. 4. Conception of an integrated application for PSS value proposition This section describes the proposal features and the proposal overview, respectively.
214
Kênia Fernandes de Castro Rodrigues et al. / Procedia CIRP 16 (2014) 211 – 216
4.1. Proposal features Based on the research background findings, the first feature should reflect the building of scenarios since they comprehend the use of real options method. Next, the feature customization of real options types is required to define the options. They should be also reinforced by financial indicators as well, presented as determination of financial indicators feature. At that point, as the final feature, performance indicators are proposed to assist on ongoing assessments during the gates. 4.1.1. Building of scenarios The scenarios method, already presented in section 2.2, is appropriate to build scenarios. Nevertheless, two important issues remain: one concerning the identification of key factors and the other about the selection of future projections. The first issue relates to the fact that there is little information about the NPSSD of innovative products. Thus, the market uncertainty, particularly, the customer demand is considered a challenge in the context of PSS. Moreover, it is one of the most important uncertainties when application of real options method takes place [12,17,21]. The second issue deals with the plausible projections of scenarios. The literature findings show that the use of real options method should explicitly recognize “optimistic” “moderate” and “pessimistic” projections considering market uncertainty [21]. 4.1.2. Customization of real options types The literature presents numerous real options types to address the uncertainties. For instance, eight different types of real options were embedded in an empirical research which concluded that they should be adapted [16]. Nevertheless, there are three main types of real options that always should be taken into account when valuing the decisions of whether to invest or not. They are: to expand, to abandon and to defer the investment [8,23,24]. The strategies to expand, to abandon and to defer the investment are most appropriate because they are the most used ones and they can be adapted analogously to the PSS product oriented context. In a scenario where a product is going to be developed in the context of product oriented PSS, the first real option type, to expand, means to invest in the corresponding service. The second option refers to abandon of the investment of incorporating the service. Finally, the third option means to defer the investment of the incorporation of the service e until market conditions are favorable. For example, a company needs to decide whether to incorporate full service to provide a maintenance service into a product. This incorporation of services leads to a different amount of investment. So, the company has the option to sell only the product or it can also incorporate a maintenance service as soon the sales starts. Or even it can defer the
incorporation of the services, waiting for better market conditions. 4.1.3. Determination of financial indicators The investment evaluation is important to check on the continued business and economic viability of a project based on new and more accurate revenue and cost data [11]. Firstly, we identified the traditional financial indicators from investment evaluation in order to determine the ones that should be used. Additionally, we verified that whether the assumptions of the real options method permitted the use of financial indicators. Among this subset of financial indicators the ones that could complement the ROV and PR analysis were determine to support the proposal. The financial indicators determined are internal rate of return (IRR), payback (PB) and return on investment (ROI). In summary, these financial indicators should stand out for the differentiation of each real option and subsequently should point out the most appropriate one. 4.1.4. Selection of PSS performance indicators Finally, we studied and collected 25 financial performance indicators focused on PSS development. Then, these raw PSS performance indicators were submitted to a critical analysis in order to refine the recorded performance indicators. Furthermore, we verified if the transcribed performance indicators attended the definition of performance indicator [27]. At that point, we eliminate the duplicates and rewrite them on a standard format. As a result, only one performance indicator was selected, ROI [30]. After an analysis, it was concluded that for PSS value proposition another major financial performance indicators was missing. In this way, PB was also incorporated in the proposal due its importance in investment evaluation. 4.2. Proposal overview A conceptual diagram illustrated in Fig.2 shows the scenarios projections (optimistic, moderate and pessimist) with the three real options (option 1, option 2, option 3) considering the ROV, PR and financial indicators (IRR, PB and ROI). Afterwards, as the project evolves during the NPSSD the performance indicators (PB and ROI) are also calculated within the gates. In this manner, the managers are able to manage flexibility to change their decisions amongst the three options suggested as soon as more information arrives. Moving forward in time, they are also able to monitor whether the option continues to be the best as the project evolves and the uncertainties gradually reduces (see Fig.2). Hence, with the intention of supporting our proposal, we suggest seven steps which are discussed as follows.
215
Kênia Fernandes de Castro Rodrigues et al. / Procedia CIRP 16 (2014) 211 – 216
New Product Service System Development
manage flexibility
ROV
Option 1 - To expand Pessimistic Scenario
Moderate Mo M S c Scenario
Op Optimistic O S Scenario
PR Option 2 - To abandon
IRR
Option 3 - To defer
Label ROV: Real Options Value PR: Premium IRR: Internal Rate of Return PB: Payback ROI: Return on Investment
PB
PB
PB
PB
ROI
ROI
ROI
ROI
gates monitor
Fig. 2. Conceptual diagram overview.
Step one - scenario preparation Managers can begin by defining the scenario objective as the definition of the PSS value proposition. Once the objective has been defined, we also emphasize the value of defining the field of conception as the PSS product oriented context. Step two - scenario field analysis The essence of a scenario is to identify the key factors. Any uncertainty can be identified as the key factors given that they influence possible future situations. However, the single key factor illustrated in the present study is the customer demand as stated in section 4.1.1. Step three - scenario prognostic Besides the identification of the key factor, the planning horizon needs to be identified, so to this end, we recommend 5 to 10 years. Bearing in mind this planning horizon, we suggest to consider the optimistic, moderate and pessimist scenarios to develop the scenarios projections in the next step. Step four - scenario development In order to develop the future projections managers should assume the possible customer demand projections for each optimistic, moderate and pessimist scenarios. Thus, managers can use specialist opinion to envision the possible costumer demand projections since we are dealing with NPSSD of innovative products. Step five - scenario transfer As a practical manner, all the previous steps intended to support the elaboration of a focused strategy facing the three scenarios. With the intention of facilitating this elaboration, we suggest the use of the real options method. Before proceeding, it is important to estimate: investments, discount rate, costs, expenditures and taxes for the project in question. Taking into account the customer demand projections for each scenario a discounted cash flow should also be delineated.
Step six - real options calculation and financial indicators In this step, managers should calculate the ROV, formula 1, and PR, formula 2, for each option (see section 2.1). At that point, the financial indicators IRR, PB and ROI should be calculated as well. Considering the calculations, managers are able to compare each value pairwise with its match in every projection of the scenarios and seek the best option in each scenario. As a result, they can select the best option in the most promising scenario or wait for better information and conditions to make the decision if the most promising scenario is not known. Step seven - performance measurement So far, little information about innovative product is available and the previous step allows the managers to assess the value of waiting for more information or not. In this way, when more information arrives, the options can be monitored throughout the gates by measuring PB and ROI which provide a base to verify if the option continues to be the best or not. To sum up, we advise that a spreadsheet covering up these steps would help even more to apply this proposal. Hence, these steps not only assist the building of scenarios but also make simpler the use of real options method in a more strategic thinking. The bottom line is that the proposal gives the ability for managers to have a better understanding of the options that their companies have and the value of keeping them open. 5. Concluding remarks This study provides insights that can help researchers and managers interested in managing uncertainties through the gates in PSS value proposition. The proposal is a first effort to provide the ability to change the decisions concerning the PSS value proposition within projects after each incremental investment.
216
Kênia Fernandes de Castro Rodrigues et al. / Procedia CIRP 16 (2014) 211 – 216
Decisions that enhance a company’s flexibility by creating and preserving options stand a better chance when applying our proposal rather than traditional investment evaluation. Our proposal also shows that the scenarios method can be successfully integrated with a more strategic way of thinking real options. In the view of the performance indicators pointed out on literature to support real options method and scenarios method, this study also tries to fulfill the mentioned gap. It is worth mentioning that along with these indicators others should be implemented as well to monitor the performance besides the financial perspective of a successful PSS value proposition. Furthermore, this proposal considers the customer demand as the key factor to build the scenarios. Therefore, this fact leads to a limitation of this study since in real situations there are more types of uncertainty. In an analogous way for real options method, there is also a limitation concerning the three types of real options used since there are several more types beyond those considered here. In conclusion, the proposal explained in this paper still requires further development and empirical tests. The conduction of the research method until the Prescriptive study reflects the fact that companies still need to be selected. Future research should carry out case studies to evaluate and validate our proposal and consequently make further improvements. Finally, a key improvement should address the other types of PSS considering the use and result oriented business models. Acknowledgements The authors would like to thank the University of São Paulo. This research was financially supported by CAPES (Coordination for the Improvement of Higher Education Personnel). References [1] Barquet APB, Oliveira MG, Amigo CR, Cunha VP, Rozenfeld H. Employing the business model concept to support the adoption of product–service systems (PSS). Industrial Marketing Management. Elsevier Inc.; 2013 Jul;42(5):693–704. [2] Manzini E, Vezzoli C. A strategic design approach to develop sustainable product service systems: examples taken from the “environmentally friendly innovation” Italian prize. Journal of Cleaner Production. 2003 Dez; 11(8):851-857. [3] Tukker A. Eight types of product–service system: eight ways to sustainability? Experiences from SusProNet. Business Strategy and the Environment, 13 jul. 2004; 13(4): 246-260. [4] Meier H, Roy R, Seliger G. Industrial Product-Service Systems—IPS2 CIRP Annals - Manufacturing Technology. 2010 Jan; 59 (2): 607-627. [5] Kotler, P. (1994), Marketing Management – Analysis, Planning, Implementation and Control, 8th ed., Prentice-Hall, Englewood Cliffs, NJ. [6] Mont O. Product-Service Systems : Panacea or Myth ? [S.l.]: Lund University, 2004.
[7] Richter A, Sadek T, Steven M. Flexibility in industrial product-service systems and use-oriented business models. CIRP Journal of Manufacturing Science and Technology. 2010 Jan, 3(2): 128-134. [8] Damodaran A. Strategic Risk Taking: A Framework for Risk Management. Front Cover. Wharton School Pub.2008: 1-388. [9] Filho AG, Pigosso ACD, Ometto AR, Rozenfeld H. Remanufacturing on a Framework for Product Life-Cycle Management (PLM) in the Context of Product-Service Systems ( PSS ). 2009. [10] Jetter AJM. Educating the guess: strategies, concepts and tools for the fuzzy front end of product development. PICMET 03 Portland International Conference on Management of Engineering and Technology Technology Management for Reshaping the World. 2003: p. 261-273. [11] Cooper RG. In: Winning at New Products: Accelerating the Process from Idea to Launch. Basic Books: New York, 2001. [12] Crawford CM; Di Benedetto A. New products management. 9th ed. Boston: McGraw-Hill Irwin, 2008. [13] Herath H; Park C. Economic analysis of R&D projects: an options approach. The Engineering Economist. 1999:37-41. [14] Perlitz M; Peske T; Schrank R. Real options valuation: the new frontier in R&D project evaluation? R&D Management. 1999 Jul; 29(3):255-270. [15] Rese M, Karger M, Strotmann WC. The dynamics of Industrial Product Service Systems (IPS2) – using the Net Present Value Approach and Real Options Approach to improve life cycle management. CIRP Journal of Manufacturing Science and Technology. 2009 Jan; 1(4): 279-286. [16] Trigeorgis L. Making use of real options simple: An overview and applications in flexible/modular decision making. The Engineering Economist. 2005:37-41. [17] Faulkner T. Applying’options thinking'to R&D valuation. ResearchTechnology Management, 1996. [18] Miller KD, Waller HG. Scenarios, Real Options and Integrated Risk Management. Long Range Planning. 2003;36(1):93–107. [19] Upton WS.. Business and Financial Reporting, Challenges from the New Economy. Financial Accounting Series – Special Report. FASB. USA: abril, 2001. [20] Bouteiller C, Karyotis C. The evaluation of intangibles: introducing the optional capital. Investment Management and Financial Innovations. 2010, 7(4). [21] Dixit, A.; Pindynck, R. The options approach to capital investment. Harvard business review, 1995. [22] Black F, Scholes M. The Pricing of Options and Corporate Liabilities. Journal of Political Economy. 1973; 81(3): 637-659. [23] Copeland T, Tufano P. A real-world way to manage real options. Harvard business review. 2004; 82(3):90-99. [24] Mikaelian T. et al. Real Options in Enterprise Architecture: A Holistic Mapping of Mechanisms and Types for Uncertainty Management. IEEE Transactions on Engineering Management. 2011; 58(3):457-470. [25] Fink A, Marr B, Siebe A, Kuhle J. The future scorecard: combining external and internal scenarios to create strategic foresight. Management Decision. 2005; 43(3):360–381. [26] Gausemeier J, Fink A, Schlake O. Scenario management: An approach to develop future potentials. Technological Forecasting and Social Change.130:111–30. [27] Neely A, Gregory M, Platts K. Performance measurement system design: A literature review and research agenda. Int. J. Oper. Prod. Manag. 2005; 25(12):1228–63. [28] Abramovici M, Jin F, Dang HB. Product-Service Integration for Sustainable Solutions. Meier H, editor. Berlin, Heidelberg: Springer Berlin Heidelberg; 2013:311–322. [29] Blessing, LTM; Chakrabarti, A. DRM, a design research methodology. Springer-Verlag, London. 2009. [30] Yang J. A Balanced Performance Measurement Scorecard Approach for Product Service Systems. 2009 International Conference on Business Intelligence and Financial Engineering. 2009 Jul;548–551.
ScienceDirect Procedia CIRP 16 (2014) 211 – 216
Product Services Systems and Value Creation. Proceedings of the 6th CIRP Conference on Industrial Product-Service Systems
A proposal to support the value proposition in Product Oriented Service business model of Product Service Systems Kênia Fernandes de Castro Rodriguesª*, Vanessa Nappiª, Henrique Rozenfeldª ª University of São Paulo, Av. Trabalhador São Carlense 400,Postcode 13566-590; São Carlos, Brazil * Corresponding author. Tel.: +55 (16) 33739433; E-mail address: kenia @sc.usp.br
Abstract The product service system offers opportunities for companies by introducing new ways of offering value to the customer. Thus, the value proposition needs to take into account uncertainties and tangible and intangible assets in an integrated way leading to more complex decisions. To address these decisions, the study proposes the application of scenarios with real options considering the most suitable financial performance indicators. This research followed the design research methodology. As a result, the proposal considers three scenarios: optimistic, moderate and pessimistic, each showing three possible real options: to expand, to abandon and to defer the incorporation of the service. © Authors. Elsevier © 2014 2014 The Elsevier B.V. Published This is an by open accessB.V. article under the CC BY-NC-ND license Selection and peer-review under responsibility of the International Scientific Committee of “The 6th CIRP Conference on Industrial Product(http://creativecommons.org/licenses/by-nc-nd/3.0/). Selection and peer-review underofresponsibility of the International Scientifi c Committee of “The 6th CIRP Conference on Industrial Service Systems” in the person the Conference Chair Professor Hoda ElMaraghy. Product-Service Systems” in the person of the Conference Chair Professor Hoda ElMaraghy” Keywords: Product service systems; value proposition; scenarios; real options; financial performance indicators.
1. Decision making to support the PSS value proposition The product service system (PSS) offers opportunities for companies interested in gaining a competitive advantage in the current marketplace by the introduction of new ways of dealing with businesses, customers and with the value chain [1]. A PSS can be defined as an innovation strategy, shifting the business focus from merely designing and selling physical products, to designing and selling a system of products and services which are jointly capable of fulfilling specific customers’ needs [2]. There are three types of PSS: in the first category called product-oriented, the business model is geared primarily to the sale of products, the traditional way, including some extra services. In the second category use-oriented, the sale of traditional product still plays a central role, but the business model is not geared by selling products. The ownership of the product remains with the provider and is made available in a different form, like services of renting, sharing or pooling to use the product. In the third category, result oriented, the supplier offers a mix of services. The result is delivered
through a product, while the PSS suppliers maintain its ownership, the customer pays only for the results [3]. In this way, the PSS by considering tangible and intangible assets in an integrated way leads to completely modified requirements towards the service provision process [4]. A service is any act or performance that one party can offer to another that is essentially intangible and does not result in ownership of anything. Its production may or may not be tied to a physical product [5]. Thus, the service part in the PSS concept comprises services that make products available to the consumer (marketing, sales-service, sharing, leasing, etc.) and services that service products in the use and end-of-life stage (maintenance, upgrading, take back, closed loop or safe product disposal) [6]. In any case, the ability to react to changing conditions in the future gains importance as new information arrives all the time and current business environments are characterized by dynamic growth and uncertainties. Hence, the company should be flexible enough to reconsider the decision impacted by additional information in the succeeding stages [7]. The uncertainties are more prevalent at the beginning of the new product service system development process (NPSSD), in the
2212-8271 © 2014 Elsevier B.V. This is an open access article under the CC BY-NC-ND license (http://creativecommons.org/licenses/by-nc-nd/3.0/). Selection and peer-review under responsibility of the International Scientific Committee of “The 6th CIRP Conference on Industrial Product-Service Systems” in the person of the Conference Chair Professor Hoda ElMaraghy” doi:10.1016/j.procir.2014.02.009
212
Kênia Fernandes de Castro Rodrigues et al. / Procedia CIRP 16 (2014) 211 – 216
front end [7,8,9]. However, they also continue to appear during the entire NPSSD [10]. Thus, it is important to manage these uncertainties through the process because each stage entails increasingly investments and resource allocation as the project evolves [10,11, 12]. In order to enable the flexibility in the PSS value proposition, several studies suggest that real options approach addresses the uncertainties [7,11,12,13,14,15,16]. A sound proposal is to combine real options approach with scenarios method. By integrating the two, real options approach and scenarios method, it is possible to seek the best of both and show how they complement each other [12,1718]. The opportunity to integrate has a significant impact in other organizational processes, for instance, the performance measurement as they both share the perspective of future cash flows. In this way, performance indicators should assist the integration of the real options approach and scenarios method [18]. The real options “are perhaps the most promising area for valuation of intangible assets” and are especially useful in estimating the value of intangible assets [19].The traditional methods to evaluate intangibles are limited in capturing the value of intangible assets, because ignore the flexibility. However, the option pricing method, one way to apply real options approach, represents a new direction for evaluating intangible [20]. Despite these suggestions, systematic methods and tools from the scientific point of view need to be developed to design PSS. This development requires a holistic solution [4,10]. Such a solution should address the real options approach and scenarios method integration along with performance indicators. So, the research question is how real options approach and scenarios method can be integrated and, later, be assisted by performance indicators to support the definition of PSS value proposition? Therefore, this study aims to propose the application of scenarios with real options considering the most suitable financial performance indicators to support the PSS value proposition. This application should take place during the formal assessments, gates, through the NPSSD. The remaining discussions are structured into four main sections: 0 treats the main concepts; 3 illustrates the research method; 4 describes the proposal and 0 reasons implications of the findings and directions of future research. 2. Research background This section describes the main concepts of: uncertainties, real options approach, financial indicators, scenarios method and performance indicators. 2.1. Uncertainties and real options approach Uncertainty can be defined as the missing and the imprecision of information and knowledge, which consequently jeopardize the forecast of the future [11]. Generally, there are four types of uncertainty that can be
distinguished: market, technological, environmental and resource allocation uncertainty [16][4]. Besides, a great deal of literature has been dedicated to the problem of market uncertainty in the NPSSD of innovative products [12, 17,21]. There may be situations in which uncertainty over future market conditions should prompt a company to delay certain investments. In these situations, the traditional investment evaluation ignores the value of creating options because is built on faulty assumptions that the investment is irreversible and it is a now or never proposition. Thus, the value of waiting for more information is not reflected in the conventional Net Present Value (NPV) [21]. By contrast, real options approach recognizes that managers can kill the project after each incremental investment is made, so it provides to managers options along the way. The argument is that real options approach rather than NPV is the appropriate way to evaluate the worth of a new product project at each gate [11]. The classical definition states that a real option is “the right but not the obligation to take an action at the future” [14,16,22,23]. There are different ways of applying real options approach: Black-Scholes model; binomial lattice valuation; options pricing theory and its variant options thinking [17,22,24]. The Black-Scholes and binomial lattice models require sophisticated data like historical series and complex calculations such as Monte Carlo simulation respectively; however in the NPSSD these data are not available especially regarding innovative products. In contrast, the option pricing and options thinking principles can be used in a more flexible and strategic way to deal with uncertainty. In addition, they two provide the concepts of real options value (ROV) (1) and premium (PR) (2) to assess the worth of options [16]:
ROV
Strategic NPV Passive NPV
Premium
Investiment with the option Investiment without the option
(1)
(2)
The ROV characterizes the managerial flexibility which corresponds to the strategic NPV (NPV of the option) decreased of the passive NPV (NPV without the option). The PR, in turn, represents the amount that must be invested to acquire the option [16]. Indeed, flexibility might add to any asset, intangible or not, an “intangible value”, as long as the premium of the real option is lower than the benefits that it should provide [20]. So, at each gate managers are, in effect, buying options on the project by considering these concepts. Moreover, the use of financial indicators is also suggested as they can complement the differentiation of between options [11]. 2.2. Scenarios method As mentioned before, scenarios method and real options approach have complementary strengths for managers to make strategic investment decisions under uncertainty [18]. A scenario can be defined as a generally understandable description of a possible situation in the future [25,26].
213
Kênia Fernandes de Castro Rodrigues et al. / Procedia CIRP 16 (2014) 211 – 216
Whereas most methods focus on quantitative projections, the scenarios method provides a simple step by step procedure. These steps are: preparation, field analysis, prognostic, development and transfer [26]. The scenario preparation encompasses the definition of the objectives as well as the definition of the field of conception which is the object of scenario e.g. the development of a product. Subsequently, the goal of scenario field analysis is the identification of the most relevant and key factors that influence the future development of the scenario field [26]. The scenario prognostic forms the core of the scenarios method. Alternative development possibilities (projections) of key factors are worked out according to the principal of the multiple futures. In the scenario development, in turn, scenarios are created based on the formulated future projection of each key factor. Finally, in the scenario transfer the impact of the scenarios on the field of conception is analyzed. As a result, a strategic direction can be derived for a company [26]. 2.3. Performance indicators In terms of decision making, one of the major influences that affects managers is the perception of the actions they take, especially from a future cash flow perspective. The analysis of future alternatives promoted by real options approach and scenarios method should be aligned with the measurement system. Otherwise, it can create confusion and jeopardize the planning and management of projects. Thus, performance indicators should be also incorporated with real options and scenarios proposal, with the purpose of following the project throughout the stages [27]. Performance indicators are the metrics used to quantify the efficiency and/or effectiveness of actions of part or of an entire process or a system in relation to a pattern or a target. Good performance indicators should be straightforward and easy to understand in order to enable a rapid identification of what is being measured and how it is being measured [27]. Therefore, the financial performance indicators are the most established in the literature and consequently, more suitable for supporting the use of real options approach and scenarios method. There are few works concerning PSS performance indicators. In addition, they can only measure PSS very abstractly and cannot be used to measure and monitor PSS [28]. In this way, the performance indicators should be systematically measured during the gates, through the stages of NPSSD. 3. Research method The research method consists of an adaptation of design research methodology, which presents four stages: Research Clarification, Descriptive Study I, Study Prescriptive and Descriptive Study II [29]. However, this work only carries out the research method until Prescriptive Study, as highlighted in Fig.1. In the Research Clarification stage, some evidence and suggestions that support the initials assumptions were found
in order to formulate realistic and worthwhile research objective as established in section 1. Based on the findings, an initial description of the existing situation was developed, as well as a description of the desired situation, written in terms of objective, in order to make assumptions underlying each of the descriptions explicit. The remarks and findings are shown at section 2, “research background”, presenting three main subjects: uncertainty and real options approach, scenarios method and performance indicators. Afterwards, these subjects were studied with the intention of making a description detailed enough to determine which features should be addressed to execute the next stage. Research Clarification Define objective Descriptive Study I Conduct research backgound
Study these subjects
Prescriptive Study Build scenarios
Determine FI
Customize types of real options
Select PSS PI
Elaborate proposal
Descriptive Study II Conduct case study
Future
Fig. 1. Research method.
In the Prescriptive Study stage, the knowledge about these subjects allowed the elaboration of the proposal by building scenarios, customizing types of real options, determining financial indicators and selecting PSS performance indicators. Using the procedure of a scenarios method by [26] the real options method will take place as the strategies while the performance indicators are going to be used to monitor the options during the gates (section 4). This proposal represents a conception on how addressing the existing situation would lead to the realization of the desired situation. Finally, the Descriptive Study II stage aims at investigate the impact of the proposal and its ability to realize the desired situation. An empirical study must be done to gain an understanding of the actual use of the proposal. This stage is not part of the scope of this research and as a technical procedure will be conducted in the future, a case study. 4. Conception of an integrated application for PSS value proposition This section describes the proposal features and the proposal overview, respectively.
214
Kênia Fernandes de Castro Rodrigues et al. / Procedia CIRP 16 (2014) 211 – 216
4.1. Proposal features Based on the research background findings, the first feature should reflect the building of scenarios since they comprehend the use of real options method. Next, the feature customization of real options types is required to define the options. They should be also reinforced by financial indicators as well, presented as determination of financial indicators feature. At that point, as the final feature, performance indicators are proposed to assist on ongoing assessments during the gates. 4.1.1. Building of scenarios The scenarios method, already presented in section 2.2, is appropriate to build scenarios. Nevertheless, two important issues remain: one concerning the identification of key factors and the other about the selection of future projections. The first issue relates to the fact that there is little information about the NPSSD of innovative products. Thus, the market uncertainty, particularly, the customer demand is considered a challenge in the context of PSS. Moreover, it is one of the most important uncertainties when application of real options method takes place [12,17,21]. The second issue deals with the plausible projections of scenarios. The literature findings show that the use of real options method should explicitly recognize “optimistic” “moderate” and “pessimistic” projections considering market uncertainty [21]. 4.1.2. Customization of real options types The literature presents numerous real options types to address the uncertainties. For instance, eight different types of real options were embedded in an empirical research which concluded that they should be adapted [16]. Nevertheless, there are three main types of real options that always should be taken into account when valuing the decisions of whether to invest or not. They are: to expand, to abandon and to defer the investment [8,23,24]. The strategies to expand, to abandon and to defer the investment are most appropriate because they are the most used ones and they can be adapted analogously to the PSS product oriented context. In a scenario where a product is going to be developed in the context of product oriented PSS, the first real option type, to expand, means to invest in the corresponding service. The second option refers to abandon of the investment of incorporating the service. Finally, the third option means to defer the investment of the incorporation of the service e until market conditions are favorable. For example, a company needs to decide whether to incorporate full service to provide a maintenance service into a product. This incorporation of services leads to a different amount of investment. So, the company has the option to sell only the product or it can also incorporate a maintenance service as soon the sales starts. Or even it can defer the
incorporation of the services, waiting for better market conditions. 4.1.3. Determination of financial indicators The investment evaluation is important to check on the continued business and economic viability of a project based on new and more accurate revenue and cost data [11]. Firstly, we identified the traditional financial indicators from investment evaluation in order to determine the ones that should be used. Additionally, we verified that whether the assumptions of the real options method permitted the use of financial indicators. Among this subset of financial indicators the ones that could complement the ROV and PR analysis were determine to support the proposal. The financial indicators determined are internal rate of return (IRR), payback (PB) and return on investment (ROI). In summary, these financial indicators should stand out for the differentiation of each real option and subsequently should point out the most appropriate one. 4.1.4. Selection of PSS performance indicators Finally, we studied and collected 25 financial performance indicators focused on PSS development. Then, these raw PSS performance indicators were submitted to a critical analysis in order to refine the recorded performance indicators. Furthermore, we verified if the transcribed performance indicators attended the definition of performance indicator [27]. At that point, we eliminate the duplicates and rewrite them on a standard format. As a result, only one performance indicator was selected, ROI [30]. After an analysis, it was concluded that for PSS value proposition another major financial performance indicators was missing. In this way, PB was also incorporated in the proposal due its importance in investment evaluation. 4.2. Proposal overview A conceptual diagram illustrated in Fig.2 shows the scenarios projections (optimistic, moderate and pessimist) with the three real options (option 1, option 2, option 3) considering the ROV, PR and financial indicators (IRR, PB and ROI). Afterwards, as the project evolves during the NPSSD the performance indicators (PB and ROI) are also calculated within the gates. In this manner, the managers are able to manage flexibility to change their decisions amongst the three options suggested as soon as more information arrives. Moving forward in time, they are also able to monitor whether the option continues to be the best as the project evolves and the uncertainties gradually reduces (see Fig.2). Hence, with the intention of supporting our proposal, we suggest seven steps which are discussed as follows.
215
Kênia Fernandes de Castro Rodrigues et al. / Procedia CIRP 16 (2014) 211 – 216
New Product Service System Development
manage flexibility
ROV
Option 1 - To expand Pessimistic Scenario
Moderate Mo M S c Scenario
Op Optimistic O S Scenario
PR Option 2 - To abandon
IRR
Option 3 - To defer
Label ROV: Real Options Value PR: Premium IRR: Internal Rate of Return PB: Payback ROI: Return on Investment
PB
PB
PB
PB
ROI
ROI
ROI
ROI
gates monitor
Fig. 2. Conceptual diagram overview.
Step one - scenario preparation Managers can begin by defining the scenario objective as the definition of the PSS value proposition. Once the objective has been defined, we also emphasize the value of defining the field of conception as the PSS product oriented context. Step two - scenario field analysis The essence of a scenario is to identify the key factors. Any uncertainty can be identified as the key factors given that they influence possible future situations. However, the single key factor illustrated in the present study is the customer demand as stated in section 4.1.1. Step three - scenario prognostic Besides the identification of the key factor, the planning horizon needs to be identified, so to this end, we recommend 5 to 10 years. Bearing in mind this planning horizon, we suggest to consider the optimistic, moderate and pessimist scenarios to develop the scenarios projections in the next step. Step four - scenario development In order to develop the future projections managers should assume the possible customer demand projections for each optimistic, moderate and pessimist scenarios. Thus, managers can use specialist opinion to envision the possible costumer demand projections since we are dealing with NPSSD of innovative products. Step five - scenario transfer As a practical manner, all the previous steps intended to support the elaboration of a focused strategy facing the three scenarios. With the intention of facilitating this elaboration, we suggest the use of the real options method. Before proceeding, it is important to estimate: investments, discount rate, costs, expenditures and taxes for the project in question. Taking into account the customer demand projections for each scenario a discounted cash flow should also be delineated.
Step six - real options calculation and financial indicators In this step, managers should calculate the ROV, formula 1, and PR, formula 2, for each option (see section 2.1). At that point, the financial indicators IRR, PB and ROI should be calculated as well. Considering the calculations, managers are able to compare each value pairwise with its match in every projection of the scenarios and seek the best option in each scenario. As a result, they can select the best option in the most promising scenario or wait for better information and conditions to make the decision if the most promising scenario is not known. Step seven - performance measurement So far, little information about innovative product is available and the previous step allows the managers to assess the value of waiting for more information or not. In this way, when more information arrives, the options can be monitored throughout the gates by measuring PB and ROI which provide a base to verify if the option continues to be the best or not. To sum up, we advise that a spreadsheet covering up these steps would help even more to apply this proposal. Hence, these steps not only assist the building of scenarios but also make simpler the use of real options method in a more strategic thinking. The bottom line is that the proposal gives the ability for managers to have a better understanding of the options that their companies have and the value of keeping them open. 5. Concluding remarks This study provides insights that can help researchers and managers interested in managing uncertainties through the gates in PSS value proposition. The proposal is a first effort to provide the ability to change the decisions concerning the PSS value proposition within projects after each incremental investment.
216
Kênia Fernandes de Castro Rodrigues et al. / Procedia CIRP 16 (2014) 211 – 216
Decisions that enhance a company’s flexibility by creating and preserving options stand a better chance when applying our proposal rather than traditional investment evaluation. Our proposal also shows that the scenarios method can be successfully integrated with a more strategic way of thinking real options. In the view of the performance indicators pointed out on literature to support real options method and scenarios method, this study also tries to fulfill the mentioned gap. It is worth mentioning that along with these indicators others should be implemented as well to monitor the performance besides the financial perspective of a successful PSS value proposition. Furthermore, this proposal considers the customer demand as the key factor to build the scenarios. Therefore, this fact leads to a limitation of this study since in real situations there are more types of uncertainty. In an analogous way for real options method, there is also a limitation concerning the three types of real options used since there are several more types beyond those considered here. In conclusion, the proposal explained in this paper still requires further development and empirical tests. The conduction of the research method until the Prescriptive study reflects the fact that companies still need to be selected. Future research should carry out case studies to evaluate and validate our proposal and consequently make further improvements. Finally, a key improvement should address the other types of PSS considering the use and result oriented business models. Acknowledgements The authors would like to thank the University of São Paulo. This research was financially supported by CAPES (Coordination for the Improvement of Higher Education Personnel). References [1] Barquet APB, Oliveira MG, Amigo CR, Cunha VP, Rozenfeld H. Employing the business model concept to support the adoption of product–service systems (PSS). Industrial Marketing Management. Elsevier Inc.; 2013 Jul;42(5):693–704. [2] Manzini E, Vezzoli C. A strategic design approach to develop sustainable product service systems: examples taken from the “environmentally friendly innovation” Italian prize. Journal of Cleaner Production. 2003 Dez; 11(8):851-857. [3] Tukker A. Eight types of product–service system: eight ways to sustainability? Experiences from SusProNet. Business Strategy and the Environment, 13 jul. 2004; 13(4): 246-260. [4] Meier H, Roy R, Seliger G. Industrial Product-Service Systems—IPS2 CIRP Annals - Manufacturing Technology. 2010 Jan; 59 (2): 607-627. [5] Kotler, P. (1994), Marketing Management – Analysis, Planning, Implementation and Control, 8th ed., Prentice-Hall, Englewood Cliffs, NJ. [6] Mont O. Product-Service Systems : Panacea or Myth ? [S.l.]: Lund University, 2004.
[7] Richter A, Sadek T, Steven M. Flexibility in industrial product-service systems and use-oriented business models. CIRP Journal of Manufacturing Science and Technology. 2010 Jan, 3(2): 128-134. [8] Damodaran A. Strategic Risk Taking: A Framework for Risk Management. Front Cover. Wharton School Pub.2008: 1-388. [9] Filho AG, Pigosso ACD, Ometto AR, Rozenfeld H. Remanufacturing on a Framework for Product Life-Cycle Management (PLM) in the Context of Product-Service Systems ( PSS ). 2009. [10] Jetter AJM. Educating the guess: strategies, concepts and tools for the fuzzy front end of product development. PICMET 03 Portland International Conference on Management of Engineering and Technology Technology Management for Reshaping the World. 2003: p. 261-273. [11] Cooper RG. In: Winning at New Products: Accelerating the Process from Idea to Launch. Basic Books: New York, 2001. [12] Crawford CM; Di Benedetto A. New products management. 9th ed. Boston: McGraw-Hill Irwin, 2008. [13] Herath H; Park C. Economic analysis of R&D projects: an options approach. The Engineering Economist. 1999:37-41. [14] Perlitz M; Peske T; Schrank R. Real options valuation: the new frontier in R&D project evaluation? R&D Management. 1999 Jul; 29(3):255-270. [15] Rese M, Karger M, Strotmann WC. The dynamics of Industrial Product Service Systems (IPS2) – using the Net Present Value Approach and Real Options Approach to improve life cycle management. CIRP Journal of Manufacturing Science and Technology. 2009 Jan; 1(4): 279-286. [16] Trigeorgis L. Making use of real options simple: An overview and applications in flexible/modular decision making. The Engineering Economist. 2005:37-41. [17] Faulkner T. Applying’options thinking'to R&D valuation. ResearchTechnology Management, 1996. [18] Miller KD, Waller HG. Scenarios, Real Options and Integrated Risk Management. Long Range Planning. 2003;36(1):93–107. [19] Upton WS.. Business and Financial Reporting, Challenges from the New Economy. Financial Accounting Series – Special Report. FASB. USA: abril, 2001. [20] Bouteiller C, Karyotis C. The evaluation of intangibles: introducing the optional capital. Investment Management and Financial Innovations. 2010, 7(4). [21] Dixit, A.; Pindynck, R. The options approach to capital investment. Harvard business review, 1995. [22] Black F, Scholes M. The Pricing of Options and Corporate Liabilities. Journal of Political Economy. 1973; 81(3): 637-659. [23] Copeland T, Tufano P. A real-world way to manage real options. Harvard business review. 2004; 82(3):90-99. [24] Mikaelian T. et al. Real Options in Enterprise Architecture: A Holistic Mapping of Mechanisms and Types for Uncertainty Management. IEEE Transactions on Engineering Management. 2011; 58(3):457-470. [25] Fink A, Marr B, Siebe A, Kuhle J. The future scorecard: combining external and internal scenarios to create strategic foresight. Management Decision. 2005; 43(3):360–381. [26] Gausemeier J, Fink A, Schlake O. Scenario management: An approach to develop future potentials. Technological Forecasting and Social Change.130:111–30. [27] Neely A, Gregory M, Platts K. Performance measurement system design: A literature review and research agenda. Int. J. Oper. Prod. Manag. 2005; 25(12):1228–63. [28] Abramovici M, Jin F, Dang HB. Product-Service Integration for Sustainable Solutions. Meier H, editor. Berlin, Heidelberg: Springer Berlin Heidelberg; 2013:311–322. [29] Blessing, LTM; Chakrabarti, A. DRM, a design research methodology. Springer-Verlag, London. 2009. [30] Yang J. A Balanced Performance Measurement Scorecard Approach for Product Service Systems. 2009 International Conference on Business Intelligence and Financial Engineering. 2009 Jul;548–551.