Now that the economy is bumpy, industrial executives might be asking their CTOs: Why do a digital transformation and take the risk of diluting our margins when our EBIT numbers are excellent?
Frankly, I get that question quite often when discussing the need to diversify an industrial company portfolio and to move to a recurring business model. This is a questions leaders on the digital side must prepare for. You could use the typical arguments:
- If we do not do it, our competitors will do it.
- Customers are asking for it and we need to respond.
- The world is digitalizing, and we must play in the space.
- We need to diversify our business portfolio to expand our total addressable market.
- We have made all these digital and technology investments to support this strategy.
These are all legitimate reasons to get started and to push forward. But there are not enough to convince a CEO and CFO to “swallow the fish” (meaning sacrifice cash flow up front while sales are moving to a recurring format) and invest in innovations that provides little return. This is even more complex when your performance is extraordinarily strong, and you are growing. Additionally, most companies have posted record profits post-pandemic and are now facing what could be a big recession.
There is a better approach to convince these executives to support your digital initiatives and to invest in recurring business models in the context of the upcoming economic slowdown. I have written about this in the past, but this is even more relevant today.
First, you must change the overall narrative of your business cases and requests for investments. You must focus on profitable growth, and not on explosive growth at all cost or growth that is not supported by convincing evidence of success. Today, SaaS manufacturers and tech start-ups with a manufacturing component are facing an investment crunch and have started to reduce costs and focus on profit. So, it would not be a clever idea today to refer to successful unicorns and the rule of 40, for example! Second, you must change the overall arguments to make the case for investments in digital innovations.
I propose five critical considerations to include in the presentation of your business cases:
1. Stay close to the core and reinforce the existing business model: That is a key top management priority. Industrial digital innovations must reinforce the core business and enable the sales of core products, equipment, and machinery. It becomes an augmentation message and not a replacement message. Pay close attention to margin dilution through cannibalization.
2. Prioritize areas of high profit margins: This starts with leveraging the installed base and increasing current customer lifetime value. Selling more services, maintenance contracts, spare parts and connected solutions can significantly increase margins. These areas must be the focus for the next 18 to 24 months, and your investment requests need to include the right technologies.
3. Focus heavily on differentiation and high-value innovations: Change the evaluation criteria used to select the right opportunities in your digital innovation pipeline. It is no longer about growth and sales. It is more about differentiation power, pricing power and customer willingness to pay. Make sure you include these criteria in your gate reviews and your portfolio evaluation.
4. Make sure your sales enablement program is well-executed: You might get challenged on the ability of the existing salesforce to execute the plan and to sell these high-value innovations. That is a fair point. You must strongly focus on sales enablement programs, and prepare a robust sale and value playbook. Training all go-to-market team members on the playbook is a requirement. The playbook must include battle cards, customer value propositions, ROI calculators, selling sheets, objection management guides, etc.
5. Involve finance to get P&L projections: Your business case and financial projections must be detailed and believable. You must address potential cannibalization of existing profitable sales, impact of gross and profit margins, cash flow impact and potential incremental costs (sales, commissions to partners, customer success, etc.). You also should propose worst-case, base and best-case scenarios. That means that you must work deeply with your core business finance team. Top executives have trust in them and will be more inclined to listen if they have worked on business cases collaboratively with you.
The upcoming recession was predictable. Current levels of inflation and high demand are not sustainable. Most industrial companies have been able to build some reserves and are in an advantageous position to invest in their digital future. But it must be done in a practical and pragmatic way.
Growth for the sake of growth is no longer an option. Growth to support the core and increase profitability is the new way to go. That will require potential changes in the way your digital organization works, is organized and communicates to top management. It is a good thing for industrial companies, and they have strong advantages against start-ups when a recession looms. One of them is access to a strong customer base and deep product intelligence. The future is profitable and bright for industrial natives.
Stephan Liozu is Founder of Value Innoruption Advisors, a consulting boutique specializing in industrial pricing, digital business and subscription-pricing models, and value-based pricing. Stephan has 30 years of experience in the industrial and manufacturing sectors with companies like Owens Corning, Saint-Gobain, Freudenberg and Thales.