The high cost of software
The value-added digital services and intuitive user interfaces discussed above are achieved through software integrated into the appliance in the form of a mobile app or software infrastructure.
In contrast to hardware development, development costs for this kind of software tend to increase from year to year. In addition, the software also costs money to operate and for ongoing development.
Manufacturers therefore need to ask themselves how they are going to recoup the cost of developing and operating the software over the entirety of the product life cycle. Either they add that cost to the product price or they need to develop new revenue models. The problem with adding these life cycle costs to the product price is that it makes the product significantly more expensive, raising barriers to purchase for the consumer. Generally, businesses will only get away with big jumps in price or with adding the cost for these value-added services to the product price where the product is truly on-trend, is caught up in some major hype or is a first-of-a-kind product with major consumer appeal. Manufacturers should therefore be thinking about bringing in new revenue models from the outset – models which deliver genuine added value for consumers and, by generating recurring revenues, cover ongoing software costs.
In practice, three new revenue models stand out, offering a range of advantages over bumping up the up-front price.
A subscription is akin to renting or leasing and represents the simplest revenue model. With this model, services or software functions are activated for a specific period of time and billed on a recurring basis. Payments are often made monthly. When it comes to digital services for consumer goods, this model is definitely an option, as consumers are well used to recurring charges for similar services. Most consumers pay a monthly fee for their phone and for streaming services such as Spotify and Netflix. Since the benefits provided by functions and software are generally realised over a longer period rather than as a one-off, subscription services make it easy for customers to weigh up the costs and benefits. When calculating the price of the service, vendors can also take into account the actual value to customers.
2. Pay per use
The boundary between a subscription and pay per use is somewhat fuzzy. There are time-based pay per use models, comparable in principle to a subscription, except that the time periods involved tend to be shorter, with usage often billed by the hour, minute or even by the second. In 2021, for example, Volkswagen announced that, as well as being able to purchase its autopilot feature as a one off for the lifetime of the vehicle, it would also offer a subscription option for under €7 per day per vehicle. Standard car sharing models also tend to combine both usage and time components. In future, washing machines might charge a one-off fee to run a special, rarely used wash programme. Apps for kitchen appliances could also charge for recipes on a per use basis, perhaps with a seasonal aspect, with recipes for biscuits, duck and roasts holding more appeal in winter and lighter meals and fruity smoothies more popular in summer. Additional benefits and sales could be generated by selling relevant cooking utensils.
3. Outcome-based payments
Now we come to the premium option. Outcome-based payment models are the hardest to implement, but the most appealing model for the customer. With outcome-based payments, billing is based on outcomes. And herein lies the challenge, as this means you need an automatic, fraud-proof means of measuring these outcomes. For a robot lawnmower, for example, this might mean mowing the lawn within a specified time, for a wine refrigerator keeping the temperature within a specified range or for a household appliance achieving the promised energy consumption. Availability is another possible metric. The customer would get money back if the appliance was out of action, but would automatically pay a fee if it was always working.
Manufacturers will need to work out which model is most suitable for their product and define an appropriate billing model. This will depend on the product segment, software functionality, measurability and monitoring options. What’s clear, however, is that manufacturers need to start thinking about payment and billing options now. Should their competitors – whether established vendors or up-and-coming start-ups – get there first, they might be able to grab significant market share.