I’m a sucker for innovative new business models, new ways of organizing the way products and services are produced, marketed and priced.
Years ago, I got fascinated with the new way Harnischfeger, a Milwaukee-based maker of earth-moving and extraction equipment, was marketing to the mining industry. Instead of just selling big machinery to miners, Harnischfeger offered something akin to a leasing-and-maintenance arrangement in which the price was set based on the number of tons of coal or iron ore extracted.
Steven Pearlstein is a Pulitzer Prize-winning business and economics columnist at The Washington Post.
Under this arrangement, Milwaukee-based Harnischfeger would own the equipment and, over the life of the contract, be responsible for maintaining it or replacing it whenever there was a breakdown. For the mine owners, the advantage was that Harnischfeger was effectively providing financing for the equipment and assuming some of the risk from any slowdown in coal production. By turning a potentially risky capital investment into a predictable operating cost, Harnischfeger — now part of Joy Global — made it easier for mining companies to provide their customers the longer-term, fixed-price supply contracts they demanded.
Similar arrangements developed in other industries, from computers, office copiers and medical equipment to pharmaceuticals and shipping. Some of them have stood the test of time, others not, but all were part of a broad outsourcing trend that sought to take advantage of economies of scale, turn fixed costs into variable costs, and turn manufacturing firms into service companies while shifting pricing risks from downstream customers to upstream suppliers.
I was reminded of all this last week reading an article — okay, it was in the New York Times — about the growing popularity of energy-savings performance contracts offered to governments and corporations. Under these arrangements, a big energy or engineering firm offers a public or private enterprise a plan to reduce its energy costs and consumption, some of it through conservation or changes in operation but usually most of it through investment in lower-cost or higher-efficiency equipment. The innovative twist is that the energy savings are actually guaranteed by the provider, which makes it easier and cheaper to finance these energy-saving investments. In some instances, the energy or engineering company also takes the credit risk and finances the project as well.
We’ve already seen a similar development in the legal business. Some large law firms have arrangements with big corporate clients to do all of the company’s legal work, or all of it in a given area, for a fixed annual fee. The law firms get to look at several years of legal bills before making their fixed-price offer. Obviously, neither the law firm nor the client knows all of the legal services that will be required in the future, but by sharing some of that risk with clients, law firms are able to lock in a customer’s business and guarantee a steady stream of income that makes it easier to borrow working capital and manage the ups and downs of its business.