I recently read a thought-provoking article in CFO Magazine that discussed how Adobe Systems successfully completed a sweeping transformation of its business model in just three years. Adobe transitioned from selling boxed software to collecting monthly subscription fees for cloud-based tools. This represented a fundamental shift. Instead of collecting hundreds of dollars up front from a customer and recognizing the revenue, the company collects a far lower amount on a recurring basis.
Given the risks entailed in reinventing the business model, you might think that the company’s investors would run for the exits, but that’s not what happened. Even though Adobe’s earnings fell sharply at first, the company’s stock price began to slowly rise after it announced its new model, and the price reached an all-time high within less than four years, outperforming the major indices.
What does a software company’s success story mean to manufacturers of capital medical equipment? Although the jury is still out, the subscription model is a potential game-changer, and it couldn’t be emerging at a more opportune time.
Like other industries, medical equipment manufacturers face a rapidly shifting business environment. Across the healthcare ecosystem, profit margins are shrinking and pricing pressures are increasing, with providers’ bottom lines more closely tied to patient outcomes and process efficiency. As one response to these pressures, hospitals are reducing capital budgets and extending equipment lifecycles beyond the manufacturer-suggested period.
Because manufacturers’ revenue streams under the traditional capital sales or leasing models are threatened, a subscription model for capital equipment warrants a closer look. Under this model, the manufacturer maintains ownership of the asset, and the hospital makes no upfront payment. Instead, the hospital pays a fixed, recurring payment each month. In addition to covering the asset itself, the subscription payment covers an integrated solution that includes maintenance, parts and labor, value-added clinical or operational services, and product upgrades and replacements. This means that hospitals can capture the benefits of well-maintained equipment and the latest technology while avoiding the need for large capital outlays and costs related to maintenance and repairs. With well-designed clinical or operational services included in the package, this will ultimately translate into better patient outcomes, higher efficiency and improved financial results.
Transitioning to the subscription model won’t be easy. Manufacturers will need to work with their customers to help them adapt their buying and accounting processes. For example, equipment costs will shift from the capital budget to the operating budget, which means that hospitals will no longer be able to depreciate the assets. At least in the short term, there’s a risk that some customers will be unwilling to transition to the new model.
Manufacturers will also need to make some fairly radical changes to their own businesses to provide the full scope of offerings under a subscription model. For example, they’ll need to design new packages of products and services that are truly meaningful to customers. Although the long-term impact will likely be positive, manufacturers’ earnings will drop in the near term as large upfront payments for equipment are replaced by much smaller payments in a recurring revenue stream.
However, as the success of Adobe and many other companies in software, aerospace and restaurant service industries demonstrates, barriers like these can be overcome. First and foremost, you’ll need a value proposition that persuades hospitals that they will capture significant benefits by switching to the new model. This starts with designing distinctive integrated solutions to help hospitals address their most important needs. By creating integrated solutions that competitors can’t match, you will promote the lock-in effect that’s critical to the subscription model’s success. Solutions and the supporting infrastructure must also be scalable to allow the addition of new services or next-generation products.
Given the high stakes, manufacturers should test and refine the subscription model by piloting it in selected geographies or market segments. But once you’re ready to roll out the new model, go all in. Pulling the plug on the traditional capital sales and leasing models will be essential to accelerate the transition to the subscription model—within both your own organization and your customers’ organizations—as well as to persuade investors that you’re committed to making it happen. To ease the transition, you’ll need a carefully designed and orchestrated approach to change management. This includes planning, forecasting and alignment of key performance and financial metrics, and over-communicating to internal teams and investors so that everyone understands the long-term objectives.
Only time will tell whether the subscription model works for capital medical equipment, but if it does, the first companies to successfully transition are likely to be the biggest winners. By forging strong ties with their customers, these companies will reap the long-term benefits of a sustainable, growing and recurring revenue stream.
Jay Zhu is an associate principal in ZS’s Evanston, Ill., office. Jay has helped many medical device and pharmaceutical companies make and implement business decisions on portfolio optimization, commercial strategy and organizational design. Jay’s main areas of expertise include portfolio strategy, opportunity assessment, new product launch, go-to-market strategy, commercial organization design and marketing excellence. Jay earned his M.S. in management science from the University of Illinois at Urbana-Champaign. He holds a bachelor’s degree in mechanical engineering from Shanghai Jiaotong University.