by
Martin Spring and Katy Mason
Lancaster University Management School
Paper prepared for the Symposium on
Procuring Complex Performance
University of Bath School of Management
Operations and Supply Group
5 th and 6 th December 2007
A technical basis for the definition of services, using the so-called IHIP characteristics, is rejected in favour of one based on institutional arrangements. Mundane Transaction Costs and the notion of qualification are discussed in relation to making services tradable. The evolution of the Business
Model concept from e-business to wider usage is briefly reviewed, and its applicability to complex product-service systems considered. Four common elements are identified: the structure of networks; how transactions are made possible; how payments are made; and how information and knowledge are transferred. These ideas are then applied to a case study concerning the offshore subcontracting of engineering design services by Rolls-Royce aero-engine makers. Three themes of analysis are developed: a chain of services; the process of aggregating and packaging work between organisations; and the multiple, ambiguous and dynamic boundaries of the firm.
We wish to acknowledge the participation of respondents from Rolls-Royce, Assystem and Quest.
Some of the material was presented at seminars in Lancaster and the Stockholm School of
Economics, and at IMP and EUROMA conferences. Comments and suggestions by participants at these events and by Keith Blois are gratefully acknowledged. The usual disclaimers apply.
The present paper is the first attempt we have made to bring together the PSS and Business Model literatures and, as it stands, probably creates rather than ties up loose ends. There no doubt remain a number of inconsistencies of terminology, missing references and the like that time (or lack of it) did not allow us to iron out. Our apologies: nonetheless, we hope it provides some food for thought.
Please do not reproduce or quote the paper without express permission of the authors.
1

In Operations & Supply, in Marketing, as well as in practice, there is a renewed focus on buying and selling performance rather than products. This is of particular significance where complex bundles of products and services are being traded, often over extended periods and in extended supply networks (Davies, 2004). The motivations for this shift are many and various, and present many new challenges to management thinking. In this paper, we explore this phenomenon using the emerging notion of Business Models.
The paper is organised as follows. Section 2 proposes a novel basis for defining services in an operations & supply context, and examines how services are made tradable. Section 3 introduces the Business Model concept, and Section 4 brings this together with key ideas from the service definition approach outlined in Section 2. Sections 5 and 6 present and analyse a case study on the procurement of engineering design services in the Rolls-Royce aero-engine supply network.
Sections 7 and 8 develop more general discussion and conclusions.
The term ‘Product/Service System (PSS)’ will be used to refer to any combination of products and service relationships involved in the delivery of benefits to customers (Mont 2002).
The term has been adopted in the same way by the Cranfield EPSRC-funded IMRC working in this area (Baines et al 2007)
This section presents a fairly brief summary of ideas developed and discussed at greater length elsewhere (Araujo and Spring 2006; Spring and Araujo 2007).
In both OM and Marketing, the distinctive characteristics of services have been a concern since at least the 1970s. The Harvard Business School introduced a course called “Management of
Service Operations” in 1972, on the premise that ‘the tasks of managing service firms differ significantly enough from those of manufacturing firms to justify separate (or at least special) treatment’(1978). This is no place to review the development of service OM literature (see
Johnston, 1998; Roth and Menor, 2003), but there are two relevant, pervasive themes. First, services have been treated as an aberration, commonly defined in terms of what they are not: intangible, non-storable, non-transportable and so on. Secondly, in both operations management
(OM) and marketing, services have been defined by the so-called ‘IHIP’ characteristics
(Intangibility, Heterogeneity, Inseparability and Perishability) (Lovelock and Gummesson, 2004), and concerned with the involvement or otherwise of “things”(cf Bowen and Ford, 2002). A study of academics in service OM (Nie and Kellogg, 1999) shows that this view continues.
In this section we suggest an alternative approach to defining services, drawing on the work of economists of national accounting. For them, distinguishing between products and services is very important: if we are to speak of and quantify “the service economy”, then we need a basis for
2

deciding what is and is not a service. Here, the approaches of two such economists, Hill (Hill,
1977; 1999) and Gadrey (2000) will be summarised. Hill (1977) holds that:
“the production of a service cannot generally be distinguished from that of a good by means of the technology used but by the fact that the producer unit operates directly on goods which already belong to the consumer of the service” (Hill, 1977: 319).
For example, if a worker on a car assembly line fits a tyre to a wheel, it is considered to be a manufacturing operation, because what results is a ‘thing’– a completed car. If a garage worker fits a new tyre to a car brought in by its owner, it is considered to be a service operation. And yet in terms of most of the IHIP characteristics, there is no difference. What differs is (a) that there is a direct relationship between the two economic entities, and (b) the ownership of the car. A similar argument is applied to services affecting persons, except that the idea of ownership is not appropriate: services affecting physical or mental state, customer location and so forth are performed on the customer’s own body or on the bodies of those for whom the customer has responsibility e.g. children. These points, and elaborations upon them which there is no time to discuss here, result in the following definition:
“A service may be defined as a change in the condition of a person, or a good belonging to some economic unit, which is brought about as a result of the activity of some other economic unit, with the prior agreement of the former person or economic unit” (Hill,
1977)
Gadrey (2000) takes this definition as a starting-point, but notes that it would lead to the definition of the employees of a firm (manufacturing or service) being regarded as producers of services – to their employer. Hence they develop a more discriminating definition which, whilst perhaps appearing a little complex, is crucial to our understanding:
“a service activity is an operation intended to bring about a change in state in a reality C that is owned or used by consumer B, the change being effected by the service provider A at the request of B, and in many cases in collaboration with him or her, but without leading to the production of a good that can circulate in the economy independently of medium C”
(Gadrey, 2000: 375-376).
We will refer to this approach as an institutionally-based definition and conceptualisation of services (Araujo and Spring 2006). This does not refer to the ‘institutional theory’ of, say, Di
Maggio and Powell (1983), but to the formal institutions governing production and exchange
(Coase, 1992): firms as economic entities and the formal assignation of property rights. Here, in contrast, the key issues are the relationship and boundaries between economic entities and the way in which property rights are exchanged, not the presence or otherwise of a ‘thing’ (Bowen and
Ford, 2002). This matters, because the IHIP characteristics have been used to determine what is a
‘service firm’ and hence how one should be managed (e.g. Sasser et al 1978); if the basis for classification is wrong (or at least in doubt), then so is the prescription that follows from it. It is important for firms who are ‘servitizing’ because often, on the technical basis of IHIP, nothing is changing, and yet firms have to adjust their strategies profoundly.
The central feature of the institutional basis for definition is that services are necessarily embodied in relationships between economic entities. Gadrey suggests, but doesn’t draw, the notion of a ‘service triangle’. Figure 1 shows one possible interpretation of this, where A, B and C are used as in the definition just cited.
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Operation intended to change state of C
A
C
Request for intervention
Owns or uses
B
Possible collaboration
“the output of which cannot circulate in the economy independently of medium C ”
Figure 1 – The Service Triangle (after Gadrey, 2000)
Gadrey goes on to examine three circumstances under which services are provided. The first, which underlies the definitions above, is what he terms ‘request for intervention’ – auto repairs, haircuts, surgical operations. But Gadrey notes that the definitions discussed so far do not adequately deal with, for example, using a telephone network. Here, he suggests, “what is being purchased is the temporary right to use a technical system (which is maintained for that very purpose)”: the service provider’s principal activity is the maintenance of the capacity, as when hotel rooms are cleaned and replenished with fresh linen, for example. Such temporary rights are carefully defined, often in terms of a duration of use, as when hiring a car, making a long-distance telephone call, or staying in a hotel. Finally, Gadrey identifies a third category of demand rationale, that of the ‘performance’, such as takes place in a theatre. This can be thought of as using a human capacity. This gives rise to the final definition:
“Any purchase of services by an economic agent B (whether an individual or organization) would, therefore, be the purchase from organization A of the right to use, generally for a specified period, a technical and human capacity owned or controlled by A in order to produce useful effects on agent B or on goods C owned by agent B or for which he or she is responsible”
(Gadrey, 2000: 382-383)
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Gadrey’s definition concerns the purchase of services. As we have seen, service activities do not lead to a good that can “circulate in the economy independently..” (Gadrey 2000) whereas, it seems, production activities do. On some views (e.g. Demsetz, 1993) products ‘act as a means of separating production from exchange and delimiting user-producer interaction’ (Araujo and
Spring, 2006: 800). However, Baldwin and Clark (2006) draw attention to the ‘mundane transaction costs’ – the work involved – in defining where in the totality of a chain of activities a transaction may take place – that is, in their terms, the encapsulation of knowledge and material transfers into a product that can be sold. In short, products are not self-evidently bounded, and work has to be done to define what they are. Baldwin and Clark’s main point is that these ‘pinchpoints’ – the points in the total chain of activities where transactions between economic entities take place – occur where the mundane transaction costs are lowest. Mundane transaction costs consist of the costs of standardising what is to be sold, counting the units to be sold, and compensating the provider (Baldwin and Clark, 2006: 13-15).
Baldwin and Clark, taking an engineering design view, concentrate on production chains.
But in the same way, services may also be made tradable (for we know they are bought and sold) by such processes of standardizing, counting, and compensating. However, as the offering moves further away from one encapsulated neatly in a physical artefact, more work is required to stabilise and qualify what the service is and make it tradable (Callon et al 2002). Callon (2002) also points to the important role for writing and language in defining offerings through service process files and contracts. As Shakespeare puts it:
‘the poet's pen, Turns them to shapes and gives to airy nothing, A local habitation and a name’.
(Theseus from A Midsummer Night's Dream, Act 5, Scene 1).
Baldwin and Clark’s analysis offers some powerful insights and establishes the idea of mundane transaction costs (MTCs). However, it is fundamentally a static view, taking the total set of activities to be performed, and their respective MTCs, as stable phenomena. Langlois (2005) has drawn our attention to the ‘secret life’ of MTCs, pointing out that technological and other changes alter what activities need to be performed, and even change the MTCs (cf. Zipkin, 2006). More to the point here, once dynamic transaction costs have ‘died down’, as Langlois puts it, organisations learn to reduce various elements of the MTCs in various ways; once that happens, the ‘pinchpoints’ may well shift.
Services are attracting renewed attention from business and academics alike. For example, the IBM Corporation recently has encouraged research into ‘services science’ (Chesbrough and
Spohrer, 2006). Sampson and Froehle (2006) have developed a ‘unified service theory’, defining services as necessarily involving customer inputs (which seems contestable as the sole basis for definition); Corrêa et al. (2007) also seek to move away from IHIP by defining four different characteristics: stockability; intensity of interaction with the client; simultaneity of production and consumption; and degree of difficulty in performance analysis – although these are rather like IHIP and, crucially, still relate to the technical characteristics of the activity rather than the institutional arrangements. In marketing, a sustained argument has been made by Vargo and Lusch (e.g. 2004)
(a) to reverse the dominance of product-based concepts and see products merely as particular types of vehicles for the delivery of services and (b) to dispel the ‘myth’ of the IHIP characteristics. On similar lines, Lovelock and Gummesson, (2004) tentatively suggest a ‘rental/access paradigm’, which points to the type of institutionally-based distinction that is developed here.
5

The institutionally-based conceptualisation of services has strong parallels with the literature on Business Models (BMs). As shown by the bibliometric analysis of Osterwalder et al.
(2005), the BM concept emerged when e-business grew in the late 1990s, and concerned novel ways to deliver value (Timmers, 1999; Weill and Vitale, 2001, HBR, 2001). The BM concept is now used widely in practice, is not confined to e-business, and is becoming the object of more sustained academic enquiry (Schweizer, 2005). The BM literature, not surprisingly for such a new field, has a wide variety of conceptualisations. But there are some common elements and these, and the relationship between them, have strong parallels with the institutional analysis of PSSs.
Before examining these common themes, in the following sections we provide a brief review of the development of the BM literature.
According to Ostwerwalder et al. (2005), the first usage of the term business model in an academic article was in 1957 (Bellman, Clark et al., 1957), and in a title in 1960 (Jones, 1960).
However, it only came into regular use at the end of the 1990s, re-appearing in academic paper titles in 1997 and growing rapidly over the next few years. It was usually used in connection with internet-based businesses during the so-called ‘dot.com boom’.
Paul Timmers, an early analyst of e-business and, at the time, a senior advisor to the
European Commission, provides one definition of ‘Business Model’:
 “An architecture for product, service and information flows, including a description of the various business actors and their roles; and

A description of the potential benefits for potential actors; and
 A description of the sources of revenue.” (Timmers, 1999: 32)
He then suggests that the architecture of the business model can be defined in terms of three issues
(Timmers, 1999: 33):
1.
Deconstruction of the elements of the value-chain (Porter);
2.
the interaction patterns between actors: one-to-one, one-to-many, many-to-one, or many-to-many;
3.
Reconstruction of the value-chain in terms of information-processing across a number of steps across the chain.
Note that this doesn’t involve anything unique to e-business, but also that, given internet technology, the ‘many’ in ‘one-to-many’ can be a very large number at low cost and that information processing in stage three can be highly automated. as:
In another, slightly later analysis, Weill and Vitale (2001: 34) define an e-business model
“a description of the roles and relationships among a firm’s consumers, customers, allies, and suppliers that identifies the major flows of product, information, and money, and the major benefits to participants”
They suggest that there are three critical aspects of a business model, participants, relationships and flows, and propose a set of building blocks with which e-business models may be constructed
(Figure 2)
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Firm of interest
Supplier
Electronic relationship
Primary relationship
Flow of Money
Customer
Ally
Flow of Product
Flow of Information
Figure 2 – E-business model building blocks (adapted from Weill and Vitale, 2001)
Both Timmers and Weill and Vitale then go on provide taxonomies of e-business models, including, for example, e-shops, e-malls, e-auctions, virtual communities (Timmers) and direct-tocustomer, full-service provider, portals and so on (Weill and Vitale).
Much of the logic of the business model concept can be applied to any business, internet-based or otherwise. Practitioners in many sectors use the term, and the academic literature is catching up.
Magretta (2002) suggested that a good business model had to both tell a good story – that is, offer something customers value - and pass the numbers (profit and loss) test. Linder and Cantrell
(2000) identified (a) components of business models such as pricing model, channel model, and organizational form (b) operating models, which combined these components, and (c) change models, which sketched possible ways in which business models could be adapted. There is no space here for a detailed review of all the attempts along similar lines. Osterwalder et al (2004) suggest that the literature progressed from definition of the BM concept to successive stages in identification and description of the elements of BMs
Activity
Define and classify BMs
List BM components
Describe BM elements
Model BM
Elements
Apply BM concept
Outcome Definitions & taxonomies
‘Shopping list’ of components
Components as building blocks
Reference models & ontologies
Applications & conceptual tools
Fig 3 Evolution of the Business Model Concept (Adapted from Osterwalder et al (2004): details of references omitted)
7

Business Models are, however, more than the sum of their parts. To some extent this is present in Linder and Cantrell, and in Weill and Vitale’s notion of ‘initiatives’, which are ways of combining the elements of business models. Morris et al (2005) construe this as a three layered framework. At the bottom, the foundation level, are the basic components, of which many similar categorisations exist. Morris et al suggest that these elements are likely to be replicable by competitors, and so suggest a second layer, termed the proprietary level, which is rendered unique and difficult to imitate by virtue of the idiosyncratic interactions among the components. This recalls the treatment of capabilities in organisation studies and evolutionary economics (e.g. Dosi et al.
2000) which has been drawn on, to some extent, in operations management (Slack and
Lewis, 2002; Pandza et al., 2003).
The third level is termed the ‘rules level’ and sets out simple, broad guiding principles – for example, Dell’s rule to turn inventory every four days. These layers are represented in Figure XXX
Business
Co mp
Models
6.
5.
4.
3.
How
Tim
2.
1.
Who
Sou
Com rce o
to m e, sc
How petit ope
to c
to c ake reate
mo
, siz reate f co ive p
value
value mpe ositio onent tenc ning ney?
?
s e
for?
e of am bition
Lev els
lev el
1.
Fou nd ation
2.
Pr op riet ary
lev el
3.
Ru les
lev el
Figure 4 Business Models: Components and Levels (Mason 2007)
As already shown, in both OM and Marketing there has been considerable concern with the definition of products and services. Others have been concerned to understand changes:
‘servitization’ itself suggests not a state, but a process of shifting to a service-intensive offering from one based on selling products. The BM literature has mostly been concerned with definition of BMs, identification of their elements, and their classification. Partly this is because of its origins in e-business, where the central concern was new BMs for newly established firms. Even now, the
‘non-e-business’ BM literature is centred in an entrepreneurial context (e.g. Amit and Zott, 2001;
Morris et al ., 2005). In general ‘the relationship between business models and time is little discussed’ (Osterwalder et al.
, 2005). However, more recent work turns to the dynamics of business models. Mason and Leek (2008) suggest BMs that are in some ways self-maintaining in the face of changing circumstances and which involve a preconception of a network structure,
8

followed by the establishment of routines, followed by problem-solving episodes that develop new knowledge in an iterative fashion. Teece (2007) links business models to dynamic capabilities and
‘entrepreneurial management’, interestingly pointing out that such management is not confined to new business start-ups.
The brief review of the BM literature points to some themes in common between the PSS work and the BM literature.
Almost all of the BM literature gives a central place to the structure between a focal firm and the organizations with which it transacts (Amit and Zott, 2005; Mason and Leek, 2008).
According to Zott and Amit (2008) “the BM is a structural template that describes the organization of a focal firm’s transactions with all of its external constituents in factor and product markets”.
This recalls the main insight from the PSS analysis that an institutional definition of services is necessarily a structural one, rather than being based on technical characteristics of the activities that are carried out (IHIP).
The BM concept is usually defined in terms of transactions. For example, for Amit and Zott
(2005: 511) a BM is: “the structure, content and governance of transactions”. The analysis of PSS set out above is similarly concerned with where transactions take place in ‘the institutional structure of production’ (Coase, 1992), why they take place where they do, how they are made possible (Callon et al ., 2002), and how (Baldwin and Clark, 2006) they are standardised, counted and compensated for. This leads to the next common theme.
This came to the fore in the BM literature as novel revenue-generation approaches were developed in e-business. Morris et al (2005) include ‘How do we make money?’ as one of the foundational elements of BMs; Teece (2007) includes ‘revenue architectures’ as a key BM feature.
Both in theory (e.g. Baldwin and Clark, 2006) and in practice, this is a concern for firms developing novel PSSs. For example, when computing services are accessed on a ‘Software as a
Service’ (SaaS) basis, various payment regimes may be adopted e.g. payment by transaction, or annual charge, or variations on these themes (Currie et al., 2003). Firms accustomed to making physical products and selling them are presented with major challenges in defining payment regimes when they ‘shift to service’ (Wise and Baumgartner, 1999).
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This is less consistently present – at least explicitly - in the BM literature. But it is implicit in Morris et al.
’s (2005) inclusion of ‘How we create value’ and ‘sources of competence’ in their foundation elements of BMs and in Schweizer’s (2005) emphasis on the resource-based view as an important basis for classifying BMs. Mason and Leek (2008) see an important role for various forms of knowledge in dynamic business models. The PSS analysis is concerned with the respective roles of products and services as embodiments and carriers of knowledge within and between organisations (cf. Manzini et al ., 2004). The PSS analysis identifies a class of services whereby service providers enable and regulate access to ‘maintained socio-technical capacities’, which also embody information and knowledge (Figure 5a). Secondly, the logic of the ‘request for intervention’ sees service providers bringing their knowledge and information to intervene directly in bringing about valuable change to the assets owned or controlled by the customer (Figure 5b).
Finally, knowledge and information can be transferred by the sale of products. Products embody specialist knowledge, so selling a product is one way to transfer knowledge, and users can be
“instrumentally knowledgeable, while substantively ignorant” about the products they purchase
(Loasby, 1998). In all cases, the customer’s knowledge and information also plays a larger or smaller part.
C
Operation intended to change state of C –
Maintenance of STC Uses – access to STC
A – service provider
B - customer
Possible collaboration
“May I hire your car?
”
Figure 5a The Service Triangle and Access to Socio-Technical Capacity
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C
Operation intended to change state of C – intervention
Owns
Request for intervention
A – service provider
B - customer
Possible collaboration
“Will you service my car?
”
Figure 5b The Service Triangle and Request for Intervention
We now wish to explore this synthesis of the Business Model concept and the institutional approach to service definition by means of a case. Aspects of the case will be familiar to some, as it involves the Rolls-Royce ‘Power-by-the-hour’ offering, something of a cause célèbre among servitization enthusiasts. But, unlike much of the work in this vein, the case is less concerned with the relationship between Rolls-Royce and their customers, the airlines, and more concerned with upstream service provision. More specifically, it addresses the outsourced design engineering provided by both UK-based and off-shore engineering design providers.
This longitudinal study was designed to identify and explore the dimensions of the new business model that evolved in a manufacturing firm as it shifted from selling
‘engines’
to
‘power by the hour’ (Eisenhardt, 1989; Pettigrew, 1990). The study focuses on a single business model of an offshore supply network in the aerospace industry. Using the method of a single case study
(Easton, 2003; Flyvbjerg, 2007; Halinen et al.
, 2005), the exploration of an offshore business model is likely to generate in-depth insight into how firms develop their business model.
Empirical data were collected between October 2004 and March 2006 from the three firms in the business model; Rolls-Royce (the core firm), Assystem (the Europe-based supplier) and Quest (the
India-based supplier). These companies were selected because of their endeavors to undergo a significant level of change that enables them to work together in achieving three agreed objectives:
1) to generate cost savings, 2) to utilize design capabilities of engineering service providers and 3) to develop sourcing agreements with other offshore firms.
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Table 1: Interviews
Company
Rolls-Royce
Seniority of interviewees
Senior Buyer
Director
Senior Manager
Director
Work Stream Head
Work Stream Head
Work Stream Head
Assystem
Total no. of interviews
Director
Senior Manager
Work Stream Head
Name
Chris
Peter
John
Gary
Steve
Brian
Luis
Mike
Steve
Tony
0-6 months
1
1
1
2
3
2
3
2 not yet employed
2
2
2
2
1
1
1
6-12 months
3
2
3
2
1
1
1
2
2
12-18 months
2
-
2
2
-
49
The collected data included personal interviews, contracts, minutes of meetings, quarterly reports and various procedure and review documents that represented the codified knowledge emerging from interactions between all three firms. Other sources of data included detailed field notes that recorded our impressions from each visit and archive materials. It was a key requirement of the research design to discover who was responsible for developing and managing the business model.
Key informants included the heads of each of the key functions involved in the offshore business model, the managers and the heads of each work stream from both Rolls-Royce and Assystem.
Thus, directors, middle managers and executives and front-line workers were identified as the most relevant sources as their day-to-day involvement with strategic development and operations cast them in this role (Table 1).
As our objective was to generate in-depth insight, more weight was placed on the repeated semistructured, personal interviews with the above key informants (Yin, 1994). A total of forty-nine interviews were carried out. We developed a guide for conducting the semi-structured interviews based on the conceptualization of the business model (Figure 6.). The guide helped us explore inter-firm knowledge transfer used for different problem solving activities as the architecture of the business model was developed. We consider the companies’ task of
‘learning to develop their business model’
as a knowledge transfer process in which actors identify and solve problems. In this way, the evidence that learning has occurred is manifested in changes of practices, for example, changes in structures and routines. At the beginning of each interview, respondents were asked to describe and explain the network structures and inter-firm routines that they had recently been involved in establishing and developing. The remainder of the interview consisted of open questions based around the changes made to business practice and why, how, when and with which actors the changes were developed. The interviews covered the same broad issues with each respondent. Respondents were re-interviewed approximately every three months through the period of the study (subject to availability). The geographic distance between the offshore firm, Quest, and the researchers, made it impossible to secure face-to-face interviews. This meant that we had to rely on second hand reports from Rolls-
Royce and Assytem respondents and minutes from meetings and procedural documents.
Interviews typically lasted around two hours. They were conducted individually, and were audio-
12

recorded and transcribed. Data analysis placed a significant emphasis on verbatim quotations from informants. All recorded interviews were analyzed via methods of inductive reasoning and comparative methods. Following the procedure recommended by Strauss and Corbin (1998), three types of coding were adopted to analyze the data. First, ‘ open coding’
was used to discover and identify the properties and dimensions of concepts in the data. Second, ‘ axial coding’
was employed to link the core categories together at the level of properties and dimensions. Third, ‘selective coding’ was used as a process of integrating and refining theory. To organize this process, a systematic approach to the analysis of transcripts was adopted in a procedure akin to that of Turner (1981). Analysis was carried out simultaneously with data collection creating an iterative process between interviews, literature reviews and analysis. The case analysis that follows illustrates both successful and unsuccessful knowledge transfer in the building of the supply network.
This case looks at the business model that evolved as a result of a paradigm shift in the civil aviation market. Historically, the airline operators (e.g. British Airways, Virgin Air, and
Qantas) have purchased planes and engines directly from the original equipment manufacturers; planes from Boeing or Airbus for example, and engines from Rolls-Royce or GE. However, the huge investment in R&D to develop new engines, together with the significant financial commitment required by the airline operators to purchase the new engines, created cash flow problems for the engine manufacturers. To smooth the peaks and troughs in revenue generation,
Rolls-Royce is developing a business model to offer Power By The Hour
®.
These programs are available on several Rolls-Royce engines and provide the operator with a fixed engine maintenance cost over an extended period of time. Operators are offered “accurate cost projection” that avoids significant both fixed asset investment and the costs associated with unscheduled maintenance actions. The basic coverage includes:
 Line Maintenance Replacement Parts
 Scheduled and Unscheduled Engine Maintenance
 Life Limited Part Replacement
 Incorporation of Service Bulletin Requirements


Availability of Unit Exchange Line Replaceable Units
Continuous Spare Parts Replenishment
Specific programs are tailored to the engine type and operator needs.
As Rolls-Royce moved to increase their provision of “power by the hour” to the airline operators, a review of upstream activities, specifically a make/buy of engineering design services were brought into focus. In order to secure revenue streams and profit margins, Rolls-Royce would have to maximize the effectiveness and the efficiency of their engineering services.
For some years Rolls-Royce had subcontracted design engineers from local agencies, at an hourly rate, to cope with the peaks and troughs associated with industry demand. Local agencies supplied locally based design engineers (referred to as
“bums on seats”
) that were managed and supervised in-house by Rolls-Royce engineers. When a specific job was completed, the subcontracted design engineers left.
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Offshore Engineering Services Provider
UK Engineering Services Provider
Power by the Hour
Manufacture Trent 1000 engine
Risk and revenue sharing
partners (35% stake):
 Kawaski Heavy Industries
(intermediate compressor module)
 Mitsubishi Heavy Industries
(combustor and low pressure turbine blades)
 Industria de Turbo Propulsores
(low pressure turbine)
 Carton Forge Works (fan case)
 Hamilton Sundstrand (gearbox)
 Goodrich Corporation (engine control system)

Airplane Manufacturer 787
Hong Kong Aero Engine
Services Limited
Jointly owned by:
(45%)
(45%)
(10%)
Key:
Product flow
Service flow
Information/Knowledge flow
Revenue flow ?????
Figure 6 The Architecture of the Rolls-Royce Business Model.
All Nippon Airways
In 2004 Rolls-Royce undertook a major make/buy review of engineering services. The review suggested that working continuously with a single group of ‘offshore’ design engineers might leverage both efficiency and effectiveness for Rolls-Royce. The review highlighted the rapid development of engineering service providers, creating a market in countries with a very low cost base. This presented Rolls-Royce with the opportunity and challenge of developing a new network structure through the sourcing of specialist, overseas, design engineering at low variable cost. As a result of the make/buy analysis, Rolls-Royce’s four-stage contract review process was initiated.
The outcome of the first Contract Review Board (CRB1) was to conceptualize an offshore
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business model for the strategic sourcing of specified design engineering services. Following this review, Rolls-Royce identified six potential suppliers from their experience and knowledge of the marketplace. These suppliers were contacted and Rolls-Royce personnel spent time with each supplier discussing the broad strategic aim of the offshore business model. Next, CRB 2 was carried out. Using their new knowledge of potential suppliers, Rolls-Royce identified their
‘most desirable outcome’ and their ‘least acceptable alternative’ , to create parameters for negotiation with potential suppliers. Rolls-Royce then held a Supplier Conference and asked potential suppliers to demonstrate; 1) their potential to develop a supply network in the medium and longterm, and 2) their ability to manage outsourced work, offshore. Chris [Rolls-Royce] explained,
“by this time [the time of the conference] we’d already got our eye on [Assytem] and [A.N.Other], as possibly the only two [firms] that could really provide a solution…”
Figure 6 shows in schematic form the supply network that was created, linking a typical end-user – All Nippon Airways – with the local maintenance service provider, HAESL (a RR joint venture), Rolls Royce itself, Assystem (in Europe) and Quest (in India). It also shows Boeing as the airplane manufacturer (in this case we take a Boeing 787 with Rolls-Royce Trent 1000 Engines as a specific instance of the general approach).
Assytems were invited to tender and their documentation added details to the business model to include the use of an offshore supplier – Quest. Rolls-Royce would put ‘work packages’ to Assytem at a hourly flat-rate for work done, regardless of the work type; Assytem would identify the
‘high-skill’
work, to be carried out by themselves and the
‘low-skill’ work would be outsourced to Quest. Assytem would then return the completed work package to Rolls-Royce.
The aim of the new business model was to turn fixed costs in to variable costs and to flatten out the price differential between low-skill and high-skill engineering design work. Rolls Royce designed the contract to provide Assystem with an incentive to offshore a high percentage of work.: the more Assytem sent offshore, the higher their margin. The hourly flat-rate calculation was based on Rolls-Royce’s work stream forecasts, with Assytem earning a 6% net margin. This process allowed the actors to identify and record what tasks would be carried out where in the network.
5.2.4 Working out the Sharing of Information and Knowledge for the Rolls-Royce
BM
The problem solving approach that the business model tried to foster required the development of softer, less explicit knowledge transfer mechanisms such as those captured by the concept of communities of practice. The tender document suggested a series of meetings would be held between senior representatives of Rolls-Royce and Assystem. The Assystem representative would visit Quest. Quest would begin ‘approved supplier’ procedure with Rolls-Royce. These descriptions of events established the initial knowledge mechanisms between the actors. In this regard, Assytem’s tender document focused on hard inter-firm knowledge transfer mechanisms; specifically inter-firm routines. Hard mechanisms provided the architecture to support the soft social mechanisms by which individual actors might build a platform for social knowledge production.
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The ‘Power by the Hour’ arrangement involves the airline, in this case All Nippon
Airways, accessing the Socio-technical capacity (STC) owned by Rolls-Royce. This STC can be thought of as the Trent 1000 and the wherewithal to maintain it. In turn, RR access the STC of
HAESL, i.e. their maintenance facility and its staff. HAESL as economic entity own and maintain this STC. Figure 7 is an attempt to capture these relationships in the form of the service triangles for ‘access to a socio-technical capacity’ outlined above.
Assystem and Quest become involved when there is a need for engineering change of a greater or lesser degree. Work carried out by HAESL may identify a need for modifications to some part of an engine or engines, and RR typically aggregate these requests – requests for intervention – into work packages (see Theme 6.2 below) that can be subcontracted to Assytem who, in their turn, subcontract some parts of the work to Quest. This chain of services acts not upon the physical world of engines and maintenance plants, but on the knowledge about them – in the form of revised designs and work procedures, embodied in drawings and manuals. This eventually connects with the world of engines, of course, as particular engines are modified, parts are made to new designs, and engines are subjected to revised procedures. For the time being, however, we concentrate on the chain of service relationships between HAESL, RR, Assystem and
Quest: this chain involves relationships, contracts, transactions and exchange of title of the ‘work packages’ or their embodiments.
Figure 7 – A Chain of Services
Operation
‘intended to change the state of’ the
Trent 1000
HAESL Facility
Owns and maintains STC
Owns STC
Accesses STC
Payment for
Maintenance Services
“Power by the Hour”
All Nippon Airways
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The way products and services interact to deliver the end benefit – flight power – is extremely complex. The engines themselves represent the embodiment of a fabulous amount of engineering knowledge, gained over decades. If we adopt the view of Callon and colleagues that products have ‘careers’, however, any particular Trent 1000 will, at a particular moment, be in a particular state of repair, with a particular configuration of revised parts, local adaptations, and other idiosyncrasies. All Nippon Airways may, in Loasby’s term, be instrumentally knowledgeable but substantively ignorant about its functioning. But HAESL and RR need, in their respective parts, to be substantively knowledgeable at the level of individual engines in particular planes. RR staff are embedded in Boeing to take part in the original installation; subsequent modifications may be unique to one engine. Routine maintenance activities such as planned overhauls and replacement of wear parts are fairly well defined and repeatable; they remain stabilized as service offerings (albeit involving ‘things’ in the form of spare parts and maintenance materials). More idiosyncratic and reactive interventions – problem-solving – may initially be addressed by the deployment, by HAESL and RR staff, of their general and specific knowledge to develop a solution. But this may then lead to design changes that take a particular context-specific intervention and, to a greater or lesser extent, stabilize, codify and institutionalize it in drawings, procedures and, indeed, in the engines.
Roll-Royce identified three distinct work streams for Assystem; Routine Engineering,
Tooling and Instrumentation. The Chief Engineers from each of these work streams, together with a forecasting team, developed forecasts of the type and quantities of work that would be outsourced to Assystem. On the basis of these figures, Assystem were contracted to provide somany man hours, at an agreed flat rate, over a given period of time (the initial contract was for three years). One of the key challenges faced by Roll-Royce and Assystem was learning how to package work. An example of a work package that emerged from the routine engineering stream was the conversion of drawings from a previous CAD package and from pencil drawings to the new Unigraphics CAD system that had recently been adopted by Roll-Royce. This work was sent to Assystem who in turn outsourced it to QuEST. The conversion of engineering drawings to a
Unigraphics format was important to the development of the ‘power by the hour’ services provision that Roll-Royce were trying to develop.
A second work stream that proved harder to forecast was that of Tooling. One of the principle work packages emerging from this stream was for the design of tools to maintain the new
Trent 1000 engine. The complex and necessarily evolutionary design-and-build process of the new engine used concurrent engineering practices that precipitated the design and redesign of tools to maintain it. After Assystem experienced some quality control issues with QuEST, Assystem recategorised this work as ‘high-skill’ and completed the designs themselves. Assystem and Roll-
Royce personnel met on a weekly basis to discuss the progress of each work package, to reevaluate and estimated completion times (and costs).
The need for design work typically comes to light as a result of maintenance interventions by HAESL. When problems arise, requests either for defined equipment or for broader problemsolving work are fed back to Rolls-Royce. These are aggregated: so, a number of individual requests relating to, say, instrumentation are made into a package of instrumentation work with a defined work content in terms of number of design hours, and sent out to Assystem. They, in turn,
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identify any lower-skilled elements of the package which they can pass on to Quest: these are even more generic, so may be just “detail drawing” or similar, no longer categorised in any specific workstream. Thus we see a process of turning disparate requirements for more or less novel and more or less uncertain design tasks into standardised, measurable and recompensable units of work, some ‘high-skill’ and some ‘low-skill’. Such a problem was familiar to Edith Penrose:
“Productive services are not “man-hours”, or “machine-hours” or “bales of cotton” or
“tons of coal”, but the actual services rendered by the men, machines, cotton or coal in the productive process. Although it is manifestly services that in this sense that are the actual
(physical) “inputs” in production, a less specific or more indirect definition is usually required when services must be expressed as measurable homogeneous quantities, for example, if it desired to measure the cost of certain productive services or to construct technological production functions for certain outputs'” (Penrose ,1959, pp. 74–75)
Within the firm, this would present less of a problem: although there may be some attempt at filling in time-sheets on a Friday afternoon to account for the way time has been used, once this becomes the object of an external transaction, the basis for the tradability of services, the implications are much greater.
The process of ‘learning to create a supply network’ for engineering design services also exemplifies a complex process of finding, trying and failing to impose, and adapting the boundaries of the firms involved. This came about – and continues to – by an intriguing interplay of exploring capabilities, trying to shape transactions (‘packages’) and, in an operations management sense, trying to level capacity downstream.
This whole story can be seen as one of revenue and capacity levelling: airlines want more predictable costs; RR want to level their own revenue streams – replacing lumpy revenue flows from engine sales with more predictable and stable revenue streams from ‘power-by-the-hour’;
Assystem want predictability of revenue by contracting for large blocks of work and to maximise its profitability by concentrating on the high value-added elements, and sub-contracting the rest to
Quest.
In principle this is clear enough, but in practice, hard lessons had to be learned, and are still being learned. Rolls-Royce had a Business Model in mind, certainly, and chose Assystem because they were the only ones who “got it” (i.e. understood the business model). But difficulties in defining with sufficient accuracy what the ‘work packages’ were meant that the neat division of labour – the ‘pinch-point’ in Baldwin and Clark’s (2006) terms – was not so neat after all. In fact, it is worth introducing a little of the ‘back story’ here: the approach previously used by RR was to employ agency design staff in the UK to cope with peaks in demand for engineering design services, what was know as ‘bums on seats’ (perhaps this is what Edith Penrose had in mind when she wrote of ‘ measurable homogeneous quantities’ ). Critically to the present discussion, those seats, and the bums on them, were in RR’s UK design offices in Derby. The business model was construed or framed as an ‘offshoring’ business model, the broad aim being to transfer commoditylike design engineering work to low-wage economies. Rolls-Royce did not feel able to do this directly themselves, but used UK/European design houses as intermediaries. Some of the erstwhile providers of ‘bums on seats’ were among those who were considered for this role but, unlike
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Assystem, they didn’t ‘get it’ (the business model). Over the first six to twelve months, however,
Assystem found that it was necessary to locate many of their design staff in Rolls-Royce offices – in a sense, back to bums-on-seats.
Although the idea of the offshoring business model was to place the lower-skilled work in the off-shore firm, retain the high-skilled work in Rolls-Royce, and have Assystem act as
‘packagers’, the reality was something different. Finding that Quest did not have such high capabilities as had been expected, Assystem began to keep more of the work to themselves – they shifted from packaging the work to doing a lot of it themselves. Meanwhile, the principle that
Rolls-Royce would outsource the easier, lower-skilled work was undermined by a tendency for many of their design engineers to hold back the easier, lower-skilled work for themselves and make available for outsourcing the newer, more challenging tasks. Many of these engineers had worked for Rolls-Royce for many years, were near the end of their careers and wanted an easy life; furthermore, they were the only ones with the detailed knowledge of the work that was to be done, which enabled them, at the detailed level, to screen out the work they didn’t want to do. The result of this for Assystem was that they had more work, with a higher proportion of high-skill activities, than they had budgeted for. This led to something of a crisis in the relationship between Rolls-
Royce and Assystem, which was resolved by an increase in the flat rate per hour paid to Assystem.
In terms of Baldwin and Clark (2006), there had been a difficulty in standardising what was to be transacted.
And in many other ways, the boundaries of Rolls-Royce were very ambiguous: one of the key managers at Assystem was an ex-Rolls-Royce employee, as were others in the network; downstream, Rolls Royce ‘embed’ their staff in the facilities of Boeing and Airbus; HAESL is a
Rolls-Royce joint venture. Upstream, the engine design and manufacturing projects are run with
‘risk-and-revenue-sharing partners’ – engine project by engine project. These aspects of complexity are important areas for further analysis in terms of revenue and risk elements of the business model.
So, does a Business Model ‘lens’ help us to understand complex PSSs any better? We suggest it does, in at least two ways.
In much of our research as management academics, we are in the position of relating the empirical world to frameworks and constructs that are meaningful to us, but not so meaningful to the practitioners with whom we work. For example, we may have in mind the notion of dynamic capabilities and ‘go looking for them’ in practice, among practitioners who are blissfully ignorant of David Teece, Kathleen Eisenhardt and their fellow travellers. Or we may work with managers to use a theoretically-informed framework in the development of, say, their manufacturing strategy.
With Business Models it is different. Relatively little published work deals with BMs, especially
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outside the e-business domain, and yet practitioners use the term widely and frequently. It is not unusual for academics to lag behind practice in operations management, but this has often involved examination and critique of rather specific practices that have their origins in particular firms (e.g. the Toyota Production System) or consultancy/’guru’ initiatives (e.g. Total Quality Management).
The Business Model concept, as discussed already, has its origins in e-business, but has been adopted in a rather generic way by managers in many sectors. So, in this case, we believe that it is important that RR managers consciously and actively use a concept of Business Models in what they are doing. For example, the BM concept seems intrinsically to incorporate a network perspective; ‘strategy’ doesn’t (necessarily).
This presents an interesting epistemological and ontological challenge. It calls to mind
Giddens’ notion of the double hermeneutic (Giddens, 1976) i.e. that social actors are, to a significant degree, aware of and influenced by the way in which social theory constructs what they do, and that as we research practice, we have to be aware of that. So, we are not just understanding their business models, we are understanding their understanding of their business models and of
(our understanding of) business models in general. We won’t pursue this theme any further here, but make this comment as a marker for future development of this line of thinking.
The four common elements of the institutional analysis of PSS and BM (Section 4 here) seem, from the analysis of the case, to interact with one another in both the initial ‘design’ and the subsequent dynamic change of the ‘power-by-the hour’ approach. Furthermore, they explain a good deal of what seems to have happened in the evolution of the approach i.e. they are a parsimonious set of ideas.
Strategy
Knowledge of Network
Structure
Transaction PSS Business Model
Knowledge of Activity
Payment
Figure 9 – Product-Service System Business Model and Strategy
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We can take this framework past the type of analysis that says ‘everything relates to everything else: isn’t life complicated?’ by incorporating the insight of Morris et al.
(2004) concerning the ‘proprietary’ level of BMs, i.e. that the difficult-to-imitate resource is understanding of and control over the way in which the foundational elements interact with one another. In our Rolls-Royce case, we contend, there is a strategic role for the BM in helping us to understand who will be expert manager of the network, who will best understand and control the interplay of the four elements: structure, transaction, payment and information about the activities
(Figure 9). The relationship between Business Model and Strategy is a concern of the BM literature (e.g. Chesbrough and Rosenbloom, 2002; Teece, 2007) and we suggest that this offers another fruitful avenue for exploring this case further and PSS BMs in general.
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