Charging per running hour, not per machine: a Rolls-Royce lesson for small firms

Suppose a workshop in Binh Duong builds air compressors for packaging factories. In the same week one customer postpones an order until next quarter and another disputes a repair bill because a two-year-old machine has broken down. The owner asks whether it would be possible to charge for the hours the customer actually uses, instead of selling the machine outright. It is, but that means rewriting the business model canvas, not just the price column. Rolls-Royce has offered aero engines on a fixed charge per flying hour since 1962, and its press release shows what the company added around that service.

What did Rolls-Royce actually sell when it sold "flying hours"?

It sold a complete engine replacement service at a fixed charge for each flying hour. "Power-by-the-Hour" is a Rolls-Royce trademark, invented in 1962 to support the Viper engine on the de Havilland/Hawker Siddeley 125 business jet. On 30 October 2012 the company announced its 50th anniversary (Rolls-Royce, 2012). The company says the fixed charge aligned the interests of manufacturer and operator, because the operator paid only for engines that performed well (Rolls-Royce, 2012).

In 2002 the company launched CorporateCare, built on that basis, with a range of added features. Engine Health Monitoring tracks performance on the wing with onboard sensors. Lease engines replace the operator's own during off-wing maintenance, which cuts downtime. A global network of authorised maintenance centres provides support (Rolls-Royce, 2012). Rolls-Royce says the service lets operators remove the risk of unscheduled maintenance events and makes maintenance costs planned and predictable (Rolls-Royce, 2012).

I read these features as the infrastructure that lets the seller carry the risk. That is my reading, not the source's. The Rolls-Royce case summarises the situation.

Which blocks of the business model canvas change when you charge per running hour?

In my analysis, at least five: revenue streams, key activities, key resources, customer relationships and cost structure. The canvas has nine blocks in four groups: customers, offer, infrastructure and finance (Osterwalder and Pigneur, 2010).

Here is Rolls-Royce's own description laid onto the canvas, one block per line:

• Revenue streams: a fixed charge for each flying hour (Rolls-Royce, 2012).
• Key activities: monitoring engines with onboard sensors and managing maintenance, from the 2002 service (Rolls-Royce, 2012).
• Key resources: lease engines and a network of maintenance centres (Rolls-Royce, 2012).
• Customer relationships: manufacturer and operator interests are tied together, and the operator pays for engines that perform (Rolls-Royce, 2012).
• Cost structure: the press release gives no figures. From the description I infer that the cost of replacement and maintenance sits with the company, but that is an inference, not a fact from the source.

What would a compressor workshop change? A hypothetical example

This example is hypothetical. Every number is invented to show the arithmetic. None belongs to a real firm and no market data stands behind it. Workshop A sells a compressor for 480 million dong and builds it for 300 million dong. The new plan is to keep ownership of the machine, charge 60,000 dong per running hour, and handle maintenance and a spare machine itself.

Assume maintenance, spares and the standby machine cost 45 million dong per machine per year, and for simplicity that cost does not vary with running hours. The machine lasts eight years. The sell-the-machine column leaves out repair income after the sale.

The table ignores tax, the cost of capital and the risk of not being paid. Two things follow from these assumptions. First, the workshop moves from collecting once to collecting over time: with 10 machines it holds 3,000 million dong of build cost instead of taking 4,800 million dong in sales. Second, the model wins or loses on real running hours. Over eight years, keeping the machine earns less than selling it below 1,750 hours a year: (60,000 dong × 1,750 hours − 45 million dong) × 8 years − 300 million dong = 180 million dong.

Which risks move from the customer to the seller?

The risk of unscheduled breakdown and the risk of buying a machine that sits idle both move to the seller. Rolls-Royce says CorporateCare lets operators remove the risk of unscheduled maintenance (Rolls-Royce, 2012); the idle-machine risk is my analysis. In Workshop A the risks change hands like this:

• A breakdown: the customer used to pay for the repair, now the workshop does.
• An idle machine: the customer used to lose the capital tied up in it, now the workshop loses revenue because the hours are low.
• Build quality: an early failure used to be an argument, now durability is the workshop's profit.
• Cash timing: selling collects once, charging by the hour means chasing payment every month.

One new risk appears: moral hazard. When the workshop pays for repairs, the customer may look after the machine less, overload it or let dust build up. The contract needs clear operating conditions and a right to inspect. The Rolls-Royce release does not discuss this, so it is my own analysis.

When does this model not fit?

It does not fit when one of three conditions is missing: measurable usage, funding to hold the machines, and customers who trust the meter. The table below is my inference from the hypothetical example and from Rolls-Royce's description, not a research finding.

Before quoting by the hour, do three things:

1. Collect real running hours from your existing customers, not the hours in the brochure.
2. Work out the break-even hours against an outright sale, like the 1,750 hours above.
3. Write a minimum-hours clause and operating conditions, then try it with one or two regular customers before offering it to everyone.

Going deeper: is this business model innovation, and how far do the sources go?

Types of innovation splits innovation into four places where something can change: product, process, service and business model. This case sits in the last. By the library's definition, business model innovation changes how a firm creates, delivers and captures value.

Three limits deserve a plain statement.

First, Schumpeter. The framework credits his 1947 article as its origin (Schumpeter, 1947). This section rests on the abstract only. It says that nearly all nineteenth-century economists, and many twentieth-century ones, believed uncritically that naming conditioning factors such as population or the supply of capital is enough to explain a historical development. In his view that is sufficient only in the rarest of cases (Schumpeter, 1947). The abstract does not mention business models, so I do not attribute the idea of business model innovation to him. The four-way list is the library's way of organising the field.

Second, the concept. The library entry on innovation versus invention says innovation is doing existing things in a new way, with no need for new science. The release calls Power-by-the-Hour an approach to engine maintenance management (Rolls-Royce, 2012), which fits that reading. But the business model idea is itself unsettled. Osterwalder, Pigneur and Tucci (2005) reviewed the literature and found a broad diversity of understandings, usages and places in the firm (Osterwalder et al., 2005). The nine-block canvas (Osterwalder and Pigneur, 2010) shows which block moves, not whether the move pays. That takes arithmetic.

Third, the evidence. The only Rolls-Royce source here is the company's own press release. It gives no fee, margin, customer count or customers who left. The company profile at its end says underlying group revenue in 2011 was £11.3 billion, more than half from services (Rolls-Royce, 2012). That is a group figure, not one for Power-by-the-Hour. An aero-engine maker and a small Vietnamese workshop also differ in capital, data and reputation. What transfers is the walk through the blocks, not the company's results.