Woman Using Futuristic Digital Interface Display
Woman Using Futuristic Digital Interface Display

Is your company prepared for the 4th industrial revolution?

The fourth industrial revolution has ushered in a whole range opportunities for implementing data driven business models. Mathias Rasmussen, Working Capital Advisory at Nordea, discusses the effects increased data will have on asset life time spans, customer relationships, working capital and value creation.
Mathias Rasmussen

Mathias Rasmussen, Analyst, Working Capital Advisory at Nordea

The use of pay-per-use and subscription business models have increased heavily over the latest couple of years and it is estimated that 53% of all software revenue will be generated from a subscription or pay-per-use business model in 2022.

Two years ago on Nordea Insights we discussed how companies could utilise the opportunities coming with the Internet of Things.

It’s an old invention!

As covered in our article from 2019, the pay-per-use business model was actually invented already back in the 1960’s. A company that was an early adapter and still is in the forefront is the U.K. based engine-manufacturer Rolls Royce. Rolls Royce’s ‘engine as a service’ provides a good source of inspiration and with their ‘power by the hour’ model, they are able to provide airlines with engines and charge them by the number of hours they are being flown instead of requiring a full upfront capital cost. This was way before any proper computing capabilities or let alone any type of connectivity that would allow IoT to happen. Back then they were simply measuring how long the plane was in the air and charged accordingly.

The 4th industrial revolution is taking off

As the business model has been working since the 1960’s, you can ask the question ‘what is new?’. The answer to that question is the amount of real-time and very reliable data that the fourth industrial revolution is making available. Data on how assets are being consumed which makes it possible to create highly reliable reports on the wear and tear of the equipment, also making it possible to create different pricing models.

Today: Lean and automated makes it efficient

Companies can utilise the real time data in order to optimise their balance sheets and value creation. As an example of how Dynamic Pay-Per-Use Rental models work today, fleets of assets being leased out with IoT sensors, which makes it possible for the leasers to measure the actual consumption and wear and tear of the assets. Today, a report is often made at the end of the month as an excel file, based on how much the asset was used. The file is then used to create an invoice which is processed through ERP systems.

The example shows that even though the business is based on a pay-per-use model, the creation of invoices and reports still remains a manual process. In order for companies to optimise their balance sheets, value creation and to mitigate risks, the excel sheets need to be automated and replaced. Instead of collecting data, creating a report and an invoice statement from that, and then to wait for the user of the equipment to pay the invoice within 30 days, the real time data that is available can be used to automate cash flows and instant payments.

Instead of collecting data, creating a report and an invoice statement from that, and then to wait for the user of the equipment to pay the invoice within 30 days, the real time data that is available can be used to automate cash flows and instant payments.

Mathias Rasmussen, Working Capital Advisory at Nordea

What’s up next?

In the future, the ideal scenario would be to set up an agreement between a bank, the user and the owner of the asset. Based on agreed pricing conditions and rules on how the asset is used, wear and tear and service obligations, the bank could automate cash flows and provide instant payment or upon request from the owner. Depending on the agreement between the user and the owner, payment frequency could be configured to be anything from one second to the original invoice period of 30 days.

The traditional trade dilemma where the owner prefers to get paid immediately and the user prefers to pay as late as possible will still be present in this setup, but with real time data available, financing and forecasting would be easier and more transparent. Instant payments would also have a great value for the owner of the asset, meaning that if the user is willing to pay in real time, using the asset could be cheaper.

When the owner has the possibility to claim instant payment, companies can start optimising balance sheets and mitigate risk. A great part of a company’s value creation lies within working capital management and how outstanding receivables, inventory and payables are handled.

A great part of a company’s value creation lies within working capital management and how outstanding receivables, inventory and payables are handled.

Mathias Rasmussen, Working Capital Advisory at Nordea

Today, payment terms between buyer and seller are usually somewhere between 30-120 days, based on the operating industry, goods and relationship. The possibilities to automate cash flows and payments can help decrease the amount of outstanding receivables significantly. When the infrastructure between banks and the trading parts are more developed, working capital can be improved through financing as well as claiming payments.

The move from financing the cost of the asset to the use of the asset, and the move from financing 30-120 days to financing the wear and tear, provides banks with deep insight into expected use and the financial situation of companies. A bank would instantly know if a company is not able to make a payment and whether there is a risk of default that can be detected before it happens.

One concept that may be interesting to look at is what is known as the ‘car as a service’ model. This relates to using connected cars with IoT data capabilities to understand how the car is being used and by how much, so that drivers can be charged based on real usage of the car rather than an estimate, which is usually the case with traditional leasing models.

In the future, a consumer should be able to buy a new car by creating a contract that states “I would like to operate the car and here are the conditions that I will fulfil” with most of the actual payment being based on the actual usage and depreciation of the asset, in this case the car. The change to the traditional leasing model is first of all simplifying the value chain in terms of distribution, but also simplifying the value chain in terms of maintenance. The car manufacturer could theoretically, in the very same way as Rolls Royce managed for airplane engines, take over the maintenance and ownership of the car as the best possible entity to make sure the most lifetime value is derived from it.

The consumer can also be charged not only based on the kilometres that they have driven, but also on other sustainable principles such as safe and economical driving. The safer and more environmentally friendly they drive, the less they pay, for example. This would not only be a benefit for the overall value of the car but also from a broader perspective, especially if the car manufacturer is interested in promoting safe driving, this is a very concrete way they could actually make that happen.

A bank would instantly know if a company is not able to make a payment and whether there is a risk of default that can be detected before it happens.

Mathias Rasmussen, Working Capital Advisory at Nordea

The benefits of Pay-Per-Use models are first that the acquisition costs are lowered. So far, the business model is mostly used in Cloud and Software-as-a-Service companies, as this industry often experiences high costs and upfront payments. The business model also engages customers for a longer period of time, as the affordability and flexibility is increased. Customers can actively choose not to use the asset, which bring some sort of cost-effectiveness to the user. As the business model is connected to real time data, Pay-Per-Use provides a deep insight into market demand and needs.

The challenges connected to the pay-per-use business models are unpredicted revenues. In the beginning, it can be difficult to forecast how the users will consume the assets and what the income will be. With time, forecasting will become easier with the data available for the previous behaviour from customers. Another risk is that the assets will not be used. The COVID-19 pandemic has affected Rolls Royce as very few of their engines are being used with global air traffic grounded. Furthermore, many offices are not using their coffee machines and printers, as many are working from home, which are other examples of assets under a pay-per-use model.

The Fourth Industrial revolution is coming and as seen before it is all about the ability to adapt. With future infrastructures between banks, owners and users we see great potential to optimise asset life time spans, customer relationships, working capital and value creation.

 

If you would like to hear more, you can write to Mathias at mathias.rasmussen@nordea.dk.

Read more Transaction Banking-related articles and sign up to receive monthly TxB insights.

Sign up for the Open Insights newsletter

TAKE ME TO THE SIGN-UP PAGE
Woman Using Virtual Reality Headset

The information provided within this website is intended for background information only. The views and other information provided herein are the current views of Nordea Bank Abp as of the date of publication and are subject to change without notice. The information provided within this website is not an exhaustive description of the described product or the risks related to it, and it should not be relied on as such, nor is it a substitute for the judgement of the recipient.

The information provided within this website is not intended to constitute and does not constitute investment advice nor is the information intended as an offer or solicitation for the purchase or sale of any financial instrument. The information provided within this website has no regard to the specific investment objectives, the financial situation or particular needs of any particular recipient. Relevant and specific professional advice should always be obtained before making any investment or credit decision. It is important to note that past performance is not indicative of future results.

Nordea Bank Abp is not and does not purport to be an adviser as to legal, taxation, accounting or regulatory matters in any jurisdiction.

The information provided within this website may not be reproduced, distributed or published for any purpose without the prior written consent from Nordea Bank Abp.

Related articles