PRODUCT SERVICE SYSTEMS: EXPLORING THE POTENTIAL FOR ECONOMIC AND ENVIRONMENTAL EFFICIENCY ECON 4545 Prof. Edward Morey Desirée Pacheco December 17, 20031Abstract Product Service Systems (PSS) is a business model whereby companies sell the services associated with a product. Under this model, companies sell a “product-service package” such as maintenance agreements, product leasing, and product management services. Research in the PSS area claims that this product-service mix can lead to an increase in economic and environmental efficiency (eco-efficiency). This project uses economic theory to explain the conditions under which PSS can increase these efficiencies. It proposes that the transfer of property rights towards the manufacturer has the potential to increase economies of scale, reduce information asymmetries and create stronger incentive structures that can eventually drive economic and/or eco-efficiency. These effects are further demonstrated through the use of examples from the PSS literature. 1.0 Introduction In the past decades, a transition from manufacturing to services has been notable in advanced economies. In the U.S., services have become the leading economic sector, contributing to approximately 80% of the country’s GDP (U.S. Bureau of Economic Analysis, 1997). There are multiple examples of corporations in the U.S. and Europe that are growing the service aspect of their business. They are selling product functionality rather than products: flooring services instead of carpeting, document management instead of photocopiers, and clean clothes instead of washing machines. This product-service mix is commonly known as Product Service Systems (PSS). Many researchers (Stahel, 1998; Goedkoop 1999; White, 1999) view this concept as having great potential to achieve economic and environmental effiency1. They claim that PSS can deliver financial benefits, while reducing the environmental impacts associated with the product’s life cycle. For example, selling services may create an incentive for the manufacturer to redesign products to extend their life span, therefore reducing energy and material intensity (Stahel, 1994). PSS contributions proclaim to achieve economic and environmental efficiency. However, literature in the PSS area lacks explanations of why services can be responsible for these efficiencies. This project seeks to fill these gaps. It will use relevant economic theory to create hypotheses that seek to explain: what are the characteristics that can increase the potential of PSS to achieve economic and environmental efficiency? A model outlining these characteristics is 1 These terms are defined and contrasted in Section 3.2presented and explained. This is part of a working effort for a Master Thesis to be completed during the Spring of 2004. 2.0 Product Service Systems: Definition and Categorization The IIIEE2 defines PSS as “a system of products, services, networks of actors and supporting infrastructure that is developed to be: competitive, satisfy customer needs and have a lower environmental impact than traditional business models”. In this definition, PSS shifts the strategic focus from a pure product3 to an integrated product-service strategy. This definition also implies that the existence of financial and environmental benefits is a necessary condition of the concept. An example of a company who has adopted a PSS model is Xerox. The company offers integrated services across the document cycle: document outsourcing, document production assessment, network (software and hardware) re-design, and training. All of these services are associated with the implementation or use of Xerox photocopiers. There have been various attempts to categorize the diverse types of PSS arrangements. Below is a description of the three main categories of PSS (Tischner, 2002) that have been generally accepted by researchers in this field. These categories were formed based on the interface and relation between the service provider and the customer. 1. Product-oriented services: Customer retains ownership of the product. An extended product service is provided by the manufacturer or a service provider. The most familiar examples of these services include maintenance agreements, repairs, upgrades, and warranties. Take-back and recycling services are other examples within this category. 2. Use-oriented services: Product is owned by the service provider who sells functions instead of products by means of modified distribution and payment systems. Typical examples include: leasing, pooling, and sharing (e.g. car sharing). 3. Result-oriented services. Replace products with information and services by providing customers with a specific result rather than a specific product. For example, product substituting services. Products are substituted by new services, often driven by new technologies (answering machine is substituted by “mailbox system”). Also in this category is 2 The International Institute for Industrial Environmental Economics (Lund University, Sweden). 3 Customer purchases good. No services are provided by an external party for that good.3the example of chemical management services (CMS). Under the CMS model a chemical company is contracted to provide chemicals, manage their use, transportation, and disposal. The chemical company is compensated by a management fee with a shared savings incentive. Other typical examples within this category include energy, refrigeration, and cleaning services. 3.0 Economic and Environmental Efficiency PSS contributions proclaim to achieve economic and environmental efficiency. Economic efficiency refers to an allocation of resources that maximizes net benefits (Tietenberg, 2000). From the perspective of the firm, economic efficiency is either achieved by increasing profits, or decreasing costs. A firm will produce at output and input levels up to the point where the marginal private benefits are equal to the marginal private costs. PSS can achieve private economic efficiency if the services provided can either increase the private benefits or reduce the private costs in comparison to a pure product offering. From society’s perspective, the economic efficiency4 may differ from the private efficiency (i.e. the firm) in the presence of market failure(s). A market failure occurs when free markets, without government intervention, fail to deliver an efficient