Vendor Service Strategies: HVAC Business

The HVAC market is changing. To succeed in service OEMs must up their game, expand their offerings and upgrade their sales and operational capabilities. And the competition is not standing still.

The HVAC market

The HVAC sector is a highly competitive space, with numerous vendors operating at significant scale. Yet, a reasonable concentration exists with the leading 10% of companies accounting for roughly half of the market. The industry is global, with an estimated market size at US$130-150 billion for products (plant and equipment) — encompassing furnaces, boilers, chillers, air conditioning units, ventilation systems, and humidifiers among others. Prominent players include the US-based companies Carrier, Trane, and Johnson Controls, alongside their Japanese counterparts such as Daikin, Mitsubishi, and Toshiba, as well as South Korea’s Samsung and LG. Recently, Chinese firms have made spirited forays into this domain, initially focusing on smaller systems before venturing into more substantial offerings. European companies tend to be smaller and focused more on heating than cooling or air conditioning -with Atlantic (FR), Bosch (DE) and Electrolux (SE) having a presence in AC and a plethora of medium-sized manufacturers, mostly German, (Viessmann, Vaillant, Buderus, Wolf, and others) playing a prominent role in the heating systems market.

Complementing plant and equipment, the automation and control domain is gaining traction, buoyed by the escalating significance of energy efficiency and other advanced functionalities within building operations. Notable companies in this sub-sector include Honeywell and Siemens, along with Carrier’s Automated Logic. Furthermore, there is a large derivative market for products and components that constitute the bill of materials of HVAC systems, incl. compressors, pumps, motors, coils, filters, condensing units, burners or sensors.

Geographically, the broader Asia-Pacific region stands as the preeminent market, outpacing North America — predominantly the US — and Europe. Asia’s more pronounced growth rates are attributed to a burgeoning necessity to augment installation density, though these figures do not vastly outstrip those recorded in other territories.

However, the HVAC landscape is facing structural transformations: Global warming, alongside other climatic effects and localized meteorological shifts, has spurred latent demand. For instance, the previous summer’s heatwave in the northern hemisphere propelled air conditioning unit sales to unprecedented heights — 20-30% above the benchmarks of 2022 — benefiting manufacturers with both volume and price surges but also exposing the sector’s technical staff shortages. This trend shows no signs of abating. At the same time, regulatory initiatives to curtail CO2 emissions have ushered in rigorous energy efficiency mandates for both new and existing buildings. These regulations are designed to phase out traditional fuel combustion technologies in heating, whilst bolstering the prospects for alternative solutions like heat pumps.

Moreover, the COVID-19 pandemic has ignited a sustained remote working trend. Despite receding from its zenith, this paradigm shift endures, profoundly impacting the construction and building markets. There is a palpable decline in demand for commercial spaces — office and retail (as also e-commerce gains in importance). These structural shifts are compounded by the surge in interest rates, inflation and low economic growth rates, further straining the industry.

The initiated transition within the HVAC sector from traditional combustion systems to heat pumps mirrors, the automotive industry’s shift to electrification, albeit on a slightly less dramatic scale. Heat pumps, which transfer heat rather than generate it through combustion, stand out for their efficiency and reduced environmental impact: They are operated by electricity—ideally sourced from renewables or nuclear energy. Though at present they are more expensive than their combustion counterparts, their reversible nature, offering both heating and cooling functions, presents a compelling, cost-effective alternative to separate systems. And as they are at an early stage on their developmental trajectory, heat pumps are poised for significant cost reductions through scaling and technological advancements.

According to the European Heat Pump Association, the uptake of heat pumps has surged, with sales in 21 European markets reaching 3 million units in 2022—an impressive 40% increase from 2021, which itself marked a 34% rise from 2020. While 2023 may see a plateau or even a dip in sales, attributable to high electricity costs relative to natural gas and heating oil prices, steep installation charges, and the lack of sufficiently robust incentives or regulatory mandates, the European Union’s target of 60 million installed units by 2030 remains achievable. Across the Atlantic, the narrative is similar: the United States observes robust growth, albeit in the single digits, with heat pump sales surpassing gas furnaces for the first time in 2022, accounting for 53% of all heating systems sold.

HVAC manufacturers find themselves therefore, on the one hand, navigating a burgeoning demand for comprehensive indoor climate control, mainly cooling, solutions, bolstered by global warming. Additional demand is driven and being shaped by efforts to decarbonize and is shifting towards a different core technology, all within a market currently bracing against sluggish economic growth, high interest rates, and the unpredictable volatility of energy prices. It is not therefore surprising that OEMs are vying for strategic positioning in this space through new technology and capacity investments and launch of a stream of new products in important markets. Carrier’s acquisition of Viessmann, a major German player in heating systems and heat pumps, earlier this year can be understood in this context.  

 

The HVAC service market

Segmentation in the HVAC space can be approached in different ways though primarily systems are categorized by application as residential versus commercial or industrial (and many sub-segments), with size, capacity, and complexity being the primary differentiators. Commercial and industrial systems are often large and centralized, necessitating chillers for large-scale cooling capabilities that offer consistent and efficient temperature and humidity control—though these attributes can be shared, to some extent, by large residential complexes.

In this sector, the residential market primarily falls under the purview of installers who act as channel partners for OEMs. These business, usually independent (owner managed) and ranging from local to regional in scale, offer a comprehensive suite of services encompassing both pre- and post-sale activities such as maintenance, repairs, upgrades, and optimization, in addition to installation.

The commercial and industrial markets are served by a mix of installers and specialist electro-mechanical contractors. These are typically larger operators equipped to manage substantial projects, assume warranty responsibilities, and execute sophisticated engineering tasks. Recent trends have seen a wave of consolidation in this space, driven by contractors under the aegis of private equity entities engaging in buy-and-build strategies. By acquiring firms specializing in electrical, mechanical/HVAC, sanitation/plumbing, and related construction trades, these companies try to leverage scale to gain competitive advantages in sales, marketing, procurement and operational efficiency, thereby enhancing profitability and growth. This consolidation enables them to capture a larger share of the customer’s expenditure by offering comprehensive solutions that span various building systems.

Nonetheless, it is in the commercial and industrial spheres where OEMs have endeavored to establish direct sales and service footprints, focusing on large clients who might standardize their HVAC systems around a specific OEM’s solution in exchange for incentives. They also target sectors where the complexity of requirements and the critical nature of applications demand substantial engineering expertise and robust service support, for example data centers, clean rooms, hospitals, educational and research institutions, large sports and leisure facilities, landmark buildings as well as industrial process cooling.

Assessing the global HVAC service market is a complex task, given the vast installed base and its varied distribution. A rough estimate would place it on par with the product market in size, although categorizing installation services as part of service or product can vary. Market share delineation between OEMs, installers, third-party service providers, and facilities managers is intricate, given the multi-tiered channels to market. However, a reasonable assumption suggests OEMs command approximately 40% market share, with non-OEM service providers capturing the remaining 60%—albeit with OEMs claiming a disproportionate share of profits -though with significant variations between different applications and customer segments.

 

Strategically, OEMs concentrate on their own installed base, addressing large and complex systems and direct engagement with sizeable customers, while also providing support, including spare parts, for the broader market. Conversely, service providers cater to a more extensive brand range, sourcing spare parts and materials from the open market as well as the OEMs, and generally servicing less complex applications. This landscape, however, is in flux. With ongoing changes in primary equipment markets and technological advancements, OEMs have been shifting focus towards service provision, seeking to harness growth, revenue stability, and enhanced profitability.

Between 30% and 45% (estimates vary) of the commercial and industrial HVAC installed base is currently serviced directly by OEMs, with a concentration on newer, larger, and more sophisticated systems. These often fall under warranty or extended warranty agreements offered by OEMs as part of strategy to drive market share. Nevertheless,  a significant portion of the older HVAC installed base remains under-serviced by OEMs. This gap in service coverage not only deprives OEMs of continuous customer engagement and a deeper understanding of customer needs and potential market opportunities, but it also limits access to valuable operational performance data, crucial for enhancing both equipment and service offerings.

OEMs aiming to capture a larger share of the installed base must increase their service-related investment and up their service game. This effort encompassing sales and technical staff, service infrastructure, systems, and tools – necessitates considerable additional resources. And becomes more palatable, and its costs more easily absorbed, if the target market, i.e., the installed base, is larger. Consequently, OEMs are incentivized to broaden their target customer base beyond their traditional focus, potentially including smaller customer segments and even the installed bases of competitors. Their familiarity with the technology, applications, and requisite technical skills, coupled with the general availability of spare parts in the market, positions them well for such an expansion.

 

HVAC service strategies

For strategies in competitive markets to succeed, it is necessary to have clear intent and objectives, anticipate the competitive repercussions and responses, and harness the resources needed in a way that enables the desired outcome. Furthermore, it is necessary to decide on the basis of the competitive approach. In service markets this boils down to “skills vs. scale”: A skills-based approach hinges on superior technical expertise to address complex problems. This is a high price (and margin), low volume approach. Conversely, a scale-based approach relies on extensive logistics systems, standardized processes and robust infrastructure to resolve (simpler) problems en-masse, a low price (and margin), high volume approach. Traditionally OEMs have been closer to the skills than to the scale approach. If they move across this continuum towards the other side, they need to consider that the two approaches require  distinct operational frameworks and support systems (incl. personnel and technology strategies, as well as different management metrics) and compete under different market conditions. Otherwise, there is high risk of trying to sell premium branded products to commodity buyers. This usually doesn’t succeed well.

In any case, HVAC OEM service expansion strategies intensify competition in already well contested markets. They must demonstrate superior value to be successful. Other OEM competitors are compelled to react as encroachments on their installed bases increase the likelihood of these eventually transitioning to rival brands. Third-party service providers are also under pressure to respond. Part of the recent consolidation in the sector may be attributable to OEMs’ increased targeting of service markets. This spurs contractor efforts to differentiate service offerings, often by expanding the scope to include other building trades, thus presenting customers with comprehensive, one-stop-shop solutions for service and facilities management.

OEM vendors can adopt various counter-strategies. These may range from defensive, e.g., limiting their competitive efforts to an ‘optimal’ level – to maximize profitability while achieving reasonable service growth and maintaining good relations with channel partners to offensive, e.g., acquiring service capacities and significantly expanding service sales and technical networks to cater to a broader range of customer segments and applications or diversifying and expanding their service portfolio, e.g., by adding remote services, predictive maintenance or energy management.

Of course, in some cases, OEMs -as product suppliers- have an inherent advantage in differentiating their total offer and demonstrating superior value through Product-as-a-Service offerings: These are usually outcome-based solutions that intertwine products and services while the customer pays for an agreed level of performance. In this case of HVAC-as-a-Service, customers eschew the traditional purchase of HVAC systems. The OEM installs the system and retains ownership, akin to an operational lease, while the customer pays for the service rendered. This service extends beyond basic heating and cooling to encompass at least maintenance, repairs, upgrades, and energy optimization. Performance-based contracts sit at the heart of this model, with payments tethered to the attainment of specific performance benchmarks such as overall availability, maintaining designated temperature and humidity levels, ensuring air quality, and meeting energy efficiency goals. This incentivizes OEMs to guarantee optimal system operation. And customers reap considerable benefits such as diminished initial outlays, predictable operational expenditures, access to the latest technology and upgrades (facilitated by OEMs to meet performance standards). OEMs, in turn, benefit from recurring revenue supplanting one-off sales, longer and strengthened customer relationships, enhanced ability to collect data and insights on system performance, which can inform future product development and service improvements and last, but not least, a dominant share of the service revenue from the installed base over time, a high customer wallet share and a neutralization of competition.

Of course, servitized business models carry inherent risks:

  • Customer acceptance in some cases may be low as customers may not want to be too dependent on one supplier.
  • The capital intensity is high and can be a burden for the balance sheet.
  • Performance (execution) risk lies with the supplier necessitating careful management and potentially higher resource demands squeezing margins.
  • Competition, lack of transparency or unrealistic expectations may lead to pricing that does not fully cover performance risks leading to low margins or even losses over long contract terms rather than one-off sales.

But successful OEM service strategies are not only dependent on differentiated offerings and superior value propositions. They also require building superior operational capabilities while keeping costs at appropriate levels and service delivery capacity high. Technology implementation and investment in infrastructure is another formidable challenge, as is the orchestration of an efficient supply chain and spare parts inventory, and, indeed, a high quality salesforce which can actively pursue and win orders under intensely competitive conditions.

Finally, the quest for skilled field personnel remains an uphill battle, given the demographic shifts and evolving job preferences. To succeed in service OEMs must therefore leverage technology and organizational designs to ensure service excellence with a leaner workforce. Strategic partnerships with external contractors may also provide a stopgap for labor shortages.

In sum, for OEMs to navigate this service-centric trajectory, they must be adept at balancing cost, technology, and talent, all while cultivating enduring customer relationships and broadening their service offerings to meet the ever-evolving demands of the market

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Service Innovation for value-driven opportunities:

Facilitated by Professor Mairi McIntyre from the University of Warwick, the workshop explored service innovation processes that help us understand what makes our customers successful.

In particular, the Customer Value Iceberg principle goes beyond the typical Total Cost of Ownership view of the equipment world and explores how that equipment impacts the success of the business. It forces us to consider not only direct costs associated with usage of the equipment such but also indirect costs such as working capital and risks.

As an example, we looked at how MAN Truck UK used this method to develop services that went beyond the prevailing repairs, parts and maintenance to methods (through telematics and clever analytics) to monitor and improve the performance and  fuel consumption of their trucks. This approach helped grow their business by an order of magnitude over a number of years.

Mining Service Management Data to improve performance

We then took a deep dive into how Endress + Hauser have developed applications that can mine Service Management data to improve service performance:  

Thomas Fricke (Service Manager) and Enrico De Stasio (Head of Corporate Quality & Lean) facilitated a 3 hour discussion on their journey from idea to a real working application integrated into their Service processes. These were the key learning points that emerged:

Leadership

In 2018 the Senior leadership concluded that to stay competitive they needed to do far more to consolidate their global service data into a “data lake’ that could be used to improve their own service processes and bring more value to customers. As a company they had already seen the value of organising data as over the past 20 years for every new system they already had a “digital twin” which held electronically all the data for that system in an organised fashion. Initially, it was basic Bill of Material data, but has since grown in sophistication. So a good start but they needed to go further, and the leadership team committed resources to do this.

  • The first try: The project initially focused on collecting and organising data from its global service operations into a data lake.  This first phase required the development of infrastructure, processes and applications that could analyse service report data and turn it into actionable intelligence. The initial goal was to make internal processes more efficient, and so improve the customer experience. E+H looked for patterns in the reports of service engineers that could:
    • Be used to improve the performance of Service through processes and individuals
    • Be used by other groups such as engineering to improve and enhance product quality.
  • Outcome: Eventhough progress was made in many areas, nevertheless, even using advanced statistical methods, they could not extract or deliver the value they had hoped   for from the data. They needed to look at something different.
  • Leveraging AI technologies: The Endress+Hauser team knew they needed to look for patterns in large data sets. They had the knowledge that self-learning technologies that are frequently termed as AI, could potentially help solve this problem. They teamed up with a local university and created a project to develop a ‘Proof of Concept’. This helped the project gain traction as the potential of the application they had created started to emerge. It was not an easy journey and required “courage to trust the outcomes, see them fail and then learn from the process”. However after about 18 months they were able to integrate the application into their normal working processes where every day they scan the service reports from around the world in different languages to identify common patterns in product problems, or anomalies in the local service team activities. This information is fed back to the appropriate service teams for action. The application also acts as a central hub where anyone in the organisation can access and interrogate service report data to improve performance and develop new value propositions.
  • Improvement:  The project does not stop there. It is now embedded in the service operations and used as a basic tool for continuous improvement. In effect, this has shifted the whole organization to be more aware of the value of their data.

Utilizing AI in B2B services

Regarding AI, our task was to uncover some of the myths and benefits for service businesses and the first task was to agree on what we really mean by AI among the participants. It took time, but we discovered that there are really two interpretations which makes the term rather confusing. The first is a generic term used by visionaries and AI professionals to describe a world of intelligent machines and applications. Important at a social & macroeconomic level, but perhaps not so useful for business operations -at least at a practical level. The second is an umbrella term for a group of technologies that are good at finding patterns in large data sets (machine learning, neural networks, big data, computer vision), that can interface with human beings (Natural Language Processing) and that mimic human intelligence through being based on self-learning algorithms. Understanding this second definition and how these technologies can be used to overcome real business challenges is where the immediate value of AI sits for today’s businesses. It was also clear that the implication of integrating these technologies into business processes will require leaders to look at the change management challenges for their teams and customers.

To understand options for moving ahead at a practical level we first looked briefly at Husky through an interview with CIO Jean-Christophe Wiltz to CIOnet where we learned that i) real business needs should tailored drive technology implementation, and ii) that before getting to AI technologies, there is a need to build the appropriate infrastructure in terms of database and data collection, and, most importantly, the need to be prepared to continually adapt this infrastructure as the business needs change.

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