Why Do People Buy B2B Service Contracts
Before we discover why people fail to renew service contracts, we must understand why they buy them.
Before COVID, the people who purchased service contracts were at the Manager level. They were responsible for ensuring the equipment created the value they expected when placing their original purchase order. After many discussions with operations people, I concluded that there were four reasons why they purchased a service contract. They are:
- To maximize equipment uptime. “The service organization keeps my purchase operational and available.
- Predictable expenses. “I will never exceed my budget with your service organization.”
- Peace of mind. “The service organization has my back covered.”
- To reduce hassle. “One call and the service organization owns the problem.”
When I had the assignment to grow service revenue, I surveyed customers and asked them to rate these four characteristics, with one being the most important. Here are the results of three of my pre-COVID engagements:
The first and last columns are part of the same survey for the same client. The last column is for a few customers with many instruments that provide the company with excess testing capacity. Yet the managers were interested in a service contract for all their devices! They were not worried about maximizing equipment uptime but wanted to minimize their daily hassles. They were willing to spend company money to reduce their job-related stress. Their managers supported their plan since they had the same issues.
Before COVID, the results generally followed the pattern of the first three data columns. The last column first appeared after work-from-home and is more reflective of the results I see these days. The message is that things have changed, and the reason for buying the service contract depends on what happens in the contract buyer’s business when they decide.
Keep this message in mind: You must understand why your customers buy the contract before you can figure out why they are not renewing it.
What to Do to Preserve Your Service Contract Revenue Stream
Why do people fail to renew an existing service contract, agreement, plan, or program? Are you seeking the right actions to preserve and grow your revenue stream? Then you’ve come to the right place, as we’ll explore these in detail in this article.
Simply put, people buy service contracts because they expect that the value they receive will exceed the cost of the contract. The contract will only be purchased or renewed if the perceived value is high.
Why Do People Fail to Renew a Service Contract?
It seems rational to assume that failure to deliver on one or more promises would result in non-renewal. While this is true, there are additional reasons why people do not renew.
The three reasons for the failure to renew the service contract that the service providers do not control are:
- The owner’s company is going out of business. If your front-line support people are in contact with your customers, this should not be a surprise. Internal customer employees know when workloads and equipment utilization are decreasing. They are very good at reading the tea leaves and assessing the situation. This does not have to be a loss but can generate additional business. If a customer is forced to liquidate, there is a good possibility that the equipment will be sold.
Ensure you have up-to-date equipment history records, keep track of the purchaser, and offer to de-install the equipment (if appropriate), move it to a new location, reinstall it, train the new operators, and place it under contract. You may lose service revenue if you manage a single territory or country. However, if you do your job well, someone in your company will enjoy the long-term benefits.
- A customer downsizing or closing an operation or project can prevent a company from failing to renew its service contract. Perhaps this is due to mothballing or selling the equipment. This is similar to “going out of business,” except the company is still obligated to fulfill its contracts.
Make a relationship vs. money decision if your equipment is removed from service. You may also make some form of pro-rata adjustment for the balance due, or you can take a hard line and demand full payment for the term balance. This last action helps your financial results for the short term and may earn you internal respect for your business acumen, but it may turn the company or its employees against you. Do you want to void the contract and earn goodwill with the business? There is no correct answer. It depends on the factors involved. Remember, if you work in a limited marketplace, the people you work with may relocate and become your customers again.
- A corporate mandate to cancel or not renew service contracts goes into effect. This is a typical cost-cutting, knee-jerk reaction, along with travel and wage freezes, reduced employee education, and other measures.
This situation is likely the most difficult to navigate. If your customer believes the problem is “temporary,” you must decide what benefits of the contract you will pass along while they are on a pay-as-you-go scheme. You want to demonstrate continuing support, but you do not wish to deliver such a high level of service that the customer does not reinstate the contract when the corporate mandate is lifted. And, of course, you have to make the same decision when the customer downsizes. Do you suspend the agreement, prorate it, cancel it (with or without penalties), or negotiate an extended or deferred payment scheme?
There are also six additional reasons why customers fail to renew service contracts:
- You need to deliver on your value proposition, and they need to renew the contract. This frequently happens with very reliable equipment coupled with few, if any, value-added services. We hear comments like, “If I had known the equipment was so reliable, I would never have purchased the contract.” The contract is perceived as an insurance policy with a low likelihood of being cashed in.
To avoid this situation, ensure your contract is valuable, especially if the equipment is reliable. There are two ways you can do so:
- Make sure your contract marketing documentation includes all services provided. For instance, if you offer free telephone support, ensure this is clearly stated—the same as any other service.
- Include services available only to contract customers or non-customers at a premium cost. For example, include a priority telephone response with the contract and sell the enhanced response for a higher price to increase the contract’s value. The same applies to priority parts availability, rapid on-site response, etc.
- The competition offers a similar contract at a lower price. When a company’s experience meets expectations, customers purchase on price. But when their expectations are exceeded, they buy on value. Consistently exceeding your customers’ expectations creates loyalty. You should continually demonstrate value to protect your business to prevent people from failing to renew a service contract/
To ensure you are consistently creating customer value, monitor two factors:
- How your customers rate your business. What is important to them, and how successfully are you delivering against their expectations? Focus on key drivers that impact current service business and future sales. This is a big deal!
- Your competitive landscape. Are your competitors offering multi-vendor services (standard in the healthcare, instrumentation, and data communications industries)? Are other software providers moving to the services as a business (SaaS) model? You must strengthen your delivery processes and evaluate the opportunity to enter the multi-vendor service or SaaS arena. This is not a decision to be taken lightly, nor should it be the result of a multi-year study. Evaluate, make a business case, and decide quickly but thoughtfully.
- Too much hassle. Customers want their service provider to take full responsibility for quickly solving their problems. For them, managing the resolution process is a real hassle. They feel that the service provider is forcing them to do what they perceive as one of the reasons they purchased the service contract, which equates to low performance against expectations.
Transaction surveys can help determine if your processes and people are letting your customers down. You will quickly learn whether they are happy or whether you need to redesign processes, retrain or replace people, or both.
- Uptime fails to meet expectations. Frequently, when employees recommend the purchase of capital equipment (hardware and software), they feel like they are playing a game called “You Bet Your Job.” If their recommendation is accepted and the equipment fails to meet expectations, then at best, they use bad judgment and could lose their job. Customers protect themselves by purchasing a service contract. If you do not help them meet the CapEx assumptions, they have choices:
- Self-maintenance.
- Third-party.
- Time and materials.
- Scrap the product (the most drastic and least likely choice.) Your service contract should include an uptime expectation. Every service organization should be monitoring their contract customer’s uptime. If there is excessive downtime, take the responsibility to identify the root cause for a solution. We know of one company that replaced equipment worth several hundred thousand dollars because it was unreliable. It was returned and thoroughly diagnosed. The outcome was:
- A delighted customer.
- An opportunity to identify and repair the root cause of the failure.
- It’s a great story to use with prospects.
- A demonstration of contract commitment.
- An opportunity to educate and motivate employees.
A particular case of uptime and service contracts is the service level agreement (SLA). While some purchasers and suppliers like the SLA, many do not since it places the parties into an aggressive mode instead of a partnership. What is an SLA? According to Wikipedia, “The SLA records a common understanding about services, priorities, responsibilities, guarantees, and warranties.” Each area of service scope should have the “level of service” defined. The level of service can also be specified as “target” and “minimum,” which allows customers to be informed as to what to expect (the minimum) while providing a measurable (average) target value that shows the level of organization performance. In some contracts, penalties may be agreed upon in the case of non-compliance with the SLA.
So, when you develop an agreement’s terms, conditions, and deliverables with your customers, remember that success is measured by meeting or exceeding expectations. On average, only about 60 percent of companies today can perform at the SLA level (a little over 80 percent for best-in-class). You must be prepared to measure and deliver. It is better to underpromise and over-deliver than overpromise and under-deliver.
- Your service contract requires unplanned (and unbudgeted) expenditures. Many service contracts are all-encompassing, but if yours does not cover all possibilities, it should list each exception, its possible cost, and the most likely frequency. For example, a service contract for a dozer may say, “This contract does not include transmission failure, which typically costs $100,000 and usually occurs after 25,000 miles.”
Here’s a true story: An associate of ours purchased a two-year service contract on her car when the factory warranty expired. She expected it to cover all repairs and scheduled services. She further expected her only expense would be a $50 per-visit deductible. Within a few months, she had an engine oil leak. For whatever reason, that repair was not covered. Our friend was not happy even though the repair cost was not excessive. However, the service advisor had a “bag of tricks up his sleeve” and was able to make her feel better by offering her a branded keychain and a baseball cap. It was not an equal exchange, but the bag of tricks turned the situation around. What could have been a miserable customer turned into a happy one.
When designing service contracts, carefully evaluate the value proposition and any deviations that adversely affect the customer. Make sure that the cost/benefits of exclusions exceed the emotional downsides of your decision. Any exclusion must be clearly articulated. You must be able to do this, and they must “pass the smell test.”
- You dropped the ball and did not deliver peace of mind. Your customer lost confidence in your ability to fulfill the contract’s terms (both written and implied), and, of course, they failed to renew the contract.
This is an emotional situation that’s difficult to rectify. When it happens, all efforts must be made to correct the problem. It will continue unless the organization learns where and why it dropped the ball. Like a stone rolling downhill, it will accelerate with time since it begins a downward spiral: lose revenue à cut costs (people) à lose more revenue.
Key Takeaways
In the long run, the service organization’s management team is responsible for ensuring that it does everything possible to prevent customers from failing to renew service contracts. Losing the contract would be a shame because the organization did not consistently execute the plan.
Also Read: How to Design a Service Contract to Maximize Revenue
About Middlesex Consulting
Middlesex Consulting is an experienced team of professionals whose primary goal is to help capital equipment companies create more value for their clients and stakeholders. We continue to provide superior solutions to meet our clients’ needs by focusing on our strengths in Services, Manufacturing, Customer Experience, and Engineering. If you want to learn more about how we can help your organization avoid revenue loss because customers fail to renew service contracts, please contact us or check out some free articles and white papers here.