As a consultant, I talk with a lot of people. At some point, the conversations go like this:
Prospect: How large can I grow my service business?
Me: First, let’s get the question straight. You are asking me how much service revenue I can make as a percentage of total sales, right?
Prospect: Right.
Me: Great question. The answer is “it depends.”
Prospect: Why can’t I get a straight answer from a consultant?
This article will give you an understanding of why the “it depends” answer was correct.
Introduction
Transitioning the service business from a cost center to a profit center is a long-term trend that seems to be picking up speed. As a profit center, the head of the service business is compensated based on how much revenue and profit the company can generate. This means that the person asking the original question is not just talking but has a compelling reason to take action.
Making a plan that will lead to a significant increase in revenue and profit requires that the planner knows two facts:
- What are my current income and profit?
- What is a reasonable target?
Getting the revenue and profit the service business generates should be easy, but it’s not. That is because when service is a cost center, there are usually no ongoing efforts to optimize costs, revenue, and profits. They are a cost center and are expected to lose money, so why spend lots of effort to track it? However, since that is what the business leader transmits up the chain of command, we start there.
There are two steps to take before trying to answer the second question.
Step 1. What are other businesses accomplishing?
Step 2. What decisions have they made that affect their financial performance?
This article is an update to an earlier article published in 2014, “Service Revenue as a Percent of Total Sales (2014)“. There is still helpful information in the earlier article.
What are other businesses accomplishing?
As I started collecting data. I obtained a list of the largest US-based Industrial companies in 2022. I eliminated the non-manufacturing companies (logistics and distributors) and started reading their Annual Reports and 10-K filings. I found two things:
- Many companies do not break out their results by segment.
- I could not find meaningful data about service profit (see PACCAR below.)
So, let’s start with service revenue as a percent of total sales. But first, I want to share some good news: Honeywell and GE report the annual income of each of its major sectors. The data is meaningful, as you will see when looking at the following chart:
GE reports on four segments, with the service revenue as a percentage of total sales varying from a high of 71% for GE Aerospace and a low of 21% for GE Renewable Energy. Also, each segment has individual units operating as separate companies, with their results consolidated to the segment level.
The spread of service revenue within a business segment is impossible to guess, but we can assume it follows the segment-level trend. At least we can see how much the service revenue percentage can vary so we can keep an open mind as we try to make sense of this data.
In this data, the median is 29%. Therefore, I recommend that if your service revenue as a percent of total revenue is less than 30% then that should be your initial target. A nice, round number.
If your company culture is to set big, hairy, audacious goals (BHAG), then shoot for Honeywell Aerospace’s 82% contribution or Honeywell Performance Materials’s 78%. If you have never heard of BHAG, read about where it comes from:
“BHAG (Big Hairy Audacious Goal) is a compelling, long-term goal that is intriguing enough to inspire employees of an organization to take action. BHAG comes from the 1994 book “Built to Last: Successful Habits of Visionary Companies” by Jim Collins and Jerry Porras.”
Not all segments of a corporation are organized or managed the same and do not achieve the same results
We now know that the four segments of GE are all individual businesses with different business models and results. That is not unique. In the data presented above, we can look at Otis Worldwide and Carrier Global Corporation. Historically, these two businesses, along with Pratt & Whitney and Collins Radio, were once a part of the United Technology Corporation (UTC). Then, in 2018, the business started making some significant changes.
In 2018, UTC announced it would spin off Carrier and Otis and merge the remaining business into Raytheon. The new Raytheon now earns 22% of its sales from service (including P&W, which competes with GE Aviation.) Carrier gets 11% of its revenue from service, and Otis Elevator’s service operations are responsible for 57% of Otis’s total revenue.
What are the significant differences between OTIS and Carrier service?
The incomplete information here highlights several differences influencing each business’s service performance.
Simply put, Otis has a history of offering a full range of services that its direct employees perform in all the countries where it sells elevators. It is a mature field service organization.
Carrier is in a different situation. It has a well-structured set of service offerings that have the potential to significantly increase service revenue across its sizeable installed base. However, it only launched its BluEdge service platform one year ago. This new set of services explains why its 2022 service revenue was on the low end of our data.
The PACCAR story (2021)
PACCAR Inc. is an American Fortune 500 company among the world’s largest manufacturers of medium- and heavy-duty trucks. PACCAR is unusual because the company and its dealers are believed to have captured 60-70% of all aftermarket service parts used on the $200 billion of all trucks sold during the past 12 to 15 years and still in use. Their aftermarket business is primarily spare parts. While their service business contributes 20.9% of company revenue, they earn a 4X margin rate compared to their new truck sales.
The key takeaway is that service can generate a much higher margin rate than the product.
You can read about the basics of growing service revenue here.
Conclusion
Now you know why the only honest answer to the question about what percentage of total revenue our service business can generate is “It depends.” And the reasons are:
- Maturity of the service business
- Size of the active installed base
- Who is earning the service revenue – the OEM, the distribution channel, or a combination? The percent of the active installed base you can convince to buy service from the OEM.
- Type of product and its need for service
- Pricing
- Service marketing
- Internal alignment – will sales push back against service charging for services being given away?
- Competition and the OEM position – leader, laggard, or part of the herd.
- Customers – governments or for-profit businesses?
About Middlesex Consulting
Middlesex Consulting helps its B2B product manufacturing clients grow their service revenue and profitability by applying the methodologies and techniques associated with Customer Value Creation and Customer Experience professions to assist clients as they design and commercialize new services and the associated business transformations. Contact Sam here.
Image credit: Gerd Altmann from Pixabay