Ron Giuntini, the CEO/Founder of G35 Software, wrote this post.
Introduction
This post is a high-level overview of the whole service contract scene, focusing on the sales events occurring during the contract’s life. If it were a course, it would be called Service Marketing 101.
B2B service contracts, sometimes referred to as extended warranty, extended service contract, and managed services, have been around for decades. The following is the basic premise of a service contract:
- A seller supports a buyer’s management of the maintenance of its equipment assets (i.e., operability performance levels and adjusted asset value),
- During a defined period (e.g., five years),
- By delivering a portfolio of performance-assured solutions (e.g., correct failure within 2 hours),
- For a fixed fee (e.g., $1,000/month/unit).
The US annual revenue generated by B2B service contracts is an estimated $20 billion in support of $10 trillion of equipment, from aerospace to construction, to medical, to trucks, and many more sectors.
Why someone buys a service contract
The value proposition of a service to the buyer is:
- Provide more efficient solutions than that delivered organically (e.g.,
reduce component shop repair costs by 35%),- Access to best practices developed by the seller:
- Provide more effective solutions than organically (e.g., increase parts availability by 10%).
- The shift of risks of unplanned costs to the seller (e.g., failure of a repairable part resulting in it being scrapped and replaced with a new feature; a 40% higher cost than the planned cost of being repaired).
- General cost obligations for several years; reduced employment of administrative resources in the annual budgetary process and eliminated financial performance “surprises.”
- Conversion of some balance sheet investment into a period Operating Expense [OpEx]; increases ROI (e.g., parts inventory are not purchased, and thus not reflected upon the balance sheet, but bundled into service at the time of product purchase; may even be capitalized [CapEx]).
Why someone sells a service contract
The value proposition of a service to the seller is:
- Assures recurring revenue over a defined time; favorably perceived by owners/investment community.
- Profit margins, over the contracted period, are potentially higher than product sales margins; if the configuration and price of the contract are well designed.
- “Sticky” customer relationships; constant face time with customers over an extended period.
- Provides product sales teams with another offer to sell, increasing commission potential.
Sales events during the equipment life cycle
Below are details of the three life cycle sales events of a B2B service contract. Note that some of the terminologies of these events may differ from industry to industry, but the events below cover the vast majority of situations.
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Create Life Cycle Sales Events:
a. Attachment; service contract sale applied with the sale of a never-employed or previously-employed product.
This is by far the most significant source of service contract revenue.
b. Post-attachment; service contract sale upon a limited product warranty’s pre-expiration/at-expiration/post-expiration.
Usually occurs when the buyer has “regrets” not engaging in a service contract; as a result of the performance assurances of the limited warranty not meeting the operator’s requirements (e.g., 24-hour part delivery promised when 4 hours is needed).
2. Revise Life Cycle Sales Events:
a. Up-sell; service contract sale that increases the revenues of a contract by adding solutions/performance assurances for the same machine.
b. Down-sell; service contract sale that decreases the revenues of a contract by reducing solutions/performance assurances for the same machine.
Note that the seller who acknowledges that the solutions under contract do not provide the intended value to the buyer should initiate this event.
c. Cross-sell; service contract sale that provides solutions/performance assurances for the different machine models.
d. Extend; service contract sale that adds to the duration of an existing contract.
e. Modify; change in buyer’s operational environment impacts price drivers of original contract configuration (i.e., working hours decrease by 30%). Seller and buyer mutually agree to change the price.
3. Renew Life Cycle Sales Events:
A service contract sale in which the buyer renegotiates an expiring service contract; solutions/performance assurances, contract duration, and fees may or may not change.
The opportunity
Studies have indicated that a service contract currently covers less than 15% of all commercial equipment assets on balance sheets, and of the 15% covered, less than 50% of all maintenance expenditures of a buyer are supported by the service contract; the remainder is either in-sourced or transaction driven products and services. For example, total annual maintenance costs are $1,000 for an enterprise that is a buyer of a service contract paying a yearly fee of $400, covering only the correct-failure maintenance process. The remaining $600 of the buyer’s annual expenditures is in the prevent-failure and inspection processes. The buyer’s enterprise employs its organic technicians and buys parts transactionally.
Less than 8% of all annual commercial machine maintenance management expenditures are estimated to be supported under a service contract. One of the drivers for this low penetration level is the nature of most service contracts; they are “standard” offerings of “one size fits all.” Most enterprises require offerings that address their specific maintenance management requirements.
Customized offerings materially raise the risk for the seller of service contracts; smaller populations of machines covered under customized versus standard offerings have greater volatility in demands, with a probability of a higher variance in planned versus actual costs. Without a proper configuration and pricing quotation tool that can assess and mitigate risks, customized service contracts can often be a non-starter with a seller’s financial leadership.
Key takeaway
In conclusion, B2B service contracts can potentially be a much larger market. Still, many issues must be addressed, from sales event engagement management by sales teams, to configuring and pricing customized quotes and to enterprise leadership developing confidence in managing risks.
As US enterprises evolve from an operator-access-through ownership/insource-maintenance business model to one of an operator-access-equipment-through-lease/outsource-maintenance business model, customized service contracts will be the solution of choice of the seller to assure that their asset values are properly maintained, as well as that the buyer’s operability performance levels are met.
About the author: Ron is the CEO/Founder of G35 Software. In a past life, Ron was the Business Unit Director, Parts at Dassault Falcon Jet. He can be contacted at ron@g35software.com or 570.713.4795.
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