Ron Giuntini, CEO/Founder of G35 Software, wrote this post.
This post is a high level overview of the whole service contract scene. If it were a course, it would be called Service Marketing 101.
B2B service contracts, also referred to as an 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 of time (e.g., 5 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 current 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 that provided organically (e.g., increase parts availability by 10%).
- 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 part; a 40% higher cost than the planned cost of being repaired).
Known cost obligations for several years; reduces employment of administrative resources in the annual budgetary process and eliminates 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 a service at the time of product purchase; may even by capitalized [CapEx]).
Why someone sells a service contract
The value proposition of a service to the seller is:
- Assures recurring revenue over a defined period of time; favorably perceived by owners/investment community.
- Profit margins, over contracted period, are potentially higher than that of product sales margins; if the configuration and price of the contract is well designed.
- “Sticky” customer relationships; constant face time with customer over an extended period.
- Provides product sales teams with another offering 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 terminology of these events may differ from industry to industry, but the events below cover the vast majority of situations.
- Create Life Cycle Stage:
a. Attachment; service contract sale applied with the sale of a never-employed or previously-employed product.
This is by far the greatest source of service contract revenue.
b. Post-attachment; service contract sale upon the pre-expiration/at-expiration/post-expiration of a limited product warranty.
Usually occurs when the buyer has “regrets” of not engaging in a service contract; as a result of the performance-assurances of the limited warranty not meeting the requirements of the operator (e.g., 24 hour part delivery promised, when 4 hour is needed).
2. Revise Life Cycle Stage:
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., operational hours decrease by 30%). Seller and buyer mutually agree to change price.
3. Renew Life Cycle Stage:
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.
Studies have indicated that less than 15% of all commercial equipment assets on balance sheets are currently covered by a service contract, 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 an annual fee of $400, covering only the correct-failure maintenance process. The remaining $600 of the buyer’s annual expenditures is engaged in the prevent-failure and inspection processes, in which the buyer’s enterprise employs its organic technicians and buys parts on a transaction basis.
It is estimated that less than 8% of all annual commercial machine maintenance management expenditures are 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 has 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 has the ability to assess and mitigate risks, customized service contracts can often be a non-starter with a seller’s financial leadership.
In conclusion, B2B service contracts have the potential to be a much larger market, but there are many issues to 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 CEO/Founder of G35 Software. He can be contacted at firstname.lastname@example.org or 570.713.4795. In a past life, Ron was the Business Unit Director, Parts at Dassault Falcon Jet.