Enterprises May Be Overlooking Profits from After-sales Service
Written By: Ashfaque Ahmed
Published On: August 15 2006
Traditional sources of profit margins for manufacturers from product sales are diminishing as more and more products are commoditized, and margins are thus further and further reduced. On the other hand, profit margins from after-sales service are good (if managed well), and hold the promise of sustained (if not increased) revenue in the future. In industries like aircraft, automobile, computers, mobile phones, electronics, and so on, a major portion of revenue comes from after-sales service. Also, from the point of view of retaining customers, efficient and reliable after-sales service is important.
These facts warrant investment in good systems—popularly known as enterprise service management systems—to better manage after-sales service. Unfortunately, AMR Research points out that manufacturers invest four times as much in IT solutions for their product businesses as they do for their service businesses, but one quarter of their revenues—and half of their profits—come from service.
The Rising Importance of After-sales Service
After-sales service is no longer an afterthought for manufacturers. It is now firmly on the strategy agenda for most manufacturers with significant after-sales service operations.
Across all industry segments, an Aberdeen-Industry Week study found that profit margins for after-sales service and parts ranged from 25 percent to 1000 percent higher than margins for initial product sales. The study further revealed that after-sales service accounted for 20 to 30 percent of revenues, and about 50 percent of profits for most companies.
In the automotive industry, parts and services constitute nearly half of revenues, and 45 percent of profits, for both automotive original equipment manufacturers (OEMs) and dealers. Much of the remaining profit in the automotive industry come from financing and other value-added service (rather than sales of new cars).
A few quotes from research agencies indicate how important after-sales service has become for manufacturers:
- "Service also allows organizations to compete for and retain customers based on values other than price. In markets in which the product offering is viewed as a commodity, high-caliber service can serve as a rationale for higher prices."
— Aberdeen Group
- "A massive revenue opportunity follows each product sale."
— AMR Research
- "While original manufacturers spend billions to develop, produce, and market their durable goods, they don't pay equal attention to servicing these products once they're sold. As a result, OEMs' after-sale activities are held together with strings and baling wire."
— Forrester Research
Major input costs in after-sales service are labor charges and service part costs. Service parts costs consist of inventory, transportation, purchase order, item, and administrative costs. This is why service parts costs can be as high as 70 percent of after-sales service. There is definitely scope to reduce this cost by as much as 50 percent, by reducing inventory and other costs. Service levels for service parts in many cases can be as low as 60 percent. This can be increased to over 95 percent, without increasing inventory costs. This can be achieved by better managing the whole process of procurement, transportation, and inventory management at all stocking points. This will result in reduced lead times, better predictability of demand, better visibility of supply, and more inventory turns. This helps to reduce safety stocks at all stocking points, and due to fewer chances of stockouts, helps in increasing service levels. Thanks to better visibility inside your safety stocks, you can also eliminate or reduce obsolescence of parts.
Currently, the service parts pricing model used by manufacturers is "cost-plus," where the sales price of a part is calculated by adding a certain percentage of the manufacturing or purchase price. This ignores the impact of competitive and comparable price points, and sacrifices opportunities to increase revenues and profits. By adopting optimal pricing strategies, manufacturers can increase revenues and profits.
One last consideration is the cost economics effect of having service part networks on a global scale. Having global suppliers, regional hubs, and service stations located in different parts of the world (and in mobile units) makes for a huge network. If this network can be managed efficiently, to minimize localized excess inventory, transportation costs, lead times, and delays in providing service, then huge savings can be realized by the manufacturer. There are some best-of-breed software vendors whose software can be used to achieve these cost savings, including Servigistics (http://www.servigistics.com), Xelus (now Click Commerce [http://www.clickcommerce.com]), and so forth.
Service Parts Supply Chain The service parts supply chain network basically consists of a chain which extends from service parts suppliers (after-market manufacturers and service part dealers) to central warehouses of manufacturers, to repair sites, field locations, mobile units, and so on.
The service part supply chain is very different from production parts or products. First of all, demand for service parts is not predictable, and is wholly dependent on predictive and preventive maintenance (and thus on calculations of mean time to failure). The sparse nature of usage or consumption data makes it difficult to generate valid forecasts for service parts. These parts are costly, and so excess inventory at any inventory location is always a costly affair. These factors means that effective supply chain management for service parts is very difficult.
Based on historical data, customer service departments make a projection for need of service parts for any future time period. Based on this forecast (coupled with lead times, order costs, inventory costs, and other cost factors), service departments decide how much inventory they should be keeping with respect to different service parts. Since there is no firm demand as such, and since supply is totally dependent on this forecast, exact matches of supply with demand is very elusive.
Potential for Savings
There is huge potential for saving costs in service parts management, as well as for improving service. Among the major potential areas for improvement, there are five which merit close study:
- Reduction of inventory costs and parts optimization: By reducing inventory throughout the supply network, inventory costs can be substantially lowered. Parts optimization can be achieved through supplying the right parts, to the right places, at the right time.
- Service improvement: Through accurate forecasting and supply planning, service levels can be significantly improved.
- Revenue enhancement: With optimal pricing and better service levels, revenues can be increased.
- Bottom-line and top-line improvement: Increasing revenues will improve the top line, while reducing costs will improve the bottom line.
- Efficient management of global supply chain network: The efficient and effective management of the global service network delivers significant value in the form of dramatic cost reduction, revenue gain, increased profitability, and higher levels of customer loyalty.
All of these potentials for savings can be achieved if supply and demand information can be integrated in real time for all points in the supply chain, right from suppliers to service centers, production units, mobile service stations, and so on. This will ensure that live information is available to make the right decisions. With a planning and forecasting system, things can be improved further, as demand and supply can be matched in the most optimal manner.
Scenario in Developing Countries
In developed countries, service parts management is well-organized. In developing countries like India and other Asian countries, however, service parts management is still nascent. Manufacturers and service centers in these regions may thus not be able to obtain benefits from the business opportunities which are increasing due to high market growth and favorable government policies. For instance, the Indian government recently announced policies to enhance India's status as a major hub for small car manufacturing. Demand for small cars in India is already reaching double-digit growth annually, and after this governmental policy is instituted, growth is going to explode. All this will lead to high growth for service parts management. Similarly, the use of computers, mobiles, and many hand-held devices has been growing, and the need for efficient service parts management in these sectors has become critical.
One estimate is that in India, revenues from after-sales service in the automobile industry does not contribute more than 10 percent of the total revenues for the manufacturer. Contrast this with figures of more than 50 percent in countries like the US. These facts indicate that there is huge potential for manufacturers.
A Brief Case Study from India
A tractor and farming equipment manufacturer had been struggling with service management of its products. This manufacturer had an ERP system installed but was not using any service management application.
A study was conducted with help of a management consulting agency. This agency evaluated the manufacturer's situation and compared its existing performance against the benchmark standard for similar businesses operating in the US who were using service management applications. There were seventeen major areas included in the study. In areas such as "improving fill rates for spare parts" and "reducing customer response times," there was room for as much as 40 percent improvement. In eight areas, as much as a 25 percent improvement was possible. In three areas, 20 percent improvement was possible. All of these gaps were attributable to the fact that business processes, although similar to the US counterparts, did not have any service management application at the enterprise level. Such applications can integrate all business processes within the enterprise, and with suppliers, customers, and partners. This manufacturer would definitely benefit from investing in any good service management application.
As the market is becomes more and more commoditized, margins are shrinking from product sales. Most manufacturers are trying to find new avenues for obtaining more revenues, and trying to find new business lines from which they can get better margins. In this scenario, after-sales service looks very promising, and is becoming a savior for the manufacturers. But efficient and reliable after-sales service needs a good enterprise service management system to manage it. And there lies the rub. Manufacturers are still slow to invest in buying and implementing a good enterprise service management system.
Undoubtedly there is a big potential in after-sales service for saving costs by streamlining service parts procurement, improved service, and inventory management. Revenue can be increased by service parts price optimization and improved service. To tap this potential, manufacturers should look into making investments in enterprise service management systems.
About the Author
Ashfaque Ahmed is a seasoned consultant and business analyst in the areas of advance planning and scheduling in supply chain management. He has worked with many large and medium clients in the retail, distribution, and manufacturing industries. Some of these industries include the automotive, consumer packaged goods, pharmaceutical, food, textile, steel, and packaging materials sectors. He holds a bachelor's degree in engineering and an MBA in information systems. He can be reached at email@example.com.