Lucrative but "Risky" Aftermarket Business—Service and Replacement Parts SCM
Olin Thompson and P.J. Jakovljevic
The Business Challenge
Growing pressure to improve customer responsiveness and profits has lately changed the traditional role of service management for spare and replacement parts. As competitive pressures push more products to a commodity-like business model, many manufacturing companies are increasingly relying on customer service to retain or establish a competitive advantage. Many manufacturers and distributors are also beginning to recognize that there are significant revenue stream and ways to increase customer satisfaction in the aftermarket once their product has been sold.
aftermarket has traditionally been a lower priority, a sort of "necessary
evil" for many, particularly manufacturers, who historically view themselves
purely as product companies where their brand new or well established products
are "cash cows" consistently generating revenue for the company. However, the
singular focus of developing and selling products ignores the fact that maintenance
costs can easily be several times greater than the purchasing cost of the product.
As a result, this additional revenue has often been left to various third party
companies, such as third party parts, service, and repair providers.
the aftermarket is becoming a major driving force for many original equipment
manufacturers (OEM) as opportunities are created when original parts include
additional and often heavy customizations designed to ameliorate the operation
and care of products and services. The value of the aftermarket is highly dependent
on the type of product and the industry. In industries that sell capital equipment
such as medical devices, telecommunications, instrumentation, information
technology (IT) hardware and other complex equipment, companies are starting
to significantly increase their focus on services revenue. For some companies
this is a strategic move to increase the top line, while others are looking
to replace revenue from slower new product sales in the current economic conditions.
service has also been directly correlated to improved customer satisfaction
and loyalty. Many manufacturers are discovering that maintaining account control
of their customers and differentiating themselves from intense, global competition,
means offering enticing and creative service, maintenance, repair, and warranty
programs. Managing spare parts is a critical part of accomplishing this. Some
firms like third party service providers even offer to manage the spare parts
inventories of their customers, often with a consignment payment or vendor
managed inventory (VMI) arrangement. In such arrangements the customer
does not own nor is invoiced for the part until it is used.
Electric (GE) is an excellent example of a company that has focused
on aftermarket opportunities, going so far as to call itself a "services" company
as opposed to a "products" company. GE has proved the value of serving the product
aftermarket. It has been widely reported that the company has significantly
increased both its total revenue and profitability by focusing on service opportunities
in addition to developing world-class products,
Dictionary (the 11th Edition) defines service parts (synonymous
with repair parts and spare parts) as those modules, components, and elements
that are planned to be used, without modification, to replace an original part.
They differ from replacement parts, which are parts that can be used
in place of original parts, after some physical modification (e.g., boring,
cutting, grinding, or drilling). Likewise, replacement parts differ from interchangeable
service parts. In any case, both service and replacement parts are
delivered to end users by a diverse network of partners including OEMs, distributors,
retailers, third party logistics providers (3PL), and other third party
service providers. Also, for asset-intensive industries, asset owners might
deliver these parts to various locations.
with these are service parts demand, which is the need or requirement
for a component to be sold by itself, as opposed to being used in production
to make higher level products or finished goods. To that end, service part planning
requires dealing with a sparse and certainly uneven, volatile demand. For example,
two units per year, may be requested. It also requires dealing with supply chains
that are much more complex than those in new product manufacturing, wholesale
distribution, and retail, because knowing in advance when, where, or what kind
of equipment breakdown (or any other reason for a service part requirement)
will take place, is difficult for anyone (other than clairvoyant fortunetellers).
Estimating typically low, yet highly stochastic demand; exploiting multinode
opportunities to determine optimal safety stocks within the supply chain; incorporating
parts substitution (e.g., interchangeable and rotable parts) and assembly options;
and integrating repair streams with replenishment require quite different supply
chain management (SCM) methods.
challenge is having the right number of spare parts to meet demand. This is
a precise process, because having too many parts will unnecessarily increase
and tie-up investment, overhead, and other inventory carrying costs; however,
having too few parts will impede swift replacement and contractual service
level agreements (SLA). Inventory carrying cost (synonymous with
holding cost) is the cost of holding inventory, usually defined as a percentage
of the dollar value of inventory, per unit of time (generally one year). Currently,
the technology component within parts, such as programmable logic memory chips,
has increased and has changed the parts cost structure. Namely, stock items
with embedded expensive technology can each cost a thousand dollars or more.
Consequently, associated inventory carrying costs have increased to the point
where intelligently planning parts inventory has become a financial necessity
for many enterprises.
cost depends mainly on the cost of the capital invested and of maintaining inventory.
These include taxes, insurance, obsolescence, spoilage, and space occupied,
and cost between 10 percent to 35 percent annually, depending on type of industry.
Carrying cost is ultimately a policy variable reflecting the opportunity cost
of alternative uses for funds invested in inventory. Storage costs
is a subset of inventory carrying costs, including the cost of warehouse utilities,
material handling personnel, equipment maintenance, building maintenance, and
is Part One of a four-part note.
Two will discuss the changes in service and replacement parts.
Three will continue analyzing service parts planning.
Four will cover players and benefits and make user recommendations.
Further, holistic service and replacement parts supply chains should provide support to end users of serviceable products via several channels, including
call centers (with necessary information on hand and call-in assistance for
available service and replacement parts, where and when required;
field service or after-sale service (the functions of installing and maintaining
a product for a customer after the sale or during the lease, which may also
include training and implementation assistance); and
provided carry-in service support (service centers/repair depots).
service or spare parts have lately become both a blessing and a curse for many
manufacturers of complex finished products. On one hand, contract manufacturing,
maintenance repair and overhaul (MRO), depot repair activities, and
aftermarket service parts and sales can generate additional revenue streams
with higher margins (even at multiple levels of original product sales). They
can also contribute significantly to corporate profits and thus offset typically
lackluster growth in other mainstream operations. Yet, on the other hand, these
companies must maintain large inventories of highly expensive, often slow-moving
parts. At the same time, they are dangerously susceptible to obsolescence, as
they satisfy customer demands for immediate delivery and action. Shrinking margins
are placing greater pressure on all manufacturers to operate with leaner inventories
(including spare parts) throughout their complex supply chain networks. At the
same time, many enterprises are realizing that a good way to increase margins
is to offer MRO services. In fact, a number of high tech and electronics companies
make the most of their profits from repairs and upgrade kits. Industrial equipment
manufacturers often earn more than half of their gross margins on complex spare
parts, without incurring much sales costs (given that most equipment users are
captive audiences for spare parts anyway).
the need for better service parts management is finally gaining top-level management
attention in many aerospace and defense (A&D) companies, and in similar
complex manufacturing or asset intensive industries, including automotive, high
tech/electronics, medical equipment, office equipment, specialty equipment,
telecommunications, utilities, etc. The basis for this new found interest is
that excessive inventory carrying costs and obsolescence losses are now being
recognized as an unexploited opportunity for savings and a means to better bottom-line
performance. Companies with extensive spare parts needs include manufacturers
that service products (e.g., IBM, Philips Medical,
Nortel Networks or Cisco Systems), provide
parts for dealers or others to service products (e.g., Ford,
Nissan, or Boeing), or own a large number
of assets which they maintain themselves (e.g., United Airlines,
US Airways, DHL, Delta Air Lines,
With increased customer demand for a quick response, often within hours, manufacturers, and service organizations must plan inventory to proactively respond to changes in customer requirements or material availability. Many manufacturers and service organizations have service contracts with their customers to provide service in a fixed amount of time, often in as little as two to six hours with guaranteed parts, and service technician availability across the globe.
To further complicate things, product lifecycles are becoming shorter to better accommodate ever-changing customer demands, which has further muddled the challenge of weeding out obsolete parts. In many cases, it becomes necessary to know, for example, which and how much equipment have extended warranties in a particular region in order to allocate the appropriate number of discontinued parts in regional and satellite warehouses, or to determine if substitute parts can be used. Also, increased equipment uptime and guaranteed parts availability are directly correlated to higher customer satisfaction, as customers increasingly demand reliability and responsiveness.
move to just-in-time (JIT) and demand-driven manufacturing styles makes
equipment uptime even more critical, as many enterprises can no longer afford
large and costly inventory safety stock buffers and risk complete production
line shutdowns if repair parts are not available when needed. Moreover, customers
expect equipment, appliances and so on, to be restored on the first visit instead
of having to wait for replacement parts to be ordered. Thus computer and appliance
service firms have long introduced "swap and replace" programs rather than asking
customers to wait (seemingly endlessly) for their equipment to come back from
the repair shop.
Ultimately, the quintessential business challenge is to minimize downtime on assets while minimizing the cost of spare and replacement parts inventory. To meet these challenges, heavy investments have been made in extensive spare and replacement parts networks. Here, inventory is staged at central or regional supply centers, local maintenance shops, or field service centers and even in the trunk of service technicians' cars and vans. Multilevel and multi-echelon inventory locations are critical to the balance between rapid part availability and curbed inventory cost. For instance, it makes more sense to deliver some parts from a second or higher tier rather than from the central warehouse, whereas expensive items or slow-moving non-critical ones should often be better held at central locations to reduce the overall safety stock carrying costs.
concludes Part One of a four-part note.
Part Two will discuss the changes in service and replacement parts.
Part Three will continue analyzing service parts planning.
Four will cover players and benefits and make user recommendations.
About the Authors
Thompson is a principal of Process ERP Partners. He has over twenty-five
years experience as an executive in the software industry. Thomspon has been
called "the Father of Process ERP." He is a frequent author and an award-winning
speaker on topics of gaining value from ERP, SCP, e-commerce and the impact
of technology on industry.
can be reached at Olin@ProcessERP.com.
Jakovljevic is a principal analyst with TechnologyEvaluation.com (TEC),
with a focus on the enterprise applications market. He has nearly twenty years
of manufacturing industry experience, including several years as a power user
of IT/ERP, as well as being a consultant/implementer and market analyst. He
holds a bachelor's degree in mechanical engineering from the University
of Belgrade, in the former Yugoslavia, and he has also been certified in production
and inventory management (CPIM) and in integrated resources management (CIRM)