Service as a business
Service as a business (or additional source of profit) for companies, selling the equipment for B2B market, as a rule, is not regarding. In reality, maintaining and technical support cannot provide the same revenue as sales.
Nowadays, service marginal contribution higher than profit from equipment sales. The average marginal contribution rate in the service can be from 40% relying to support and up to 100% for spare parts, depends on competition and chosen strategy. Compare these with sales of equipment profit which is 5-20%. With tenfold less turnover the service profit can be equal to sales department profit.
How much you can earn on service?
Why companies don’t seek to earn more on service, initially consider it a profit-loss unit? In the majority of companies’ managers don’t understand which costs should be included in the service and which in the sales. The service costs can include trainings, travel expenses and even spare parts, which are replaced with guarantee. As a result, the sales department can show good profit and service only losses. In the same time, part of the costs which considered to belonging to service department, the department can’t control (but it can be made by sales department), and the other part of costs, which can be reduced by service, is left without attention just because lack of motivation and strict KPI for service manager.
Companies lose big amount of money for guarantee repairs, but why the manager should analyze and redact, if sales manager can provide a discount for commissioning work up to 100% of its cost and even after expire of guarantee can send a technician to a free repair, just putting all cost to the service?
If the service was your main business, would you send an employee to an expensive equipment training, which is sold one time per year? Would you give such discounts to commission work and free repair to keep a good relationship with your key clients? Most likely, your attitude to these questions would be more balanced and deliberate. Equitable and well-designed redistribution of income between service and sales from one hand can make the work of sales manager harder, who often works just to sell something (even at the cost decreasing the price, because “free work” – is a discount for a client)? But from the other hand it will let to decrease the quantity of “grey areas” in the responsibility between service and sales department, where like in a black hole disappear money of the company, and put the base to develop commercial service.
Service as an additional hub of profit
In most international companies the model of service as an additional profit hub and “business inside the business” work successfully many years. In contrast, in Russian organizations implementing similar practices is slowing down, firstly, by sales managers, considering that they will lose opportunity to give discounts and department employees burden will increase, who will have to control project costs. For example, take care that commission work costs billed to suppliers or transport company, in the same time now these costs just are on service or overhead costs.
Partly, it is like this. But it is needed to understand that advantages which sales department will receive most likely will cover all disadvantages. Just imagine, how much time will save the same manager, when he will stop going to service department and stop solving problems of the client, who are disappointed with the quality of the service.
In reality, that none of the service can develop like a profitable business without increasing the quality of service and work effectiveness (optimization of inner process, cost reduce and ineffective time). The growth of equipment sales for 15%-30% in two years that’s a real restructured service work results which our team was observing during the process of realization consulting products. Firstly, this growth was due to service quality increasing.
The right redistribution of income and costs and an adjective evaluation of each department contribution in company’s work is a base of successful development of the business in the constant competition conditions.
If you want to understand how much you actually earn or loose on service, just imagine that you don’t have this department in general and you have to attract outsource companies for custom support. Calculate how much it will cost and which costs from those which are now on service you can bill again and which should be compensated to sales department and other departments.
Service work result
I am sure that the numbers will surprise you. In one of our projects, we recalculated the costs and revenues of the service in accordance with the methods of international companies and compared with the calculations according to the methods adopted by our client. The results are following: according to the calculations of the company, the service in a year got “minus” of 22 million rubles. With a fair redistribution of costs in accordance with the recommendations of international companies, the service got 5 million rubles “plus”. Pretty significant difference, isn't it? And this is without considering sales of spare parts, that brings 2-3 times more profit.
The difference in 27 was spent to the sales department tasks solving: spare parts that were replaced under warranty to large customers, but the supplier did not approve the replacement, additional warranty trips and delaying commissioning work due to lack of equipment, training for new models of equipment ( there were more than 50 — the necessary numbers), recruitment and training of new employees to reduce the time of arriving for “emergency” repairs.
Some of these costs can (and have to) reduce the sales and purchase departments through competent work with suppliers, some costs can reduce service, and the other part (recruiting and training new employees) can be seen as an investment in the development of sales and after-sales services.
Now that we have discussed the importance of control and equitable redistribution of costs, we suggest considering the commercial potential of the service department when working in the open market.
Commercial service development
This is the next (after optimization and quality improvement) stage of changes in the company. It is not correct to consider the post-warranty service only as a source of income, since its availability, as a rule, is basically necessary for sales, and the price / quality ratio of such a service directly affects the development of a business.
Depending on the chosen strategy, after-sales service can work both in profit and loss. Naturally, the loss is compensated for by new equipment sales. It happens and vice versa, the equipment is sold at a dumping price, in order to get the planned profit at the expense of the service. But such strategy is quite unusual for Russia and can be effectively applied only by organizations with streamlined business processes, ideally tuned mechanisms for analytics, forecasting and corrective actions.
Therefore, we consider a simpler task, which is set before the service: at the expense of the post-warranty service, the service has to fully cover its costs. Here, we should ask again what kind of expenses the company refers to service, but we are not going to repeat ourselves and just calculate the service organization market potential.
The calculations themselves are pretty simple. But depending on what baseline data you use the results can be completely different. The right choice of source data is almost entirely dependent on the expert experience conducting the calculation.
Calculate the service profit
For example, your company sells expensive and complex equipment. Due to technical complexity, it can be repaired and maintained besides you by another 2-3 companies in Russia. Usually these are competitors selling similar equipment. Not everyone wants to take on service competitors’ equipment. Because these are additional training costs, problems with spare parts, documentation, technical support, etc. In such situation, the calculation of service potential can be made on the basis of statistics on the number of units of installed equipment on your territory (Installed base).
For example, on average maintenance and 2 repairs of one unit per year cost 100 thousand rubles. You have installed 2000 pieces of equipment. You start selling service contracts for repairs and maintenance. From our side it is possible to sign maintenance contracts for up to 70% of installed equipment in 2 years. But this is maximum. Thus, the potential of after-sales service (excluding spare parts) will amount to 140 million rubles. With a 40% marginal profit, it will be 56 million rubles. Turnover for spare parts, as a rule, 2 - 3 times higher. Spare parts profit on sales depends on both competition and work with customers. It can range from 20% to 100%. The presence of service contracts increases the likelihood of a sale with a higher profit margin.
Thus, about 200 million rubles of marginal profit a service can bring. Is it a lot or a little? If an organization sells 100 pieces of equipment the average cost of a unit is 7 million rubles, then the turnover will be 700 million rubles, per year. With a profit margin of 20%, we get 140 million rubles per year - less than the service can bring. It is clear that each case is individual. But in general, these are real numbers that we received in practice (see the case section)
Now we are going to talk about more common situation when the company sells simple equipment that can be repaired by clients themselves? by specialized organizations and freelancers. This requires detailing analysis. But as a whole it can be said that the after-sales service turnover in such a company can reach 10-15% of sales turnover with an average margin of 20%. Thus, the company with a turnover of 700 million rubles per year can earn on spare parts and service 21 million rubles. - almost 10 times less than in the first version. But the marginal profit from sales in such companies is usually much less. Taking it as a 5% turnover, we get 35 million rubles. Again, the profit of the service turns out to be comparable with the profit from sales. Such figures may seem strange, but in highly competitive markets (for example, auto parts) wholesale sales are coming with such a profit. And the value of an efficient service for a company is difficult to overestimate.
Summarizing all the above, the service can become a second profit center and a sail for your business, but it can also become a heavy anchor that reduces the sales department profit and negates all the efforts of the company's management. How it is going to be in your company depends only on you.