Additional services as a driver of value creation isn’t often talked about among machinery businesses, but they should be!
Machinery companies, regardless of sector, usually have significant service businesses, representing up to 50 percent of their total revenues. Such revenues are a reflection not only of the sector and installed base of the company but also the success of the services strategy.
An analysis of performance from leading machinery companies in recent years shows that services have outperformed equipment sales in several dimensions.
- Faster Growth Rates. Most machinery companies have managed some positive growth in spite of the global economic crisis, but service sales pulled the most weight—averaging a compound annual growth rate (CAGR) that was more than two points higher than that of equipment sales.
- Greater Predictability. Equipment sales tended to fluctuate widely. They showed twice as much variance in CAGR as did service sales.
- Greater Resilience Through Economic Cycles. The success of machinery companies depends heavily on global economic conditions—and the recent economic crisis provided a significant test. Although equipment sales fell by 23 percent—measured from the last year before the drop in sales to the last year before the recovery—services sales fell by only 10 percent during that same period.
- Greater Profitability. Services are usually more profitable, too. Equipment sales in many industries generate low margins, particularly if the analysis factors in indirect costs such as commercial expenditures and product development. Service sales show higher margins, although there are variations among types of service. Spare-parts services have had, with some notorious exceptions, higher average margins than labor-related work. Analysis of public information shows services as more than 9 percentage points more profitable than equipment sales.
Designing a Strategy to Maximize Service-Based Value Creation
There is no one-size-fits-all service strategy to suit every machinery company, but there are three broad models that cover how most can make money from services.
- A Strategy Focused on Spare Parts. With this model, companies extract most of their value from spare-parts sales, tailoring services and product offerings to capture the maximum number of spare parts throughout the life cycle of the equipment.
- A Strategy Focused on Maintenance. Industry value is concentrated in service contracts in this model, and companies aim to maximize the penetration rate and loyalty of customer contracts.
- Offering the Complete Process. In this model, suppliers expand beyond machinery servicing to cover whole processes in which their equipment plays a leading role. They can do this by using their specialized expertise to save costs for the customer.
Most machinery companies use a mix of these business models, offering a wide portfolio of services that includes spare parts, maintenance, and complete processes. It is typical, however, for one model to predominate and the others to fill in the missing pieces.
A Strategy Focused on Spare Parts
In spite of the widely held belief that service operations—in particular those involving spare parts—are hard to plan ahead, much can be handled through OEM-customer contracts such as customer service agreements. Although they come in many shapes and sizes, they usually offer the customer three things:
- Predictable operation costs, since these include the replacement of critical (and expensive) wear parts
- Fewer unexpected operating problems and less downtime for servicing, since major replacements are planned beforehand
- Better service levels, basic field and data services, and replacement of minor worn parts—all complementing the main offering
Machinery companies also do better by selling more parts and benefitting from enhanced service work. They engage in longer, closer relationships with customers, which increase opportunities to understand—and cater to—client needs. In addition, they schedule part replacements before failures occur, which helps the service provider offer simpler, faster, more spare-part-intensive operations—minimizing machine downtime.These mutual benefits mean service agreements can be introduced as part of the equipment sales process—to both help sell the equipment and create value as early as possible in the relationship.
- Competition that can cut into manufacturers’ spare-part sales and the potential for costly malfunctions or reduced performance and efficiency for the machine owner. This is why a market leader in the engine industry offers the dismantling of used equipment and a discounted price for spare parts in its customer-service agreements. By discouraging the reuse of used spare parts, the company creates value for itself and the customer.
- New spare parts can also provide competition. Companies can counter this by preventing arbitrage trades of new parts based on price differences among different regions and clients and ensuring that their own spare parts are competitive in performance and price when compared with parts manufactured by third parties.
Because of the high costs of machine downtime—particularly for that of critical equipment—some customers build their own stock of new spare parts and develop service capacities. Not all customers and repair operations can be dealt with this way, so customers will still contact service providers to fix their equipment. Speed as well as high-quality commercial and operational processes become a key success factor. Companies should focus on the following:
- Customer requests should be processed and responded to promptly. Machinery companies need to transform their commercial processes and organizations in order to optimize response times, since these are a key determinant in service-purchasing decisions. This can mean assessing the number of commercial and engineering specialists required, training such specialists, providing the tools required to rapidly identify needs and prepare documentation, and creating mechanisms for agile price decision making.
- Responses should ensure the quick delivery of services and spare parts. Customers need to not only get a quick response to a spare-part request but also receive the part as rapidly as possible to get their machine running again. By smartly optimizing logistics and designing inventory levels according to demand, OEMs can both reduce the capital invested in spare parts and speed up delivery. One European power-plant and engine manufacturer redesigned its logistics so that spare parts can now be delivered anywhere in the world faster than before even though they are centralized in a single global warehouse.
Offer additional services.
Services ranging from traditional technical assistance, such as installation and repairs, to more advanced technical operations—even helping clients with tasks closer to their business needs—can generate great value for OEMs and customers alike.
Some of these services—such as data analysis, remote monitoring, and predictive maintenance—can greatly improve the performance and reliability of machines; thus, customers are willing to pay for them. In some industries, however, such services offer limited margins and income potential.
A Strategy Focused on Maintenance
- First, because relationships with customers through maintenance contracts become a key driver of value generation for customer and service provider, they demand careful attention.
- Second, service cost structures are no longer based mainly on spare parts; they are a labor business requiring specific management.These two principles are essential to maximizing value for maintenance-focused companies—and fundamental to several initiatives that companies adopting this model should implement.
Machinery companies should actively manage customer and maintenance contracts to maximize the value created for both sides. This means not only increasing services provided in all phases of the client life cycle but also remaining the preferred provider of services for as long as possible—both of which can happen through the following initiatives:
- Contract Design. Contracts can be crafted specifically to benefit customers that remain longer with the service provider—and make it simple for customers to extend contract duration by including predictable price-updating mechanisms.
- Relationship Management. Machinery companies need to learn about customer needs throughout the equipment life cycle, proactively offering timely value-creating services such as retrofits.
- Attrition Monitoring and Customer Retention. Contract cancellation rates should be monitored on an ongoing basis, enabling prompt identification of and reaction to major events such as changes in market conditions. Companies should design commercial responses to customers requesting contract cancellations but also identify patterns that usually lead to cancellation—a customer that has remained for longer than two years but has had technical problems in recent months, for example—and take action before cancellations occur.
Industrialize service sales and operations.
Machinery companies usually have efficient processes in manufacturing plants and new-equipment sales forces. By contrast, service processes are less carefully managed and usually offer significant room for improvement. This is particularly true when labor-related activities become a significant—or even the most important—part of services.Service industrialization starts with a standardized definition of the services offered. Sales teams are armed with clear descriptions and a concrete value proposition for the customer. Industrialization also enables machinery companies to increase the quality, cost efficiency, and scalability of their service delivery. To achieve these goals, companies should act on the following dimensions:
- Process Design. Existing service processes—from sales to operations—should be redesigned with the above goals in mind in order to ensure homogeneity across regions. This will not only help best-practice application but also enable organic and inorganic growth. Introducing new services requires both the definition of supporting processes and action on related existing processes.
- Service Tools. The design and use of support mechanisms such as software, hardware, and work tools can enhance most service-related processes. For example, commercial processes can be streamlined through customer relationship management, and mobility tools such as handhelds can help personnel in the field.
- People and Organization. Process redesign involves changing not only which tasks need to be done but also who will do them and what is expected from them. Roles and responsibilities should be adapted to new processes, and appropriate training should be provided to ensure that cost and quality targets are met.
- Service Metrics. Service industrialization goals should be translated into concrete metrics that can be compared with targets, ensuring the focus of service personnel and management.
A Strategy Focused on the Complete Process
This involved taking responsibility for the plant along with 200 existing employees and introducing tough efficiency and effectiveness KPIs. Because the service supplier takes on most of the risk that processes may not improve as intended, profitability from this model is not guaranteed. How can a company maximize the value of this strategy? In addition to applying initiatives from the other service business models, machinery companies should work on the following:
- Exhaustively Analyzing Service Costs. Offering to take over the complete process means that companies have to develop deep knowledge of customer processes by identifying cost drivers and potential improvement levers. This analysis should include projected demand for spare parts and consumables as well as labor requirements.These cost analyses cannot be standardized for all customers. Although companies develop a methodology that accounts for every cost factor, they must also insist on careful studies of the individual customer’s processes and plant configuration.
- Aligning Company and Customer Interests. Service providers that take responsibility for operating costs should also have control over the events that generate them. At the same time, customers will inevitably continue to influence the generation or prevention of costs.Contracts should be designed to align incentives for the service provider and customer, forestalling experiences such as that of a mining equipment manufacturer that took on a full maintenance contract for a mine and watched as spare-parts costs skyrocketed. Relieved of repair costs, the customer’s workers had started to treat equipment more carelessly.
Coordination Between Service and New-Equipment Strategies
When None of the Service Strategies Seems to Apply
As already noted, few companies pursue a single service strategy and instead prefer to combine models. There may even be times when none of the models works, and companies may appear unable to extract value from services. This can be true if some of the following conditions are present:
- Equipment characteristics do not foster service value creation. This can happen if the required service adds too little value (because of low complexity and frequency), the equipment life cycle is too short, or the equipment costs too little to warrant significant attention.
- Too many companies are competing on price and offering little differentiation. If barriers to enter the service market are very low, large numbers of companies—typically non-manufacturers—may reduce business profitability.
- A company cannot deliver the required services. This capability deficit may result from service personnel shortages (in sales and field positions, for example), insufficient financing needed to set up a service organization, or insufficient presence in relevant regions.
- A company prefers to focus on equipment sales. Company history and culture can be an important deterrent to service, and high profitability from some types of equipment might lead to a misplaced perception that services dilute margins.
For some companies, these barriers may be insuperable, but most should be asking themselves whether they can really afford to lose the service opportunity. They should be thinking about how to increase the volume and profitability of services, how to improve competitiveness by differentiating themselves from other companies, whether they can build capabilities to reach service excellence, and how to create a service focus without neglecting their new-equipment business.