Aftermarket Service as a profit center-Part II: Service Revenue
In order to operate as a Aftermarket Service as a profit center, a company must be able to generate income. This requires that a service company identify their target market and identify sources of revenue. In essence, we need to define the serviceable installed base. To this, we must be able to answer the following questions:
- What equipment are we going to service?
- Where is it located? Who owns it?
- How many units are in the population?
- Who is the customer for our service? How many customers are there? Where are they located?
- How many customers will buy our service? How many units will that represent?
Market data obtained from primary or secondary market research will provide the answers to this information.
Once we understand the size of our addressable market, we can find ways to monetize the value of the installed base. This is the key to generating a predictable and sustainable revenue stream. Service revenue is a function of the demand characteristics for service & support. There are several ways to forecast service revenue ranging from back of envelope approaches to very sophisticated and precise methodologies. A significant portion of service revenue comes from the provision of basic maintenance and repair services including replacement (spare) parts. At the most basic level, revenue is determined by adding a profit mark-up to the fully loaded cost of service delivery. The fully loaded cost of service delivery is a function of demand characteristics and resources required to support these characteristics.
Basic service will typically account for approximately 5-10% of the total value of the installed base. With value defined as the size of the installed base multiplied by the average purchase price of units of the installed base. This has become a rule of thumb since conventional wisdom suggests that a customer will spend about 5%-10% of annual purchase price on basic maintenance & repair services. The percentage can be much higher when dealing with complex, capital-intensive equipment like an MRI machine, locomotive, mainframe computer, etc.
However, most customers require more services than just basis maintenance and repair such as training, configuration management, technical support, remote maintenance, advanced exchange, spare parts, etc. These activities are called value-added services. Faster turnaround time, guaranteed uptime, or longer service hours of coverage are also examples of value added services. The revenue from basic and value added services can be significant. In fact, market research has shown that revenue from basic and value added services can represent as much as 10 to 30 times the original purchase price of their equipment per year.
To calculate the revenue stream possible from value-added services, one either has to charge an uplift fee for the value-added service or research customers’price sensitivity to paying a premium over the basic service fee for the value-added coverage. This is how value based billing is achieved. One way of determining what the market will bear is to estimate how much it will cost the customer in lost revenue or lost productivity for every hour of downtime/ lack of service. This approach will help you determine if your value-based price is reasonable.
So far, I have provided you with basic knowledge of how to determine the revenue potential. Ultimately, you will need to conduct your own research and analysis or hire a 3rd Party to assist you. You will also have to make some assumptions about your target market or obtain real data as to how much of the service potential is actually achievable in year 1, 2, 3 and so on. Once you complete this exercise, you will now have accomplished the first step to building a business case pro-forma and building a high performing profit center.
In my next series of blog posts, I will cover the remaining building blocks involved in running a profit center. Stay tuned.
To learn more about Blumberg Advisory Group’s experience in building profit centers and creating sustainable and predictable income streams for our client, please visit our website (www.blumberg-advisor.com) or email us at info@blumberg-advisor.com