The service business is booming! Not only because it helps to generate new financial resources for investments when sales and margins in the machine business decline. Aftermarket services and other value-added services for products strengthen customer loyalty. Companies in the plant and mechanical engineering industry can use data from the long-term business relationship to derive business-relevant information.
While the revenue numbers in services are rather small compared to the product sales, the margin is much bigger. Depending on terms, the contracts run for several years and generate continuous revenue over the whole duration of the contract. The management consultancy Deloitte compared the profitability of new machine sales and after-sales services.
"In our experience, there are two points that determine whether the service business can become profitable: Precisely calculating services over the term of the contract and identifying and hedging risks from the contracts."
Which service and maintenance contracts belong to the revenue drivers?
We consider contracts that are related to the product sale. These may include traditional and digital services such as…
- Installation or set-up of a new machine
- Training and implementation services
- Service and maintenance during the operations of the product
- Operation of a machine / machine park
- Ongoing technical enhancements
- A mixture of all above
These contract options are available in both the B2B and B2C sectors.
Take the automotive industry as an example: Customers buy a car or – and this is new – conclude longer-term rental contracts. The service contracts allow customers to drive any car of a certain brand for a monthly fee.
Companies with integrated service portfolios generate new revenues and reduce the volatility of sales figures through long-term business relationships.
Why is the precise calculation of services so important?
By offering digital services, companies in the mechanical and plant engineering industry are able to obtain usage and service data, derive new findings and, if necessary, new business models. The low entry barriers and high margins make the machinery business lucrative not only for the product manufacturer. The competitive landscape for predictive maintenance solutions is already very diverse. Component manufacturers, start-ups, software companies, other machine manufacturers or the customers themselves are able to implement services for products they have not produced themselves.
"From the diversity of competition, the demands grow. The customer will demand alternative offers and prices for service and maintenance services."
Short-term price reductions may help to win new customers but could end up in deficit. In the long term, machine producers will only successfully place their service offers on the market or negotiate them with the customer if they know about different options and variations and…
- Understand dependencies and track the cost of each service product over its lifetime
- Identify risks that are included in each service product (especially in the case of long-term service contracts).
How to better understand cost dependencies over the contract period?
Complex cost structures and different pricing strategies make it difficult to calculate project and service expenses over the term of a quotation. They must include expenses such as consulting and development services, X as a service offers (XaaS), maintenance, repair and operation (MRO). The following three points are all the more important:
- Use transparent cost structures: Can personnel expenses, materials, subcontractor services, and operating and capital expenditures be broken down to each element in the work breakdown structure?
- Analyze profitability: Simple modeling supports the development of different price scenarios. Mapping the cash flow over the life of the project focuses on the profitability of the project.
- Access data at any time: Placing profitable service contracts on the market requires a high degree of internal company cooperation. Globally available data memories enable every employee to access calculations and offers at any time and from any location.
How to identify and hedge risks from contracts?
Companies with too many risks in their service portfolio may face considerable problems later. The risks relate to various aspects of the contract:
- Type of contract: Is it a fixed price contract or even an output-oriented remuneration contract? For example, are there guarantees for the availability provided in the contract?
- Technical development: With long-term contracts, the question arises whether companies can already say today what will happen to the machinery after 5 or 10 or even 15 or 20 years? What margin will remain for the supplier if the production costs of new machines become more expensive over a longer period of time? How does the profit margin increase for the buyer if significantly more output can be achieved with new machines
- Financial risks: Who assumes risks of inflation, exchange rates, material prices, etc.? Suppliers should know the uncertainties in advance and be able to calculate the cost implications for the contract period. As the contract progresses, risks can be shared more clearly between supplier and buyer.
Manage costs and risks of service and maintenance contracts actively from the very beginning
Many of the points are not new for manufacturers in the mechanical and plant engineering sector. However, they are becoming more complex due to the nature of the long-term delivery of a contract. Project and service costing allows companies to
calculate service contracts on the basis of different activities,
document efforts, costs, prices and technical and commercial risks and
develop cost estimates for the contract.
This provides the basis for further quotation costing: companies transfer the internal structure of the contract into the quotation structure for the customer.
The common repository of metadata, calculation logic and assumptions ensures that customers have the same view of how contracts are calculated. Top-level reporting capabilities help decision makers implement market entry or expansion strategies. To return to the initial question:
"Yes, service and maintenance contracts can make a significant contribution to the profitability of a company. But only if the services are precisely and reliably calculated".
Get to know FACTON. Watch our webinar video to learn how we help companies calculate the cost of their services.