We've often spoken about your need to focus attention on finding new sources of revenue—especially now that you've gotten the cost side of your P&L under better control. The last time we talked about it, you defined the issue as, primarily, one of identifying attractive new business areas in which to invest or into which to diversify. We have a different suggestion to make. You have no need to look so far afield.

There is a highly profitable business in which you already have a dominant market share and a know-how-based competitive advantage—namely, all of your various after-sales activities. Demand is stable, entry barriers are high, and—best of all—opportunities for boosting revenue are plentiful. But you are not managing it as a business—either as a standalone profit center or as a part of your core operations. In fact, your people often pay little attention to pricing it and even less to adjusting their business system to match customer requirements better. As a result, revenue and profit opportunities go largely unrealized.

This is unfortunate, but not unusual. Yet the hidden potential is not hard to gauge. In most industrial companies, the after-sales business accounts for 10 to 20 percent of revenues and a much larger portion of total contribution margin (see Exhibit 1). Equally important, during a given product's life cycle, after sales can generate at least three times the turnover of the original purchase, especially for industrial equipment. Even so, it rarely gets much share of mind among senior managers.

Most sales departments do, to be sure, get involved with a range of activities linked to the initial sale: trial runs, for example, or transport, or installation, or free repairs during the guarantee period, or even training programs for a customer's maintenance personnel. But few stay on top of repair and maintenance throughout a product's operational life. Even fewer carefully manage the provision of spare parts or the process of equipment upgrades. All of which, of course, are the heart of a well-managed after-sales business.

Scoping the potential

In our view, developing your after-sales business is much too important an opportunity to pass up. The financial benefits that are possible through price and volume improvements can alone add up to 3 to 5 percent to your return on sales and 20 to 30 percent to your profits (see Exhibit 2).

At the moment, however, much of this potential remains unexploited. You do not, for example, regularly differentiate between the prices you charge for original purchases and those you charge for after-sales replacements. Nor do you regularly challenge the "pirates" that supply low-quality spare parts or cut-rate service.

A well-run after-sales business can also provide strategic benefits. Customers are usually less concerned about spare part prices than about speed of delivery and availability of service knowhow, whether on-site or via telephone (see Exhibit 3). The reason is simple: down-time costs typically run at anywhere from 100 to 10,000 times the price of spare parts or service. And that means good performance here can boost customer satisfaction and, thus, build repurchase loyalty in your original equipment business. Just think, for example, of Caterpillar's commitment to deliver spare parts anywhere in the world within 24 to 48 hours. Indeed, short repair-cycle times have always been important selection criteria in initial purchases.

The good news in all this is that you, as an original equipment supplier, have a natural competitive advantage when it comes to the service, support, maintenance, and upgrading of the equipment you sell. You know precisely where and for what applications the products have been installed, what their technical specifications are, and which spare parts or modifications can best address specific after-sales problems. This knowledge represents a high barrier to entry for other after-sales suppliers. High—but not insurmountable. A defense contractor that was unwilling to offer upgrades for its previous models left it to a competitor to exploit the $100 million-plus opportunity created by the large installed base it had established during a twenty-year period.

This is, unfortunately, all too common a form of neglect. Managers often dedicate the vast majority of their time and attention to original product sales, new products, and new markets, thereby ignoring an extremely valuable asset: their installed base of machinery and equipment. In most cases, a quick examination of this installed base, with an eye toward offering retrofits or upgrades, can reveal a potential five to ten times higher than that currently being captured (see Exhibit 4).

Capturing the value

The opportunities to tap such latent sources of value are greatest when the product in question is an integral part of a customer's production process, when that customer is highly dependent on the proper functioning of the product, and when your current after-sales business is neither transparent nor the clear responsibility of specific managers (see Exhibit 5). The major levers for capturing that value include:

Pricing

Improving your approach to after-sales pricing depends largely on moving from cost-based to value-based pricing of spare parts. In making this transition, however, remember that available alternatives and likely switching costs will influence how much a customer is willing to pay for spares. A simple part easily bought in a nearby shop cannot support a healthy premium. But a critical component for which no alternative exists can. Auto repair shops have long recognized this: a complete car reconstructed out of spare parts would cost somewhere around five to ten times as much as the showroom original.

Also relevant is the value of a part as measured by the cost consequences of its failure. The average price of the spare parts order for one electronics equipment supplier is $800. But the cost of having its production line shut down is a minimum of $10,000 per day—which jumps to $500,000 if the shutdown entails the loss of a complete batch. Clearly, the price of spare parts is not an important consideration here; the key issues are reliability, speed of delivery, and repair.

You can benefit further from these opportunities by discouraging uneconomical purchasing behavior—that is, by taking into account the true cost of spare parts delivery. You might think, for example, of charging a minimum handling fee for orders below a certain value (or, perhaps, even giving these parts away, thus saving administrative costs), adding a certain "age" factor for spares for older models, or differentiating the prices for slow and express deliveries.

Managers are often apprehensive about implementing a value-based pricing approach for fear of customer reaction. Our experience, however, is that adjustments based on the pricing matrix illustrated in Exhibit 6 do not result in significant customer loss in either the short or the long term—provided, of course, that these adjustments are communicated well and combined with good delivery performance. One example: using the matrix, an audio equipment manufacturer that raised its spare parts prices by 20 to 40 percent encountered no adverse market reaction at all.

Business system adjustments

A second major lever for improving the performance of your after-sales business is to rethink what you provide and how you provide it. You can, for example:

Tailor your services. As noted above, successful after-sales activities depend on extremely short reaction and delivery times, availability of staff and spare parts to t a customer's working hours, simplified administrative procedures, low-cost handling of small orders, and so on. Your competitors are not other equipment suppliers, but third-party maintenance specialists, or even a customer's in-house maintenance unit. As a result, offering service packages that meet the needs of specific customer groups—for example, maintenance contracts that are sensitive to the budgets of university research labs—can help stimulate demand. So can carefully focused, awareness-building marketing efforts.

Expand the services offered. Professional after-sales service is more than just a reactive response to a customer's demand for immediate spare parts delivery or deployment of a repair specialist. Rightly understood, it is also a way to improve a customer's performance by providing more "up-time"—through, say, customer training, preventive maintenance contracts, hardware and software upgrades, and special support packages for old equipment.

Different customer groups will, of course, have different needs, depending on their size, their attitude toward internal after-sales support, and the costs of product down-time.

Operate the equipment. If you decide to take an aggressive, proactive approach to the after-sales business, you might also explore actually owning and operating the equipment you sell. In most cases, the lifetime value of the equipment, spare parts and service included, is less than the value-added of running the equipment itself (see Exhibit 7). Although this approach requires delicate balancing—you can easily find yourself competing with your own customers—the companies that have tried it have found it both feasible and financially attractive. Waste treatment, for example, has evolved over the years into just such a make-and-operate business. One major provider, Waste International, offers a full range of waste disposal services and has a strong and stable profit record—unlike most other suppliers of waste treatment equipment.

Organizational changes

Raising the role and prole of your after-sales business may well involve converting it into a free-standing business unit. Because these activities and new product sales share the same customer base, close coordination is essential. The most common approach is to make the new unit a separate profit center within the sales department. Where after sales prove particularly important, some companies have even elevated the responsibility for them to the same hierarchical level as new product sales.

These organizational changes, in turn, frequently require additional skills, mainly on the marketing side, to complement existing technical expertise. After-sales staff must be able both to determine the economic value of their parts and services to the customer and to devise and implement tailored marketing packages. You may, therefore, need to transfer some of your marketing and nance specialists into your after-sales group.

At the same time, you will want to establish a clear demarcation of the point at which primary responsibility for a customer passes from original product sales to your after-sales unit. The latter should be involved well before the completion of the initial delivery in order to ensure a smooth handover. Equally important, by participating in the development phase, the after-sales group can add substantial value by making the equipment more "maintenance-friendly"—by, for example, substituting more easily replaceable subunits, building in troubleshooting systems, and so on.

In making these organizational changes, bear in mind that the group's information requirements will be somewhat different from those of the regular sales department. They will, for example, need to know the state and age of the customer's installed equipment base, the number and type of competitive machines installed, and the customer's skill levels, spare part stocks, and down-time costs. For the group to be effective, adequate support systems will have to be provided.

Recognizing the dangers

Improving an after-sales business is not an easy undertaking. First, as we have already suggested, there are numerous internal barriers to overcome:

• Lower attractiveness. With its focus on old technology, old equipment, and routine, an after-sales business often has lower corporate appeal than a new product business, with the result that companies seldom dedicate their best talents to it.
• Insufficient information. The market potential of the after-sales business is usually unknown, explicit strategies for developing and exploiting the market rarely exist, and true supply costs are neither calculated nor monitored. Negative spillover effects. Managers often believe that entering the after-sales business will detract from the work of selling new products.
• Lack of skills. The skill prole of the organizational unit responsible for after-sales activities is usually oriented toward technical and, possibly, logistical expertise, but not marketing.

But there are other dangers too:

• Servicing or providing parts for competitors' equipment can provoke counterattacks by competing original equipment suppliers on the intruding company's own customers or price levels.
• Sales departments frequently regard an after-sales group as a rival, and so discourage the proactive marketing and sales of its services. Your challenge here is to convince your sales staff that where there is a demand for after-sales service you do not meet yourself, either a specialized competitor will seize the opportunity or your customers will switch to another equipment supplier that provides the support they require.
• Insufficient coordination within your organization can lead to customer confusion and dissatisfaction. This can easily happen if, for instance, different internal groups give the same customer very different priorities. A simple example: setting the price and the sales conditions for spare parts (availability, fixed delivery times, guarantee durations) requires close coordination with the purchasing department. When the after-sales department of an electronics manufacturer guaranteed the availability of spare parts for 15 years after the initial sale, compared with a guarantee of only ten years offered by the company's suppliers, the company was left with an excess supply risk during the five years when demand for spare parts was likely to be at its highest.

It takes careful analysis of your company's after-sales potential and ability—that is, the likely customer demand, as well as the necessary organizational structures and skills—to ensure that these dangers are avoided. But the benefits are well worth the effort. For many companies like yours, the after-sales business can rapidly become an important new source of revenue and profits, with a strong stabilizing effect during downturns in original equipment sales. The barriers to success, where they exist, are mostly internal. With hard work and determination, you can overcome them—and, in the process, rev up your company's profit engine. Regards,