Where’s The Cash? The Importance of Service Revenue1 Jul, 2014 By: Jim Kahrs, Prosperity Plus
Almost every dealer I know has faced cash flow problems at one time or another. It is payroll time and a quick look in the accounting system causes a sudden feeling of concern, or even panic. Sound familiar? If things have gotten this far, there are some critical steps that can be added to prevent the situation from recurring.
Recent example: an owner that had experienced some changes in the dealership was having trouble making sales tax payments, vendor payments, and of course payroll. The dealer was convinced that the problem was his accounts receivable person not doing her job to collect on the accounts that were outstanding. He thought the cash flow problem was an “A/R problem.” I wasn’t as convinced.
The first thing I did was pull the accounts receivable aging reports. The percentage of accounts receivable aged past 60 days was then compared to our Copier/MFP Dealer Model target of 10% to find that the dealership was very close to the target. Its receivables older than 60 days were just over 15%. Though the number was not at the target it was not so far out of line that it would have caused a cash flow problem this severe.
Looking to find what had changed around the time the cash crunch started, I learned the company recently upgraded its enterprise software and lost a key administrator. I then looked at the sales numbers in all areas to see what the trends looked like. One jumped out immediately: service revenue, which was on a significant downward trend. This was odd since the dealership didn’t seem to be losing accounts, and equipment sales were on an upward trend. As we dug further into the situation, we discovered that during the software conversion one of the dealer’s employees made some errors in setting up service contracts and that 30% of the monthly contracts weren’t even billing. To make a long story short, it was the lack of billing - not the lack of collecting - that caused the cash flow problem.
The dealer in this example had the misfortune of experiencing a dramatic loss in service revenue in a very short period of time. However, many dealers are experiencing this same scenario over a few years instead of a few weeks, and haven’t recognized the danger in this situation. This hasn’t been helped by the significant drop we’ve seen in service contract street prices along with the addition of MPS and managed services. Nothing causes cash flow problems more than erosion in service revenue. Whether it happens overnight as in the example above or over the course of a few years this is a preventable situation. I’ll outline some steps to follow.
Step 1: Assign responsibility for service revenue
In most dealerships everyone knows who is responsible for driving equipment sales, whether it’s the VP of Sales, Sales Manager or Dealer Principal. Yet when I ask who is fully responsible and accountable for service revenue I often get blank stares or comments like, “service revenue just comes in from sales and renewals, we don’t need to really drive it.” Nothing could be further from the truth. Service revenue is the backbone of the company and must be driven just like equipment revenue. If you haven’t assigned full responsibility for this area you should do so as soon as possible. Depending on the size and structure of your dealership you can assign this to the service manager, contracts administrator or dealer principal. Whomever it is assigned to, the point is to hold them just as accountable for service revenue as you hold the sales team accountable for equipment revenue. Then measure their performance and put targets and incentives in place to reward increases in service revenue.
This can be as simple as assigning a service revenue quota to the contracts administrator and then paying a bonus for exceeding the quota. For example, if your current run rate for service revenue is $75,000 per month, you could pay a 2% bonus for each dollar billed in excess of $75,000. In this case, a month with service revenue of $80,000 would yield a bonus of $100 to the contract administrator and if this growth kept up the administrator would earn an additional $1,200 for the year while the dealership brought in an additional $60,000 in very profitable service revenue. This would provide an incentive for the contracts administrator to solicit new contracts from customers who currently pay per call or make sure that they do everything possible to save a contract that is being cancelled. With this plan in place you now have someone who not only tracks the service revenue but also shares in the fruits of their efforts.
Step 2: Compare your performance against industry benchmarks
The purpose for comparing your actual performance against industry benchmarks is to determine the best place to put your time and attention. You look for the areas where your performance is below the model target as these are the areas that you can realize the fastest improvement. For example, our model calls for 35% of your total revenue to come from service revenue. If your numbers reveal that 28% of your revenue comes from service you need to work out a plan to bring this number up. Of course you only target plans that increase service revenue. Reducing equipment sales would help meet the percentage goal but would be detrimental to the dealership as a whole. Another example would be the target for revenue per system. Our model targets $75-$95 per system. If your numbers fall below this it can mean that your installed base is made up of mostly small systems, that the percentage of systems under contract is low or that the volume being run on systems is lower than it should be. Either way, there are plans that can be implemented to correct the situation. Two of these plans are reviewed in steps 3 and 4. The driving point here is to establish the areas of your dealership that fall short of industry targets and start to address them.
Step 3: Implement a plan to drive service revenue
There are a variety of different plans that can be put in place to drive service revenue. They all start by simply making a decision to be proactive and truly drive service revenue. One of the most successful plans we’ve implemented begins with determining exactly which systems in the field are under contract and which are not. From there we create a list of non-contract systems and develop a plan to get as many of them under contract as possible. Once the list is created you must determine which systems are still in use and which have been removed from the customer location. The list of “still in use systems” is reviewed to remove any systems that won’t be offered a contract because of their age or condition. This list is turned over to the sales department as leads for upgrade. The balance of the list is gone through systematically to determine what type of contract will be offered and a plan to sell the contract is put in place. We utilize service, sales and admin personnel to solicit these contracts one by one. When done properly this program results in new contracts and service revenue being added. It also helps to solidify your relationship with these customers.
Step 4: Increase your contract prices annually
Your cost to service your customers increases every year. There are increases in office rent, health insurance, fuel prices, part costs and annual salaries, just to name a few. In order keep up with these costs a dealer must increase service contract prices. Dealers who do not increase contracts annually usually tell me that they are afraid of the reaction they’ll get from customers. They think they’ll be bombarded with angry phone calls. Having done this with many clients I can tell you that this is not the case. Just last month I worked with the management team of a dealership that had this concern. I asked them to trust me and we implemented a 7% increase on all contracts. Last week during a visit with the dealership, the contracts administrator couldn’t wait to tell me that they had sent out 45 contracts with the new rate and received only one phone call and the customer had questions about the increase but was far from irate. If you’re not increasing your contracts annually you should start doing so, and if your increases are less than 5%, I would recommend increasing them to 7%-10%.
There is one other area to consider that falls into the same category as increasing prices. It is minimum volume requirements on contracts. As color has become more prevalent many dealerships have found themselves in a bad situation. Their revenue is too low to allow for proper gross profit margins. I have traced this back to a lack of minimum volume requirements in a number of cases. If you put a color system in the field with no minimum volume requirement and the user does a very low volume you may never recoup the cost of the color toners installed in the system at set up. There are two answers to this; either one requires minimums that bring in enough revenue to create a 50% service margin on the system or provide a contract that excludes toner. Though the toner excluded contract isn’t the most desirable it is far better than putting $600 worth of toner in a system to get back $10 a month in color click charges.
So the answer to the question: “Where’s the cash?” very often lies in service revenue. If you allow this all-important area of your dealership to run on cruise control you may be faced with a cash crunch at some point in the future. However, if you drive service revenue with the tenacity usually applied only to equipment sales you’ll not only safeguard your cash flow you’ll increase your profitability as well. And I haven’t met a dealer yet who doesn’t want or need more profit from the dealership.