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It’s time for a New Service Business Model

29 Mar, 2007 By: Lou Slawetsky imageSource

It’s time for a New Service Business Model

This is the time of year when we all examine last year’s financial results
in order to determine what went right, or (hopefully not) what went wrong.  No
matter how positive the results of this examination, there’s always room for
improvement.  Unfortunately, that need for improvement is often far too obvious.

Interviews and informal discussions with members of the dealer community have
revealed a common theme.  Placements are up.  That’s a good thing.  Revenue is
up.  Another good thing.  Profits, however, are flat at best and all too often,
down.  Not such a good thing.

We’ve known for the last several years that the gross margins earned on
hardware placements alone are not sufficient to fuel the dealer profit model. 
While sales and general administrative expenses (SGA) have moved north of 32%,
margins for hardware placements have consistently come in at less than 30%.  In
the latest edition of the Imaging Systems Dealer Strategies Report (2006), the
average hardware margins are reported at 29.7%.

While the rate of decline has diminished somewhat, we attribute this to the
higher margins for business color products – possibly the hottest segment of the
imaging system market. However, as more units are launched, margins for these
products will decrease as well. Historically, dealers have shown little concern
over hardware margins.  While important to their overall success, the real
profits have always come from the aftermarket – service and supplies.  Dealers
have said, in effect, “I’m willing to place units (copiers, printers, MFPs) at
or near cost in order to profit from the aftermarket cash flow that spins off
over the life of the product.

> That strategy has worked well in the past. Today? Not so much. 

The average life of a product installed with the first user (excludes
subsequent placements of the same product in the used market) has declined from
5.1 years to just 4.2 years - a decrease of almost 18% (Industry Analyst’s  Inc.
Used Copier Report).  The consequence of this decrease is that the aftermarket
revenue flow from each placement is 18% less than what had been anticipated.

While supply margins are holding steady (bolstered by the increased use of
color toner), service margins continue to decline at a rate of about 2% per
year. Historically, service offered the highest margins for copier related
activities (hardware, service, supplies).  Any  decrease in this category, then,
would have a disproportionate effect on overall profitability.


Yes, it is true that print volume on MFP devices provides some incremental
activity (over and above the printing of multiple sets that used to be copied on
a device already installed by the same dealer).  But that incremental print
volume is not increasing as fast as copy volume is decreasing.


Dealers who are basing the success of their business model on placing
hardware at or below actual cost (including enough profit to cover SGA expenses)
in exchange for a predictable flow of profits from service and supplies over
five years are going to find themselves in trouble. The old business model
simply doesn’t work in today’s market.

Let’s take a closer look at the risks associated with maintaining the current
business model by examining the impact of a reduction in page volume (prints and
copies combined).  The table below shows the gross margins for digital systems (MFPs)
including hardware, service and supplies.  At the bottom of the table, we
calculated the Weighed Margin – a figure that weights each margin by the revenue
contribution of that activity.

Here, we note a weighted margin of 35.6% resulting in a net profit of 3.6%
after deducting SGA expenses (32%). But, suppose overall page volume should
decrease at a rate of 10%?  The business model would look something like this.

A 10% reduction in page volume will result in a 19.4% reduction in net
profits – this, from a decrease in aftermarket revenues and profits.  We arrive
at this conclusion when we weight gross margins for hardware, service and
supplies by the revenue contributions from these same categories.  If service
and supply revenues (with their higher margins) decrease, then hardware margins
(with their lower margins) will increase as a percentage of the total revenue

It’s clear that something must change if dealer profitability is to be
maintained.  Dealers must search for sources of incremental revenue and profits
to bolster sagging performance, particularly in the area of service.  Here are
just a few suggestions.


Our research indicates that only half of all dealers charge for
connecting an MFP to the LAN.  Yet, the effort to connect can consume more time
than the setup of the hardware alone.  Labor represents the major component of
your service cost – a component that you should recoup.  Dealers who do charge
for connectivity indicate rates as high as $300 per hour.

When connecting your devices to a customer’s  LAN, or when integrating them
into an existing application, you’ll want to be certain to issue a “statement of
work” with your service agreement.  This will spell out in advance the limits of
your service exposure.

You should also consider charging for the installation of print drivers at
the workstation level.  We’re seeing an increase in the percentage of dealers
following this strategy.  Still, more than one-third of dealers perform this
task at no charge, letting that incremental revenue slip through the cracks. 
This needs to be remedied.


Under this umbrella, you should offer two levels of support:

IT administration to reduce your service exposure.

User training to ensure that any application you’ve designed will actually be
used.  If users are uncertain how to perform the steps of a particular workflow
application, they’ll resort to the old method – not efficient, but at least
understood. When this happens, the page volume you’ve anticipated from the new
application will be lost.


Offering the services of a systems engineer to help integrate your
hardware into the existing LAN infrastructure raises your service offerings and
revenue opportunities to a level beyond that of simple “break and fix”
capabities.  Systems engineers should interface with your customers’ IT managers
in two specific areas.


Here, they will perform a site survey to determine hardware and software
requirements.  They’ll also solidify the contents of the statement of work
discussed above.  While these activities are generally offered at no cost to the
customer, they do serve to reduce your service costs after the installation.


Activities here include software support, LAN testing, driver configration,
assigning group rights and the integration of LDAP (Lightweight Directory Access
Protocol) and authentication software.  You should charge for these activities
on either an hourly basis or as an up charge to your annual service contract. 
Because post-installation services are ongoing in nature, they represent an
ideal revenue stream for your service department.


Scanning activities are increasing.  Yet, dealers continue to resist
charging for them.  Our research indicates that more than two-thirds of dealers
offer scanning at no cost to the customer.  Yet, the use of the scanner on the
MFP results in significant wear on lamps and document feeder components.  When
scanning is enabled, your customers will average 2,000 scanned pages per month. 
You can easily justify a cost per scan on $.002.  If scanning is enabled on only
1,000 units in your installed base, the incremental revenue opportunity comes to
almost $50,000 per year!  Don’t let it slip away.


Fewer than half the dealers we have interviewed in the past year apply
objective and relevant measures to the efficiency of their technicians. It’s a
relatively simply task to measure sales rep productivity – either they make
their quotas or they don’t.  When dealers attempt to apply performance standards
to their service technicians, they often use measures that may be simple but
lack relevance.  For example, dealers will measure calls per day.  But, a higher
level of calls doesn’t speak to the effectiveness of each. 

Consider using:

> EM/PM ratios    > Overall uptime averages     > Call Back ratios  

Each of these measures speaks to the effectiveness of the technician and will
help reduce service cost.  Aftermarket profits will increase accordingly.

These are but a few techniques to consider when adjusting your service
business model.  Certainly, there are more.  The first step, obviously, is to
measure the impact of market changes on your profits.  Then, begin to implement
some (or all) of the strategies discussed here in order to replace the profits
you’re losing.

A word of caution – don’t try all the strategies at the same time.  Pick one
that offers the greatest potential for your business.  Implement measure results
and adjust when necessary.  Then, move to the next one.  To try more than one at
a time reduces your ability to measure the impact of any single strategy.
Regardless of which strategy you select, you’ll want to begin now.  The risks
associated with delay are simply too great.

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