The Secret Life of Factory Service Centers

The secret life of factory service centers

For a lucrative new source of revenues, profits, and market information, manufacturers need look no further than their own repair shops.

A few miles off Interstate 696, outside Detroit, the factory service center of a consumer goods company blends easily into the commercial landscape. The seven people who work at the customer support site sell parts, refurbished products, and accessories; repair products; and answer service and maintenance inquiries. Until recently, the manufacturer paid scant attention to this place or to its whole network of factory service centers, which were seen merely as a cost of doing business--the price a company pays to support products that eventually wear out or break. Then a new division manager discovered that despite years of neglect, the centers were earning margins upward of 20 percent, more than twice those of the core business. Now the company is planning to open centers in ten new locations across the United States and expects network-related revenue to double by mid-2003, thereby providing a full 10 percent of the revenue of the division and 15 to 20 percent of its profits.

A handful of US companies have achieved similar results; with small capital investments, so could many others.1 Factory service centers can not only generate cash but also provide a gateway to the lucrative world of services. Trucks, for example, can produce after-sales revenue equivalent to four times their purchase price through financing, insurance policies, service contracts, and the sale of parts and accessories.2 At present, though, these high-margin items tend to be sold through third parties--dealers, retailers, and independently owned authorized service centers--which take a cut of the revenues from parts and all of the revenues from service contracts and extended warranties. Manufacturers can capture a larger share by enlarging their own service networks.

Service centers also provide a valuable laboratory for developing new products and services, for providing information about customers' needs, and for showing where products have failed to meet them. One midsize industrial-products manufacturer, for example, is deciding whether to rent products, start a mobile repair service, and offer service contracts and extended warranties--all as a result of insights gleaned from the company's service network.

So far, about 35 companies in the United States have created service networks (Exhibit 1), but most have yet to exploit them fully. Almost all of the businesses we looked at had fewer service centers than they should given their market size and penetration and thus were failing to maximize their revenues. Today, most service networks receive little management support. If they had more locations, a more profitable mix of services, and better management, we estimate that they could produce revenues equivalent to 20 percent of a company's core product sales. Although a few top-performing networks are on track to meet that goal, most of those in our study manage just 5 to 10 percent. To put our point another way, we estimate that service networks in only four US industries--consumer electronics, personal computers, power tools, and vacuum cleaners--could generate revenues of $6 billion to $8 billion a year from after-sales service, parts, and ancillary products. Today, we believe, only a fraction of this potential is being realized.

Running these networks effectively certainly poses a management challenge: manufacturers must develop new skills and confront channel conflicts with dealers, distributors, and independent operators (see sidebar, "Managing channel conflict"). But well-managed service centers would more than justify the risks.

The economics of service networks

Consumer products selling for as little as $100 (the price point at which many dealers begin offering extended warranties) can support profitable services. Our research indicates that consumers will pay up to half the original price of a product for a given repair--enough to make most repair jobs profitable for well-managed shops. The real money, however, lies not in carrying out repairs but in selling parts and services: the margin on replacement parts is about 50 percent, and on service contracts and extended warranties it often exceeds 70 percent.

Margins of this kind readily justify the costs of running a network. How high are they? In general, if a company aims for revenues equivalent to 20 percent of the sales of its core products, it would need to invest approximately 15 percent of that target, or about 3 percent of product sales. Assuming a small staff and a small inventory of parts, a typical retail site in a modest location costs $300,000 to $1 million a year to operate and generates returns on capital that can be higher than 40 percent (Exhibit 2). A somewhat larger, more complex site, serving industrial users or dealers, can cost from $20 million to $50 million a year to operate and can generate returns on capital of up to 30 percent. Most such networks need to have at least 10 locations to benefit from scale in logistics, distribution, and centralized support functions, but the optimal size of a network is often a good deal larger because local markets (retail and industrial alike) tend to be underserved. Most of the US companies we studied could actually support 40 service centers spread across as many as 25 or 30 of the country's metropolitan areas.

With operating expenses as the main cost, it is possible to make the venture essentially self-funding: facilities can be rented on short-term leases, for example, and surrendered if the location isn't successful within a year or two. The cost of goods and labor can be managed as volume grows. Companies should remember that a manufacturer's original warranty work usually accounts for about half of the labor expenses and for as much as 20 percent of the total value of services rendered, but these costs are typically charged back to the business unit rather than borne by the service center. As the volume and variety of network services increase, the proportion of warranty work shrinks.

The keys to good performance

Using stand-alone profitability as the yardstick, companies must judge their service centers as rigorously as they do core activities. Without profit-and-loss accountability at every location, managers might be inclined to overlook performance shortfalls that wouldn't be tolerated in a more disciplined business. Good performance depends on three basics: the choice of location and services, management and marketing, and the balance