Aftermarket sales and service are vital to manufacturers’ strategies
Manufacturers of durable goods have increasingly generated income by providing aftermarket parts and service. This is true not only for B2C companies (such as carmakers) but also for B2B firms (such as manufacturers of industrial machinery and automation) and firms in B2G (business-to-government) spaces, such as aerospace and defense. What might have begun as a side business selling spare parts has, for some manufacturers, turned into a major source of value creation.
Building a robust aftermarket offering has at least three major benefits. First, and most directly, it provides end users with a better experience. When a manufacturer provides maintenance service and replacement parts for a product it sells, customers can expect extended product life and improved product performance. Who understands an industrial machine, for instance, better than the OEM that created it?
Providing aftermarket parts and service can also help a manufacturer maintain relationships with customers. Aftermarket sales and service occasion regular interactions with customers over the lifetime of a product. What company wouldn’t want to learn about its customers’ ongoing needs and influence their choices?
Finally, aftermarket offerings can please shareholders by increasing a company’s operational cash flows and reducing its risk. The margins for providing aftermarket services are almost always at least double the margins on sales of new units, and they can reach peaks of ten times higher for companies that adopt aggressive models. In some cases, aftermarket revenue is built into sales contracts. What shareholder doesn’t like stable and predictable cash flows?
Despite these clear benefits, however, there are also pitfalls to keep in mind. Before offering aftermarket services, companies should step back to ask a fundamental question: How does this align with the company’s overall strategy? Some companies have rushed to offer increasingly sophisticated aftermarket services without answering this question—resulting in a failure to fully leverage the value of those services and to earn adequate returns on those substantial investments.
Aftermarket’s value evolution
Two decades ago, the typical aftermarket offering was reactive and transactional. It might be a simple response to events or customer needs, such as selling spare parts following a breakage, conducting repairs on faulty components, or training a customer’s new workers. More recently, however, many companies—especially B2B manufacturers—have significantly evolved their aftermarket approaches to take advantage of the gold mine of opportunities presented by aftermarket sales and service.
This change began incrementally, with the addition of various new services and upgrades. In a further evolution, some companies are now becoming true aftermarket partners with their customers—signing contracts that guarantee operational performance. Some manufacturers are even willing to share risks with customers.
The newest aftermarket frontier features the robust use of modern technological developments such as advanced sensors, big data, and artificial intelligence to offer predictive maintenance services, manufacturing consulting, and dramatic productivity boosts. Sensors on some industrial machinery allow the creation of comprehensive databases that help manufacturers anticipate the breakage of certain parts based on physical parameters (such as vibrations or temperature), thus minimizing downtime. Technological developments have also made it possible to offer product features as a service. Some car manufacturers, for example, have developed aftermarket offerings in which they will—through remote activation, for a fee—increase a vehicle’s horsepower or enable its self-driving capabilities.
The newest aftermarket frontier features the robust use of modern technological developments such as advanced sensors, big data, and artificial intelligence.
Companies can roughly estimate the potential value of a service business. First, they should multiply the average annual revenue from the sale of new units by the average life span of those units in years. They should then multiply that product by the estimated value of annual aftermarket services (expressed as a percentage of the units’ value). For example, assume a company invoices €100 million a year from the sale of new units that have an average life of ten years. If its revenues from annual services will equal 5 percent of the value of those units, the company will generate €50 million of revenues from aftermarket services over the life of the units. Because selling aftermarket services is, on average, at least twice as profitable as selling new units, the company would extract more profits from those services than from selling the new units.
Integrating aftermarket offerings into a trio of business processes
Too many manufacturers dive into aftermarket offerings without devoting sufficient thought to how those offerings can best be aligned with the company’s broader goals and approach. For an aftermarket strategy to succeed, it should be carefully integrated—prior to its launch—into three fundamental business processes: product development, sales, and execution.
Development stage: From innovation to market
During product development, the manufacturer should already have a clear understanding of the role that aftermarket services will play for the product. The nature of this role must be a deliberate choice, even if the company decides not to focus on service as a source of profitability.
A manufacturer of coffeemakers, for example, decided not to offer any aftermarket services in conjunction with a new product. The product it was developing had a useful life of at least a decade, and a key element of the product’s value proposition was its durability. Whatever revenue might be derived from postsales maintenance of the product would in fact be inversely proportional to the effect on the product’s value proposition.
Of course, not all products can avoid maintenance. When developing complex platforms or equipment—such as jet engines, helicopters, tractors, or turbines—a manufacturer might consider future maintenance contracts as it chooses designs and specifications. For example, a European OEM that mostly secured long-term service contracts with guaranteed performance clauses chose to design complex spare parts and to use patented materials in order to avoid cannibalization of aftermarket revenue by service-only players. (That said, it also designed its spare parts to be modular or standardized, which would allow different fleets to share warehouses and would minimize the immobilization of working capital.)
In contrast, a small-aircraft OEM wanted to ensure its planes would be easy to repair in remote areas, from Southeast Asia to the Caribbean, because ease of maintenance was a key buying factor for customers in those areas. Since the company did not have enough scale to provide adequate service in these places, the development strategy for the most maintenance-prone parts was the opposite of the previous example: the company made sure its spare parts were commercially available anywhere, so all customers could easily find them.
Sales stage: From market to order
Service offerings often play a central role in the sale of new units. Cost, speed, and quality of service will be basic criteria in many customer decisions. Service offerings are sometimes a relatively implicit factor in sales of B2C goods (as when consumers tend to favor a smartphone brand with a nearby service center). Conversely, aftermarket offerings frequently are explicit aspects of a B2B or B2G sales pitch. Organizational buyers requesting industrial equipment quotations often ask for service cost estimates over the first years of a product’s usage, and some ask for estimates of the total cost of ownership over a durable good’s life cycle.
Performance-based contracts are becoming widespread in durable-goods sales. This type of contract is more likely to be appealing and successful if the OEM meets the following conditions:
It has unique assets that end users can’t access, such as patented technologies, technical expertise, complex machinery, or robust capital.
Its customers are sufficiently mature, and the equipment in question is mission-critical and complicated to maintain.
It has proper expertise in areas such as advanced analytics, contract execution, legal dealings, and corporate finance.
Most important, it focuses on the end-to-end customer journey and is fully accountable for system performance.
If these prerequisites are in place, a performance-based service contract can help ensure that the end user receives better results from equipment and platforms at lower and more predictable costs. This type of contract can help the service provider secure a longer contractual duration and achieve higher margins while gaining enhanced and ongoing insight into the end user’s needs.
Final stage: Execution of the aftermarket order
After Russia’s invasion of Ukraine in early 2022, NATO defense ministries suddenly became focused on the “availability” of military platforms—meaning the ability to fully operate a platform at a given time. It emerged that, in many cases, significant portions of military fleets were unable to function, often because of long waits for delivery of OEMs’ spare parts.
Manufacturers thinking about aftermarket services should pay close attention to the anticipated execution of those services (and also to the key parameters that will describe a durable good’s performance levels). But an OEM may not always be solely responsible for reducing a product’s downtime. End users’ actions and expenditures also come into play. For example, providing complex spare parts—especially in the current context of strong demand growth in defense—could require the creation of new warehouses and other infrastructure, which an OEM might not be able to manifest without financial support from end users. To address similar challenges, many B2C companies have created service ecosystems. These can include elements such as “certified” repair companies, “authorized” service centers, and “partner” financial service providers. These ecosystems might be defined as interconnected sets of services that allow users to fulfill a variety of cross-sectoral needs through one integrated experience.
In recent times, B2B and B2G players have gone down this road, with some success. A global OEM in the aerospace industry divided the world into One Service Center Clusters (OSCCs)—areas that are geographically close and demographically similar enough to be served by a single service center. It then placed each of these OSCCs in one of three categories: (1) strategic and prioritized clusters to be served directly, without intermediation, by company-owned centers equipped with full capabilities; (2) strategic but economically nonviable clusters to be served by company-provided service centers that rely on a local ecosystem of suppliers for all ancillary services; and (3) nonstrategic clusters, to be served entirely by an ecosystem of local suppliers. Using clear communication and strict accreditation, the company was able to provide a high level of customer experience in all clusters.
Aftermarket parts and service have become crucial elements in the success of durable-goods manufacturers. In many cases, aftermarket endeavors provide a manufacturer’s best economic returns and value creation. A well-executed aftermarket sales and service strategy can increase operational cash flows, reduce risk, and improve customer experiences. Each company, however, must carefully consider the best approach, taking into account the company’s market, competition, desired level of customer intimacy, and ability to integrate aftermarket offerings into core business processes. In doing so, companies should be fully aware that choices about aftermarket endeavors can significantly affect their overall strategy.