Understanding and optimizing aftermarket services and agreements for products can create a stable stream of revenue for longer lifecycle products.
Industrial OEMs are always working to expand their profitability, especially in an unstable market. With products that have a particularly long lifecycle like large machines and automobiles, finding ways to capitalize on a product’s aftermarket lifetime value can provide an untapped revenue source.
One study by McKinsey found that across 30 industries the average earnings-before-interest-and-taxes (EBIT) margin for aftermarket services was 25%, compared to 10% for new equipment.
Additionally, according to a study by Gartner®, by 2024, organizations providing a total experience for their customers will outperform competitors by 25% for satisfaction metrics for both customer and employee experience.
Most manufacturers and OEMs have operated on a simple business model: Sell a product and service it when it breaks. However, as new equipment purchases remain stagnant or decrease, in sectors from agriculture and aerospace to energy and utilities, integrated aftermarket planning has become increasingly popular because it provides the strategy for a recurring source of income. Aftermarket services can include the provision of parts, repair and maintenance, and digital services for the products provided. By calculating the aftermarket lifetime value, businesses can increase revenue and find a way to optimize profits.
How to calculate aftermarket lifetime value
In order to take full advantage of the benefits that aftermarket services and sales contracts can bring, you have to first understand what the aftermarket value is and how to calculate it. Aftermarket lifetime value includes the total revenue an OEM can expect from their installed product. This is usually calculated by considering product lifetime, lifetime penetration, and average annual-services revenue.
Product lifetime
This refers to the entire lifecycle of a product, which may be longer or shorter than the manufacturer specified. For instance, a car may be manufactured to run for 10 years of 100,000 miles but a consumer may keep using it for 30 years, albeit sub-optimally. This can largely be disrupted by the economy and the marginal propensity to consume at the time.
Lifetime penetration
Lifetime penetration is the percentage of the installed base that a manufacturer serves during the product lifetime. This is determined by the attach rate and share of lifetime. Attach rate is the most important aspect that is directly affected by how well the OEM markets its warranty and service contracts at the original sale of a product. Share of lifetime refers to the amount of time the OEM is the primary service provider.
Many OEMs lose out to third-party providers, when in reality the original manufacturer is the most qualified to repair and maintain the product. The most successful way to increase lifetime penetration is making sure that the OEM is servicing the product long after the original 10 to 15 years of a first warranty, which can be done by offering a lower-tier or discounted service rate for long-term maintenance.
Average annual-services revenue
The amount an OEM receives under a service contract each year for each product is expressed as a percentage. In order to calculate this, you take the price the product was sold for and the revenue that is generated each year under contract. For instance, if a piece of machinery was sold for $5 million and the aftermarket service contract brought in $500,000 each year, the average annual-services revenue would be 10%.
Aftermarket lifetime value can be expressed as a percentage of a product’s initial sales price and does not take into account inflation or other market volatility that affects true monetary value. It should continually be analyzed over time. Once you understand the aftermarket lifetime value, finding ways to increase this revenue with aftermarket services becomes key.
Increasing revenue with integrated aftermarket planning
Disrupting a sector can take a long time but can also happen overnight in extenuating circumstances. Implementing an integrated aftermarket planning approach is not a new concept, but with the volatile market and unforeseen changes that may occur, their value has risen. Sales are down, but profits don’t have to be. Finding ways to optimize profitability with the data that is available and turning that into a long-term service agreement is no longer a nice to have, it’s a necessity.
The interconnectedness of everything through the internet-of-things (IoT) has provided a digital revolution that touches even the way that services and repairs are done. Instead of waiting for a product to break, which increases work stoppage and downtime, a manufacturer can monitor the health of the product and provide proactive maintenance and repairs, covered by an aftermarket service agreement.
By using an effective software solution, OEMs can track health and detect equipment failures sooner, increase product reliability, and deliver exceptional aftermarket service experiences. A key factor in customer satisfaction relies on aftermarket service fulfillment. Decreasing downtime creates an optimal work environment for a customer and increases their likelihood of continuing a long-term agreement for all their aftermarket needs.
An analysis by Deloitte found that “revenue share from new product sales for manufacturers has been declining over the past decade.” As businesses and manufacturers try to find ways to keep up, aftermarket services are providing an average operating margin 2.5 times the operating margin from new equipment sales. Using the tools at hand, like data that software is already gathering, and combining this with a deeper look into customer behavior and forecasting, can set up a long-term aftermarket services strategy destined to grow profitability.
Disclaimer: Gartner, Infographic: Future State of Manufacturing Industries, 15 July 2021, Michelle Duerst, et. Al.
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