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ARTICLE OF THE WEEK

• In strategy and business design, most companies struggle to build the foundation for service excellence. Few have sufficient insight into the barriers and opportunities for driving profitable growth through services, which makes it difficult, at best, to develop the right strategies, identify the right priorities and invest sufficiently in the service business. Yet some companies, such as Siemens AG Medical Solutions, make the service business central to their corporate strategy: they design the service business around customer requirements in order to drive customer satisfaction, loyalty and business performance.
  
  
• In operations planning and management, companies with complex service operations-those with thousands or hundreds of thousands of parts, services that need to be delivered around the clock and often in remote parts of the world, and service lifecycles that can stretch for decades-often lack the capabilities to realize service excellence. The experiences of some of the world's leading manufacturing companies, such as Caterpillar, show that persistent investment in, and focus on, improving the service and logistics operations can drive outstanding customer service, resulting in enhanced customer loyalty and a foundation for profitable growth.
  
  
• In execution, the "last mile" to the customer where battles for customer loyalty are won or lost, the majority of companies are still unable to provide customers with excellent and cost-effective service. Overall, our analysis of the benchmark results suggest that customers are likely to get exactly what they want, at the right time and place, less than 75 percent of the time-a dismal performance in a global economy where customers have more options and more information than ever before to prompt a switch to competitors' products and services. Ensuring service excellence, however, is core to the business model for many companies, such as Hyundai Motor Company and Kia Motors Corporation, where service guarantees, such as extended warranties, are an essential part of the value provided to the consumer.
  
  

There are great opportunities for companies to improve what should be an engine for profitable growth in many or most manufacturing organizations. Some companies are championing the service revolution to drive performance. Twenty-five percent of the benchmarked companies report an on-time delivery performance to customers of 96 percent or higher. Caterpillar-with more than 600,000 spare parts, and an installed base of equipment that often needs service for 40 years or longer-is able to ship its customers exactly what they want, within just 24 hours, 99.7 percent of the time.*5

While the challenges are numerous, our research suggests that companies can make strategic and operational investments in processes and technologies that will enable them to leapfrog the competition and drive continuous improvement in the operational and financial performance of their global service businesses.

• First, companies can adopt collaborative processes across the service supply chain, from suppliers to customers that are well-documented, proven, and ready for implementation. Indeed, our analysis indicates a strong relationship between the level of implementation of processes-such as collaborative planning, forecasting, and replenishment with customers-with the benefits achieved from the implementation. Across the service businesses benchmarked, the more extensive the level of implementation, the higher the benefits reported from adoption of key processes. Volkswagen AG experienced first-hand in its North American operations the benefits of implementing robust processes for service parts management. It drove dramatic improvements in customer order fill rates over just six months while reducing annual cost by over US$25 million.
  
  
• Second, information systems for designing, planning, managing and executing the service and parts business are maturing rapidly and can now support most of the requirements of even the world's largest and most complex service businesses. These systems are no longer the weak links on the road to service excellence that they were 5, 10, or 20 years ago. In fact, without sufficient technology support it will be increasingly difficult, if not impossible, to manage and optimize the service business as customer requirements increase and the service business grows more complex. While adoption rates are still abysmally low in many areas, our analysis points toward a strong correlation between information systems implementation and benefits achieved. Some companies, such as Rolls-Royce, are capitalizing on improved technology, sometimes going beyond what would have been thought possible just a few years back.
  

With profitability and growth levels in many cases far exceeding the main business, it is abundantly clear that the service revolution in global manufacturing is well underway. For most manufacturers, it is now a matter of effectively embracing the service revolution or risking being left behind.


Driving Profitable Growth through the Service Business

For many of the world's largest manufacturers, aftermarket service and parts operations essentially define the business. For example, for Rolls-Royce, one of the world's largest jet engine and gas turbine makers, service revenue is about 55 percent of the more than US$11 billion in total revenues;*6 and for Xerox Corporation, the US$16 billion technology and services giant, post-sale and other service revenues amount to more than 65 percent of total sales.*7

Indeed, findings from our ongoing Global Service and Parts Management Benchmark Survey show that the service business accounts for an average of nearly 26 percent of revenues across the industries we have studied (Figure 1). In 19 percent of the companies benchmarked the service business accounted for 50 percent or more of total revenues (Figure 2).

The Role of Service Businesses in Global Industries

These findings are not surprising in light of the crucial role service and parts management plays across industries.

• In aerospace and defense, maintenance, repair and overhaul is the cornerstone of selling airframes, jet engines, and many other big-ticket items. Like many other industries, the aerospace and defense industry is moving towards performance-based service and logistics agreements with customers-providing guaranteed availability and reliability of equipment, modules and entire platforms (such as jet propulsion) over an extended period of time. For example, Rolls-Royce has long been focused on selling "Power By The Hour©:" Major airline and defense customers can pay a fixed warranty and operational fee for the hours engines are running, which means that Rolls-Royce must focus on the entire package-products, installation, after-sales maintenance, repair and overhaul (MRO), and overall service and parts management-to ensure profitable growth of its business over the long haul.*8 While many companies base their aggressive growth plans on securing these types of agreements with customers, their future profitability depends on their ability to deliver the promised service levels in a cost-effective manner, which can be a challenge even for the best companies.*9
  
  
• In automotive and commercial vehicles, some companies have built the reputation of their brands and their business models on the back of excellence in service and parts management. For Lexus, the luxury-vehicle division of Toyota Motor Corporation, service excellence helped propel the upstart brand to market-share leadership in North America less than two decades after its launch in 1989.*10 For Hyundai Motor Company and Kia Motors Corporation, the emerging automotive giants based in South Korea, service parts management, through Hyundai Mobis' Service Parts Sales Business, is an integral part of the corporate strategy. As many vehicles are sold with warranties of up to 10 years/100,000 miles, the service and parts operation must function at the highest level of efficiency to avoid customer service problems excessive warranty costs, and sustain profitable growth.
  
  
• In the cut-throat consumer goods markets, top business performance is often driven by combining product quality and performance with service excellence. Apple Computer is going further by elegantly mixing physical product sales with digital services. Apple's iPod portable music and video player offering has leapt in just four years from being yet another consumer gadget to block-buster status with quarterly sales reaching more than 6 million units.*11 Perhaps more importantly, Apple is selling services with the product to the tune of 2 million music downloads per day while also establishing fast-growing online video sales. Some analysts estimate Apple's share of the global online music market at an impressive 80 percent or more.*12
  
  
• In diversified manufacturing and industrial products companies, such as General Electric, the service business is an integral part of the business in the eyes of the customers. According to Jeffrey Immelt, chairman and chief executive officer of GE, "Services represent about 30 percent of our industrial sales and have the potential to grow at double-digit rates for the foreseeable future. Services are a powerful growth engine because our technology is long-lived and we focus on making the customer more profitable."*13 In industrial automation, customers are under pressure to reduce costs and time to market, and to increase quality and safety. At ABB, the response has been to move towards selling "performance service" offerings, which allows the tailoring of services to customers exact needs-from simple, product focused maintenance and field services to customer focused services-called "Automation Performance Management"-where ABB guarantees the performance level (and assumes the related risk) of the customer's automation equipment over its lifecycle-independent of whether it was original ABB equipment or not.*14
  

Ensuring the right pricing and the cost effectiveness of fulfilling such comprehensive service contracts is bound to set new standards for service excellence in the years ahead.

• In the life sciences and medical device industry, the most demanding customers keep raising the bar for service excellence. Customer requests for same-day (instead of overnight or slower) service fulfillment combined with service-level agreements that put the risks (and rewards) on the back of the manufacturer will be more and more common. For some companies, such as Siemens Medical Solutions, these demands typically require the creation of more complex and costly distribution and service network in order to get closer to customers and enable faster response. The enhancements needed in processes and systems for managing and optimizing these networks will challenge even the leading service businesses in the coming years.
  
  
• For industrial customers of high-tech technology and telecommunications equipment manufacturers, machine downtime can cost US$100,000 or more per hour. Indeed, for major semiconductor equipment makers, like Applied Materials, service and parts management is at a premium and a core feature in selling the main products in the first place. For manufacturers of printers for both consumer and commercial uses, such as Hewlett- Packard and Xerox Corporation, there is often more revenue and profit in selling ink and after-sales services than in initial printer sales.*15 For companies like these, the service business is an integral part of the corporate strategy. In addition, with continued consolidation through mergers and acquisitions, many companies are left with an unwieldy base of installed hardware and software that often needs to be serviced for decades. Doing this cost effectively, without losing customers and damaging brands, is a top service business challenge for many companies. The Impact on Profitability and Growth The service business typically is a more profitable operation than the primary product business. Our analysis suggests that the average profitability of service and parts operations (SPO) benchmarked is more than 75 percent higher than overall business unit profitability (Figure 3).*16 The most profitable service businesses benchmarked-the top 25 percent-are more than three times as profitable as the average business unit. In addition, the average annual growth rate of the service businesses benchmarked is about 10 percent higher than for the business units overall. The fastest-growing service parts operations-the top 25 percent-are growing at more than twice the rate of the average business unit. On average, we estimate that 46 percent of total profits of the companies benchmarked are due to the service and parts businesses.*17
  
  

The total impact of the service business, however, varies dramatically across the companies benchmarked. A majority are struggling to join the service revolution. Despite the many opportunities for improvement, more than half of the service businesses benchmarked (55 percent) have profit levels lower than or on par with their business units. For more than two thirds (67 percent), their service businesses grow slower than or at the same rate as their overall businesses. The missed opportunities are significant.

Companies often fail to capture the market share potential for servicing their own installed base of products-the "captive" service market. The median benchmarked company's captive market share is just 40 percent in "pure" services, such as field services, and about 75 percent in spare parts (Figure 4). For numerous companies these captive market hares are much lower. For example, many automakers' spare parts sales are heavily concentrated on supplying parts to authorized dealers for vehicles during the manufacturers' warranty period, which typically covers 3 years or so. But as the vehicles age and the warranties expire, automakers' captive market shares for parts typically drop-exactly when the need for parts and service increase. Without a warranty in place, consumers shop around for the best value in parts and service. Competitors attack the customer base and manufacturers (and dealers) lose out on a large market opportunity. In addition, the total market potential-which also includes the potential of selling services and parts to customers who did not buy the original product (the "non-captive" market)-is typically 2 to 10 times larger than the captive markets. Our analysis shows that the service businesses of most companies today reach only a small share of this market, which suggests an even larger growth opportunity.

Some companies have grabbed these growth opportunities with gusto. Caterpillar has extended its internal excellence in service parts management and logistics to external customers-through the creation of Cat Logistics-in turn building a global growth business and capturing a much larger share of the available market for those types of business services.*18 From its inception in 1987, the success of Cat Logistics has been remarkable. Today, Cat Logistics has more than 9,000 logistics professionals operating in over 100 locations across 25 countries and 6 continents, managing more than 18 million stock keeping units (SKUs), and shipping more than 160 million orders and 16 billion pounds of freight per year. The client list is impressive with companies such as DaimlerChrysler, Ford, Saab, Toshiba, and Honeywell, and the growth opportunities are large. According to Jim Owens, chairman and chief executive officer of Caterpillar: "Cat Logistics has been generating growth of 25 percent annually in revenues from external customers, and massive opportunities remain for creative third-party logistics providers in this $170 billion industry."*19

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