May 2005 | Commentary | Viewpoint

The Service Supply Chain: Turning Potential into Profit

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A growing number of CFOs and manufacturing executives have discovered the profit potential buried in their service business. The big challenge, however, is transforming that potential into profit.

While after-sales service on average represents 24 percent of revenue, it generates a whopping 45 percent of profit, according to a recent AMR Research study. Why? As products become commoditized, new products develop shrinking margins and become harder to sell, so opportunities to drive profit through enhanced service offerings increase.

After-sales support provides a low-risk, long-term revenue stream, particularly when customers own products for extended periods of time, as they do in industries such as aerospace, where product lifecycles can be as long as 25 years.

Improving service quality increases customer satisfaction, which, in turn, increases new product sales. As outsourcing grows and manufacturing becomes increasingly competitive, effective after-sales support helps drive opportunities to enhance customer value.

The range of available service offerings runs the gamut from basic parts and labor sales, to same-day or faster service response, to "power by the hour" contracts, where customers pay only for equipment use and uptime. Tailoring service offerings to each individual market segment ensures that customers get maximum value.

Cisco Systems, for example, has a variety of service offerings, ranging from guaranteed damaged parts exchange, to two-hour response commitments for replacing failed units. Another example: Boeing Integrated Defense Systems offers performance-based logistics contracts to its military customers, where payments are tied to the achieved availability of the weapon system.

The lack of technology systems geared toward the service supply chain, however, is a barrier in the quest to turn potential to profit. Though many companies invest in enterprise resource planning (ERP) and manufacturing supply chain management software, these programs are limited to solving traditional direct material procurement and manufacturing/finished goods distribution problems.

The majority of existing ERP software programs don't have the capability to manage complex service supply chain scenarios—where highly individualized service offerings are coupled with stringent response standards.

ERP Doesn't Cut It

Service supply chain scenarios are highly uncertain because the random nature of situations requiring product support—a broken part threatening to bring down a production line, for instance—is nearly impossible to predict. Unique requirements—including forward and reverse repair flows across a network of customer and partner locations, managing repair facilities, and volatile engineering changes that result in part supersessions—further complicate matters.

In addition, ERP and standard supply chain software programs often fall short of meeting service organizations' needs. These organizations support thousands of globally distributed customers and hundreds of thousands of pieces of equipment, along with an enormous range of service priorities.

Despite these IT challenges, some companies have thriving service supply chain operations. Tellabs, which offers bandwidth management solutions to telecommunications service providers such as MCI and Verizon is one success story.

Previously, Tellabs handled its service business by simply selling parts to customers from a central distribution center. Customers planned and stocked the spare parts they needed on their own.

The Recipe for Profit

Driven by competitive and market pressure, Tellabs realized it needed to offer same-day service contracts to its customers. To achieve this, the company built a network of strategic parts centers, and changed its infrastructure to provide materials to customers in shorter time frames.

Determining where to stock spare parts was another concern for the company. Though Tellabs successfully implemented SAP's enterprise software, the approach it used for that project was not appropriate for planning supply distribution for a high-stakes customer service business.

Tellabs turned to third-party logistics providers for logistics planning assistance, then implemented a hosted software solution for parts forecasting and planning in the new network. It also created a service supply network able to handle same-day service contracts.

By creating new strategic parts locations, implementing logistics processes to deliver expanded service, and deploying new planning processes and software, Tellabs reduced service parts inventory by more than 60 percent in two months. Through intelligent outsourcing and effective deployment, the company leveraged internal resources and systems to deliver enhanced service to customers.

Creating a profitable service supply chain requires a commitment from management to execute proper technology and processes, and a variety of obstacles lie in the way of achieving this goal. But companies that successfully offer product-enhancing services to their customers significantly increase revenue, drive long-term customer retention, and increase customer loyalty.

That's the recipe for turning potential into profit.

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