The Service Revolution
Manufacturing's Missing Crown Jewel
By Jeffrey J. Glueck, Peter Koudal and Wim Vaessen

Henry Ford wasn’t just a brilliant supply chain innovator. He was a natural entrepreneur who understood business in all its dimensions. "A business absolutely devoted to service will have only one worry about profits," he said. "They will be embarrassingly large."

Ford’s assertion, unfortunately, appears to have gone unheard by many of today’s manufacturing companies, who consider themselves designers and producers of tangible products rather than providers of integrated solutions to customers’ broader needs. Too often, manufacturers view their service operations as ancillary businesses separate from and by no means equal in strategic or operational importance to the “core” product business.¹ That mindset is as risky as it is outdated.² There has been a clear migration toward service offerings, a shift sparked by products rapidly becoming commodities and by growth in the number of customer “touchpoints” over the lifetime of a manufactured product. The shift applies to consumer goods as well as to industrial products, and to complex industrial machining centers and commercial refrigeration units as much as to vacuum cleaners. The sale transaction is essentially just one touchpoint on a continuum of potential interactions between producer and customer, and an early one at that. At its root, the basis of competition is shifting toward the ability to drive business performance through excellence in service and parts management.

Deloitte Research, in collaboration with the global manufacturing practices of Deloitte Touche Tohmatsu, launched a major multi-year research program in 2005, the Global Service and Parts Management Benchmark Study (see “About the Research.”),³ designed to pinpoint the boundaries of best practice in service excellence and to understand more about the risks of ignoring the service side as well as the advantages of embracing it. The study conclusions reveal a wide gap between best-practice leaders - those we call “service champions” - and the rank-and-file manufacturers whose service performance is far from excellent. The findings do, however, point to a large untapped market for the manufacturers that can master the elements of superior service. This article describes how most manufacturers today approach the service factor, compares the drivers of profitability and growth on the service side, and makes a strong case for change in a wide range of manufacturing sectors.

The Profitability Imperative
Let there be no doubt about the impact of the service business. Our research found that the average profitability of the service operations we benchmarked is more than 75 percent higher than overall business unit profitability.⁴ The most profitable service businesses we benchmarked (the top 25 percent) are more than three times as profitable as the average business unit. Across the manufacturing companies that we studied, service revenues average more than a quarter of total revenues but deliver 46 percent of the profits. At many producers, there would be little or no profitability without the service business.⁵ (See Exhibit 1.)

These findings apply just to the current impact of service activities, with the future impact still more compelling. Our analysis suggests huge untapped profit potential in “non-captive” as well as “captive” markets.⁶ Yet most companies are not even close to tapping that potential. Although the fastest-growing service operations (the top 25 percent) are growing more than twice as fast as the average business unit, more than two-thirds of companies are seeing their service operations expand no faster than the overall business; in fact, their service growth rates often lag those of the whole company. The median benchmarked company derives only 40 percent of its after-sales service market and 75 percent of the after-sales spare parts market from servicing the installed base of its own products, which constitute its captive market. (Those numbers are much smaller for categories such as automotive original equipment manufacturers.) As for servicing non-captive customers, a market up to 10 times larger than the captive opportunity, only a few manufacturers have made significant inroads. Most are managing their potential high-growth “stars” as if they were slow-growth “cash cow” businesses.

A few leading manufacturers, such as aircraft engine maker Rolls-Royce plc, understand the short-term and long-term value of their service activities. Rolls-Royce provides airlines with what it calls “Power By The Hour,” selling its engines along with the services to maintain, repair, and overhaul them over many years. Service revenue already accounts for about 53 percent of Rolls-Royce’s $11 billion-plus in annual revenues, well above the 26 percent average for all the companies benchmarked.⁷ The company’s service revenues have increased by more than 60 percent over the last five years and almost tripled over the past decade, growing more than twice as fast as Rolls-Royce’s overall business. This company does not need a reminder that service matters more than ever, a message that bears new emphasis for many other manufacturing companies. We can point to six reasons why:

1. New basis of competition. The business models of many global manufacturers are under assault as customer demands change, home markets mature and low-cost rivals raise their games. In developed markets, products are becoming commodities as pricing pressures increase, particularly as a result of low-cost country sourcing. In emerging markets such as China and India, service and parts operations are facing fierce price wars as well as counterfeit parts, situations that damage long-term brand reputation as much as they hurt profits. Protecting the business through service excellence is one way of keeping out the competition while improving customer service and loyalty.
2. Product proliferation. New products are introduced more frequently. If not properly managed, the combination of shorter sales cycles and long service life cycles is a recipe for escalating costs, parts obsolescence, lost customer focus and deteriorating customer service quality. Among the service operations benchmarked, the median inventory obsolescence rate stood at five percent and in many cases exceeded 10 percent.
3. Quality backlash. Quality issues and problems with delivery of service and parts can exact a severe toll in warranty costs and brand damage. Analysts estimate that industrial equipment makers alone will invest a total of $1 billion over the next five years to overhaul warranty management and spare parts logistics.
4. Continued outsourcing. Many large manufacturers are steadily outsourcing elements of their core operations, including parts production and assembly. In effect, they are relying more on the success of their customer-facing, service-oriented businesses, although those functions too often lack the capabilities needed to succeed.⁸
5. Service resilience. In times of economic downturn, service and parts sales are often far more robust than the main business. For example, during the economic and financial crisis in Korea from 1997 to 1999, sales of new vehicles by Hyundai and Kia Motors dropped by nearly 36 percent, but the Hyundai Mobis spare parts sales business posted a 5.6 percent sales increase.⁹
6. Increasing business complexity. Whether caused by expansion into new markets, mergers and acquisitions or product proliferation, the growing complexity of business makes the challenges even more daunting. Customers are likely to demand better- tailored and better-managed service solutions, often combined with risk-sharing agreements. Ensuring the right customer experience, which involves products, service, branding and price, delivered to the right place at the right time, will become even more difficult. But it will also become a requirement for success.