Seizing the Potential of the Service Supply Chain
By Kevin Poole -- Supply Chain Management Review, 7/1/2003
"Customers will spend five to 20 times the initial sales price on subsequent services and consumables."
—AMR Research
Senior executives of progressive manufacturing companies see the diamond in the rough. They're starting to pay more attention to service parts because the profit potential is already proven and the downstream revenue potential is underappreciated and underdeveloped. They also recognize how service-parts performance can be a point of differentiation for a brand.
How important is the service-parts business? AMR Research's August 2002 report on service lifecycle management says that divisions of manufacturing companies that provide parts, maintenance, and other services to customers after the original product sale generate 40 to 50 percent of profits for their companies and nearly 25 percent of annual revenues. AMR's findings also reveal that when it comes to IT investment, the service business does not receive its fair share of corporate investment in many companies. (Exhibit 1 on page 56 summarizes the AMR findings.) As competition in the services market heats up, companies will lose their high margins if they continue to underinvest in information technology.
Customers Take Charge
The importance of service parts to a company should be viewed within the context of broader market dynamics in play today. Specifically, forward-thinking organizations are accepting the Internet-spurred reversal of power that puts end consumers, not manufacturers, in control. Gone are the days of pushing products out to the masses. Smart manufacturers strive to know consumers better because today's buyers are electronically empowered to find any number of alternative products.
End consumers in every industry have access to a nearly unlimited supply of information that greatly expands their buying universe. They use the Internet to compare prices, initiate bidding among suppliers, evaluate statistics of competing products, and even dig up invoice prices.
Think about how consumers bought cars 10 to 15 years ago. The majority of the car-buying public dealt with dealerships that had one primary mission: Sell the car and move on to sell more cars. If consumers had the initiative to conduct some research prior to making a purchase back then, they might have found a few opinions and reports from the automotive press. Otherwise, all they had was the slanted views of the dealership salesperson. Now it's entirely possible that car buyers know more about their targeted purchases than even the most informed salesperson.
The Internet has empowered purchasing departments in much the same way. Today, perhaps through an online exchange or e-marketplace, these purchasers can bid for commodity goods and award the business to qualified suppliers that they never would have met had it not been for the Internet. Information availability has put the end consumer in charge.
Acknowledging this reversal of power allows manufacturers to see the product-ownership period for what it is—a critical element of overall customer satisfaction and a source of sustainable profitability. Service parts thus become a strategic focus for manufacturers that view the initial sale of a product as the beginning of a customer relationship, not the end.
Consider what Saturn did by promoting itself as a "different kind of car company" when it began selling cars. Its executive team opted to focus the entire company on the enduring experience of Saturn ownership. Meanwhile, other automakers remained entrenched in their old ways, providing end consumers with a mere transactional experience.
Increasingly, leading companies selling medium-lived and long-lived assets are embracing aggressive service-parts business models. To cite just one example, a leading lift-truck manufacturer has revealed that it wins customers by relinquishing profits on initial product sales (beating its competitors' best prices) and instead earns all its profits from a lifetime of service.
The longer the life of the asset, in fact, the more opportunity there is downstream. A leading U.S.-based maker of aircraft engines, for example, focuses on service parts because of the continuous, long-term revenue opportunity inherent in servicing these products. Think about how long aircraft (and their engines) remain in service. Revenue from that lifetime of service could easily exceed the revenue from the initial sale of the product, perhaps by a factor of 10 or more.
When looking at your assets in terms of their service-parts potential, be sure to date them appropriately. The standard guidelines are:
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Short-lived assets (up to 2 years): personal computers, consumer electronics, and semiconductors.
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Medium-lived assets (2 to 7 years): cars, medical devices, copiers, business servers, business office telecommunications equipment, and consumer durables.
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Long-lived assets (7+ years): aircraft engines, heavy machinery, industrial equipment, and telecom switching equipment.
The Change Imperative
Across all industries, service-parts management poses one of the toughest supply chain management challenges. The multiple distribution channels typically involved in this part of the business can be very confusing. On top of this, the demands of managing the reverse logistics processes relating to the return and remanufacture of component parts can be formidable.
Given the complexities inherent in today's service supply chain, it's essential that companies leverage advanced supply chain technology. They need solutions that can integrate order fulfillment and offer sophisticated planning and forecasting capabilities, can provide increased visibility of inventory and order status across the supply chain, and can enable collaboration with their trading partners. Successful companies will need technology tools that allow them to optimize their entire investment in parts inventory across the multiple echelons in the extended supply chain.
Historically, companies have underinvested in information technology for their service and parts operations. Part of the problem has been that generic technology solutions aimed at original equipment manufacturers (OEMs) did not fully meet the needs of service-parts operations. But recently, software companies have begun to offer complete solutions aimed at improving service-parts operations.
Some consulting firms are looking at how manufacturers can apply these new service-parts solutions. They're working with software companies to identify trends within the aftermarket area; drive strategic responses to those trends through process redesign, implementation, and continuous improvement initiatives; and apply new technologies that support and integrate the supply chain to achieve sustainable benefits.
Even with the increased availability of service-parts solutions and the heightened attention of the consulting community, change won't necessarily come fast—or easy. Service-parts organizations have been burdened with a history that borders on neglect in some instances. Initial hurdles that need to be overcome include:
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Historically low IT investments.
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20+-year-old legacy systems.
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No enterprise resource planning (ERP) system.
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Lack of a C-level sponsor.
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Supply chains with multiple, competing distribution channels.
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Large product portfolios with high numbers of SKUs to manage.
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Chronic reverse logistics problems.
The potential for the service-parts software market, by the way, far outweighs the pain points. Not long ago, research firms IDC and AMR concurred that a 30-percent growth rate for this market was realistic. In a June 2002 analysis, UPS Logistics figured that total spending on service-parts activities had increased at a compounded annual growth rate of more than 9 percent for the last four years. U.S. Bancorp Piper Jaffray estimated recently that spare parts represent $700 billion in spending and 8 percent of gross domestic product in the United States.
Yet in spite of this potential, manufacturers considering the acquisition of new software as part of a service-parts initiative still often face vestiges of the old business model. Typical comments include: "My service division is a cash cow. I don't invest money there. My technology is way behind. My best people are assigned elsewhere. Even when I cut budgets, the service division always seems to make money."
Given the apparent resiliency of service-parts organizations (for example, profiting despite budget cuts), it may be tempting to look at service parts and think: "If it ain't broke, don't fix it." But the prospective benefits of service-parts initiatives are astounding. Based on our experience implementing service-parts solutions, our clients typically experience measurable and sustainable value. Examples of this potential value include:
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Inventory reductions of 30 to 50 percent.
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Fill-rate lifts from the low 90s to the high 90s.
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Revenue increases of 5 to 7 percent.
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Warehouse productivity gains between 20 and 30 percent.
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Transportation cost reductions of 8 to 15 percent.
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Field-service productivity improvements of 5 to 10 percent.
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Return on investment (ROI) as high as 60 percent.
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Annual benefits reaching 5 to 10 times the upfront investment.
New Mindset Needed
Service-parts supply chains are complex, typically involving multiple distribution and service delivery channels. Traditional thinking holds that additional investments in service-parts inventory and working capital are required to meet ever-changing customer expectations. But world-class companies are finding that they may be able to satisfy customer demands by viewing the complete supply chain as an untapped source for generating value. Think of it as an adaptive value chain.
An adaptive value chain provides companies with the flexibility required to sense and respond to changes in customer demand in the most cost-effective manner. In today's world, dealers, distributors, and channel partners demand the right service capability and service parts in the right place, on time, and at the lowest total cost. Increasingly, competition is shaping up around which value chain, rather than which individual company, can most effectively respond to that demand. The most adaptive value chain providing the best service to the end customer will ultimately gain market share.
An adaptive value chain is key to the success of a service-parts network because it enables participants to react quickly to changes in the marketplace and the supply chain. To do this efficiently and effectively, the value chain must accomplish three things very quickly:
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Recognize what is happening—gain real-time knowledge of the entire market and supply chain with an understanding of end-consumer demand, product performance, competitors, distribution channels, supply networks, and so forth.
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Determine the most appropriate response—quickly evaluate the various options and plan the most appropriate tactical and strategic responses.
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Take corrective action—once the appropriate response is identified, quickly and efficiently translate the plan into action.
Most service-parts supply chains incorporate many different companies to manufacture, distribute, and install service parts. An adaptive value chain acts as a single entity that can deliver the most efficient response to market changes. To operate this way, a company must establish planning and execution capabilities that stretch beyond its borders to include customers, suppliers, and supply chain partners. This is a relatively new concept—so new that many companies have not yet figured out how to execute it effectively.
The Promise of Technology
The technology available today can provide the necessary linkage between a company and its suppliers, customers, and partners. In particular, the explosion of Internet exchanges and related technologies over the last few years has had a lasting influence on supply chains in general and service parts in particular. Although most of the Internet business plans were poorly thought-out and contained highly speculative growth projections, the ideas and tools generated during this time are just now beginning to bear fruit. Companies are slowly learning how to apply these technologies to their own supply chains. Many recent advances in technology hold promise as opportunities to improve service supply chains. These include:
Visibility and event management. This is the ability to track events in multiple systems and alert users when out-of-tolerance conditions occur. The inherent nature and flexibility of event management enables it to provide numerous solutions to multicompany service-parts situations such as reverse logistics, supplier management, vendor direct shipments, or dealer inventory management.
Multi-echelon optimization. Service-parts networks depend on forward deployed local inventory to satisfy customers' needs for fast repairs. This tool helps companies determine where inventory should be deployed in a multilevel supply chain, while also balancing customer satisfaction with inventory and distribution costs.
Mobile computing and global positioning systems (GPS). Robust mobile computing and GPS technologies present opportunities to redesign processes supporting mobile professionals. These solutions alter the very definition of field support and enable the dynamic scheduling of field-service technicians. GPS can be integrated with visibility and event management technologies to provide more granular tracking capabilities.
Collaboration. Service-parts supply chains are fragmented. No single participant has all the information needed to make the right decision for the overall supply chain. Collaboration tools provide an online workspace for suppliers, customers, and partners to share information and solve problems. Existing tools support collaboration with forecasts, orders, stock positions, and product development.
Price optimization. Price optimization is designed to achieve the highest margins possible for a given service part. Optimization methodologies and solutions provide a means to review part lifecycles, assess market segmentation, and evaluate the economics of customer price elasticity. Pricing tools and techniques enable a pricing manager to perform detailed price analyses across vast numbers of parts, thereby maximizing service-parts margins.
Solutions in Action
Let's examine how companies are making operational improvements through service-parts solutions by looking at the following case examples:
Case Study 1
A leading auto parts and accessories retailer experiencing rapid growth realized that it needed a fact-based analysis to identify, justify, and prioritize improvement opportunities. The first step was an assessment that focused on value across three key areas: growth, efficiency, and capital management. This approach produced a prioritized improvement portfolio, which included "quick hits" that could be realized in the near term. These value propositions were grouped into four areas: inventory management, supply-base management, distribution management, and transportation management. The inventory management initiative involved implementing advanced-planning and distribution-network-optimization solutions as well as an SKU rationalization effort. The supply- base management initiative incorporated strategic sourcing and supplier management and evaluation programs that helped the company rationalize suppliers, reduce costs, and improve supplier collaboration. As part of the distribution management initiative, the company implemented an enhanced warehouse management system. Another initiative involved the implementation of a new transportation management system. These opportunities provided the basis for the retailer to achieve a competitive position across key operating benchmarks. The results to date have been impressive: $56.5 million in freed-up working capital, $1.52 earnings-per-share increase over three years, $106 million in cost reductions over four years, and a collective estimated total savings of $85 million and 409-percent ROI.
Case Study 2
A leading global computer manufacturer wanted to reduce the complexities and costly redundancies in its reverse logistics process while maintaining customer service levels. It also wanted to greatly reduce its 30-day part-disposition cycle time and 90-day backlog of parts. Visibility and event management capabilities were required to enable the manufacturer and its suppliers to react quickly across their service-parts fulfillment network. The solution selected delivered those capabilities, enabling the manufacturer to eliminate an internally run service-parts network of distribution centers and to shift responsibility for executing the supply chain fulfillment process to the suppliers. Customer returns now go directly to suppliers while the manufacturer can track the movement of goods with new software technology at its command center.
Case Study 3
A leading U.S. auto manufacturer knew that higher levels of customer choice and more intense price competition meant no aspect of the customer experience could be neglected. In reviewing its service-parts supply chain, the company set a single goal: to deliver best-in-class performance.
To achieve this goal, the automaker had to reduce inventory levels, improve customer fill rates, and reduce customer back-order lines. These activities, in turn, required that the company improve its current legacy systems to achieve much greater efficiency. The company used distribution resource planning (DRP) tools to improve forecasting and inventory visibility throughout the supply chain. Other tools were used to measure volatility and streamline inventory flows, thus shortening supply chain leadtimes. Customer fill rates improved, open customer back-order lines were reduced, and the overall inventory turnover was cut. These results are expected to drive up customer satisfaction and increase brand loyalty.
Case Study 4
A leader within the luxury car segment had experienced rapid sales growth (68 percent in 2000) that was jeopardizing its delivery efficiency. Success was putting a strain on its information systems. The company needed visibility into its stock and a centralized method of information exchange for locating cars and spare parts as well as for coping with larger volumes. The company established a Dealer Communication System (DCS) Web portal that links to its ERP system (SAP R/3). Dealers can go online to check the parts inventory in the dealer network and factory, look up prices, purchase and configure cars and motorcycles, specify quantities and receive a confirmation, and track order status through the pipeline—from the moment the vehicle is configured until it arrives at the dealership. While parts orders have doubled, they are being handled comfortably by the same number of staff. In addition, inventory is streamlined throughout the supply chain giving dealers full and clear information.
Starting the Transformation
Nearly any company can achieve world-class status in its service-parts business. How quickly this occurs depends on the available budget for the effort and, quite possibly, how long it will take for the early phases of the solution to self-fund the future phases. Another factor is speed: Is there an internal limit to how fast the organization can accommodate change? A transformation is always relative to a starting point. We've developed a practical approach called a "transformation blueprint" that companies can apply to get on the road to a world-class service supply chain.
The transformation blueprint (see Exhibit 2) initially looks at key process change opportunities in five categories: materials flow, materials management, supplier collaboration, service management, and performance metrics. A six- to eight-week analysis and design (A&D) phase follows. This phase involves six activities aimed at producing a fact-based change agenda and generating emotional energy around the initiative. The six key activities are: assess current situation; document opportunities for improvement; assess the impact of current and future technologies; develop an implementation roadmap to validate the business case for change; address rational, political, and emotional change levers; and mobilize for change by involving all levels of the organization. Once the analysis and design steps are completed, the organization is ready to begin implementing its service-improvement initiatives.
The transformation analysis typically indicates that companies need to focus on three key improvement areas: (1) service-parts fulfillment and reverse logistics, (2) supplier measurement and connectivity, and (3) forecasting and inventory deployment. Let's look at each of these in more depth.
Service-Parts Fulfillment and Reverse Logistics
Across all industries, returns range from 3 percent to as high as 50 percent of all shipments. And for brick-and-mortar companies, a return typically is three to four times more expensive than an outbound shipment. In the United States, companies spend $950 billion annually on logistics; of this amount, $43 billion is spent on returns. This means 4.5 percent of all logistics costs are related to returns. Various industry studies put the true cost of returns at 3 to 5 percent of sales.1
We find that many companies struggle with getting the right service part to customers to support service-level agreements (SLAs). They also have trouble with economically returning the "off" part. As customers become more sophisticated and more demanding, the ability to execute services becomes an increasingly important factor for success.
When we look at the relationships between manufacturers, suppliers, contract service providers, and third-party logistics providers, the resounding theme is a lack of coordination and poor information sharing. This leads to very costly problems in managing a complex service-parts logistics network. Some of the challenges include:
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Poor supplier collaboration. Companies need to leverage supplier partner resources effectively to supply parts and services to customers in a way that satisfies the SLAs.
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Lack of visibility. Achieving visibility throughout the distribution network is fundamental to creating an adaptive service-parts supply chain.
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Lack of real-time order status. Without real-time information, it becomes very costly or labor intensive to measure performance against SLAs in hours and days—which is how they should be measured. The net result is often disappointed customers.
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Manual order processing. Manual activities are a costly and labor-intensive component of service-parts management. Leading companies seek to automate wherever they can.
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Lack of visibility into the repair cycle. Parts in the repair process are often the "black hole" of reverse logistics because they are so difficult to track. Another visibility-related problem is scrapped parts that find their way back into the supply chain.
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Redundant inventory. This common problem adds unnecessary cost to the product and erodes margin.
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Labor-intensive repair processes. As parts move through the various steps and locations of the repair process, many people typically are involved.
Companies need a solution that helps them respond effectively to these challenges without sacrificing management visibility and control. Further, the solution must adapt to the ever-changing business environment.
Supplier Measurement and Connectivity
Supplier performance measurement broadly includes measuring, analyzing, and managing supplier performance in order to reduce costs, mitigate risk, and drive continuous improvement.
Why is measuring supplier performance so crucial in today's supply chain environment? According to a recent cross-industry Supplier Performance Measurement Benchmarking Report, produced by the Aberdeen Group, having a formal performance-measurement program increases a company's performance by 26.6 percent, on average. The study indicated that most of these improvements manifested themselves in direct, hard-dollar savings to the enterprise.
The benchmarking study also found that enterprises that share performance data with suppliers generate a 60-percent greater improvement in supplier-performance than enterprises that only use this information internally. A primary reason for this superior performance was that the buyer and its suppliers used the data to identify improvement opportunities.
The study also found that enterprises that leverage automation tools to support supplier performance initiatives achieve a 57-percent greater improvement in supplier performance than companies that did not automate. Clearly, automation as an enabler stands out as a key driver for obtaining value from supplier performance measurement.
What's the bottom line here? Measuring supplier performance can provide the competitive advantage in managing an extended service-parts logistics supply network. Accordingly, any solution selected should facilitate measurement while enabling the coordination and integration required to overcome the many challenges of a complex service supply chain.
Forecasting and Inventory Management
Across all industries, many companies struggle with the processes of accurately forecasting returns and bringing returned parts back into the inventory network all the way through to repair and refurbishing. Accurate forecasting and effective inventory deployment can exert a powerful influence in this area. These benefits, which are not always easy to measure, can be hard or soft. Some of the hard benefits include:
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Reduced inventory. Inventory can be reduced from several standpoints, including finished goods, service parts, and raw materials. Notably, with every 2-percent increase in forecast accuracy, there is a corresponding 1-percent decrease in inventory.
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Reduced repair expense. With good forecasting and inventory management, the repair loop can be optimized by reducing new part procurement and avoiding repair expenses on parts that have no future demand
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Better customer service. Increasing the customer-service level has multiple impacts—among them are higher customer satisfaction, more repeat business, and greater customer loyalty. In addition, improvements like first-time correct order/shipment and accurate customer shipments will reduce costs.
Making it Happen
Think of the service supply chain transformation as something that evolves over time. Companies need to move from the current "operative" state—with high inventory, high customer-service levels, and low priority on forecasting and planning—to the "internally collaborative" state of good forecasting and planning, managed inventory, and improved customer-service levels. The ultimate goal is to reach the "fully collaborative" state of low inventories, efficient planning, and high customer-service levels.
Companies that can make this transformation will reap considerable rewards—from a reduction in inventory to lower transportation costs to higher revenues. And with the competitive landscape getting tougher by the day, customer relationships need to become a critical focal point. Service parts provide a strategic differentiator for manufacturers that view the initial sale as simply a first step in the customer lifecycle. Revenue from a lifetime of service often far surpasses the initial sale price.
To get started managing this important part of your business, it's important to get an overall picture of your service-parts supply chain—identifying areas that need improving and gaps that need filling. Next you'll need to invest in appropriate solutions that provide:
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Integrated order fulfillment.
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Sophisticated planning and forecasting tools.
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Increased visibility of inventory.
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Real-time order status.
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Collaboration with trading partners.
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Optimization of your investment in parts inventory across the multiple echelons in the extended supply chain.
Importantly, these solutions should be phased in, allowing for the gradual changes that lead to the fully collaborative state without jeopardizing customer-service levels along the way.
If you start the transformation process now, by this time next year you will be well on your way to capturing the full potential of your service-parts supply chain.
| Footnotes |
| 1Norek, Christopher D. "Returns Management: Making Order Out of Chaos," Supply Chain Management Review, May/June 2002, pp. 34–42. |
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