Industrial Aftermarket Services Growing The Core Final
Industrial aftermarketservices: Growingthe coreAdvanced Electronics July 2017Aditya AmbadipudiAlexander BrotschiMarkus ForsgrenFlorent KervazoHugues LavandierJames Xing
Industrial aftermarket services:Growing the coreOEMs may find untapped goldmines in aftermarket services bystrengthening their core business in parts, repair, and maintenance.In many industrial sectors, original-equipmentmanufacturers (OEMs) face a challenging anduncertain future. In recent years, input priceshave fallen and growth in emerging marketshas slowed, decreasing new-equipment sales inindustries ranging from oil and gas to agricultureto commercial aerospace. In response, CEOs atindustrial OEMs are increasing their focus onaftermarket services—the provision of parts,repair, maintenance, and digital services for theequipment they sold. The appeal of this strategy issimple: services provide stable revenue—and oftenhigher margins—than sales of new equipment. OneMcKinsey analysis across 30 industries showed thataverage earnings-before-interest-and-taxes (EBIT)margin for aftermarket services was 25 percent,compared to 10 percent for new equipment.When exploring aftermarket value pools, industrialOEMs are often tempted to prioritize data-drivenadvanced services enabled by digital innovationand the Internet of Things (IoT). For instance,many hope to gain a competitive edge throughe-commerce platforms and increased automation—digital strategies that are already common at B2Ccompanies but less developed in B2B. OEMs mayfeel more pressure to develop digital capabilitiesthan most B2B players because digital nativeshave recently entered the industrial aftermarket,offering parts and services at low prices.Despite the rise of digital initiatives, coreaftermarket services—the provision of parts, repair,and maintenance—are also critical to success.Under these circumstances, it can be difficult forOEMs to identify the best opportunities.2To gain clarity and remain competitive, theymust undertake a more detailed examination ofaftermarket lifetime value—the total revenue theyreceive from servicing their installed base. Thismeasure, which is typically calculated for eachproduct line, provides a more comprehensive viewof aftermarket value than commonly used metrics,such as service revenue captured per customer.Companies that examine aftermarket lifetimevalue closely may find that certain services,including core offerings, contribute more to thebottom line than expected. For instance, one OEMclosely examined aftermarket lifetime value andrealized that 90 percent of its near-term growthwould come from core services, even though initialestimates suggested that digital solutions would bethe main driver.Other OEMs that analyzed aftermarket lifetimevalue have identified specific weaknesses in theirstrategy, such as a low number of long-term servicecontracts, and launched improvement efforts.They have also been able to benchmark theirperformance against competitors and companiesin other industries more accurately—an exercisethat often prompts them to reassess theiraftermarket strategy.To help OEMs develop a strategy that suits theirneeds, this article discusses aftermarket lifetimevalue in detail. First, we examine the threefactors that can influence value: product lifetime,lifetime penetration, and average-annual servicesrevenue. We then discuss how companies can useaftermarket lifetime value to benchmark their
performance against their industry peers. Finally,we look at strategies for increasing aftermarketlifetime value that can help boost the core business.What is aftermarket lifetime value?Industrial OEMs are often in the best position tocapture aftermarket value, since they understandtheir products better than third-party providers,have partnerships within their channels, and cancollect proprietary data about their equipmentfrom their large installed base. In many cases,however, OEMs lose ground to third-party partsmanufacturers or independent service providers,who offer less expensive or used parts for agingequipment. In this competitive market, OEMsmust identify potential areas for improvement bybreaking aftermarket lifetime value into threeelements and analyzing their performance oneach one: Product lifetime refers to the period duringwhich equipment is in use, which may be longeror shorter than the manufacturer specified. Forinstance, OEMs design gas turbines to last 30years, but some customers have used them forup to 50 years, even though their performancemay be suboptimal after the intended lifespan. Lifetime penetration refers to the percent ofan OEM’s installed base that it serves duringa product’s lifetime. Two factors determinelifetime penetration. The first is the attachrate—the percent of new equipment soldwith warranty or with service contracts (forinstance, a parts-supply contract or a repairand maintenance contract). Overall, the attachrate reflects how well an OEM is marketingits service capabilities at the beginningof a product’s lifetime. The second factorinfluencing lifetime penetration is share oflifetime, which is the percent of a product’slifetime in which an OEM is the primary serviceprovider. In many cases, industrial OEMslose aftermarket business after a product’swarranties and initial contracts expire.However, the most successful OEMs havefound ways to extend their business beyond aproduct’s first 10 to 15 years. For instance, somesell tailored, low-price contracts covering longterm maintenance. Average annual services revenue is theamount an OEM receives each year for eachunit of equipment under service contract. It isexpressed as percentage, making it possibleto compare products with different sellingprices. For instance, an OEM could sell amachine for 1 million and generate 100,000in aftermarket revenues for each year undercontract. In this case, the average annualservices revenue would be 10 percent.Aftermarket lifetime value is expressed as apercentage of a product’s initial sales price. Forexample, a civilian helicopter has a lifetime ofabout 20 years. If the helicopter OEM receivedservice revenues equal to half the product’soriginal sales value over that period, theaftermarket lifetime value would be 50 percent.Since aftermarket lifetime value does not provideinsight into profitability, OEMs must continue toexamine the EBIT of aftermarket services to obtaina comprehensive view of their finances. Moreover,aftermarket lifetime value is undiscounted (forsimplicity) and does not consider the “time value”of money.As noted earlier, several companies have alreadytaken a detailed look at aftermarket lifetime valueand used their insights to improve performance—often by enhancing core-service offerings. Onepower-equipment manufacturer achieved a20 percent increase in aftermarket revenue and30 percent growth in long-term contract penetration3
aftermarket lifetime value may provide additionalinsights that are not available with more traditionalmetrics. For instance, companies can benchmarkthemselves against players in other industries,even those where typical revenues and productlifetimes are very different, since aftermarketlifetime value is expressed as a percentage of aproduct’s initial sales price. When we analyzedaftermarket lifetime value in more than 40 Fortune500 companies, ranging from wind-turbineproviders to heavy-duty truck manufacturers,we found striking variations in the results. Insome industries, the aftermarket lifetime valueby creating bundled offerings and developing newservices. An industrial-machinery player improvedits EBIT margin by 2 percentage points in oneyear by re-pricing 100,000 spare-parts SKUs. At aglobal mining and construction-equipment player,a refined go-to-market strategy led to 20 percentannual EBIT growth in their services business.Benchmarking aftermarket performanceCDP benchmarking2017Whenaftermarket anies typically examine commonfinancialExhibit1of3metrics, including profitability and revenue.However, benchmark comparisons that rely onExhibit 1Elements of aftermarket lifetime value may vary by industry.Selected examplesAftermarketlifetime value,2% of sales priceGas turbines75Helicopters53Electric drives35Wind turbines34Aftermarketlifetime 7810 10–1570–802016Averageannual servicerevenues,3% of sales price4–629–77321830Heavy trucksPassenger cars20–5043Data storage1Lifetimepenetration,% of lifetime attachedProductlifetime,years42 Lifetimepenetration4–103 Average annualservice revenues1 Mainly reflects spare parts.2 Average value.3 Lifetime penetration is a function of attach rate and share of lifetime under OEM service. Typically most intra-industryvariation is in lifetime penetration.Source: McKinsey Aftermarket Lifetime Value Benchmarking database4
of the aftermarket was almost equal to the priceof the initial product; in other industries, playersstruggled to capture any aftermarket revenue. Thehighest industry aftermarket lifetime value wasfive times that of the lowest. The differences withinindustries were equally significant, with the bestperformers capturing three times the aftermarketlifetime value as the lowest performers. Thesefindings suggest that many companies couldlearn from their peers or from the leaders in otherindustries that may be taking more innovative oraggressive approaches to aftermarket.A caveat: Industry-specific constraintsWhile all OEMs have opportunities to improve, ouranalysis of 40 companies also showed that certainindustry-specific constraints influence theirproducts’ aftermarket lifetime value. Considertwo different sectors: heavy-duty trucks andgas turbines (Exhibit 1). In both industries, theequipment has high utilization, sometimes undertough operating conditions, requiring regularinspection, maintenance, and repair. But the30 percent aftermarket lifetime value associatedwith heavy-duty trucks is much lower than the75 percent for power-generation equipment forseveral reasons. First, the impact on lost revenueof a broken gas turbine is generally much higherthan that of a broken truck. Power companies arethus more likely to pay a premium to guaranteeprompt service and constant uptime. Second, truckparts are more readily available than power-gridcomponents, and competition from third-partyproviders is higher, driving aftermarket pricesdown. Finally, the lifetime of a gas turbine is twoto five times that of heavy-duty trucks. Companiesthat keep such differences in mind will not beconfounded if their aftermarket lifetime value ismuch higher or lower than that of businesses inother industries.How can OEMs expand aftermarket lifetime value?While OEMs cannot eliminate industry-specificconstraints in the aftermarket, they can take stepsto increase lifetime penetration, annual servicesrevenue, and product lifetime.1 The first stepinvolves creating a comprehensive digital tool thatmodels the installed base and analyzes individualpieces of equipment. One aircraft-equipment OEMdesigned such a tool to estimate aftermarket lifetimevalue for individual planes. After determiningproduct lifetime, lifetime penetration, and averageannual services revenue for individual elements ofthe installed base, OEMs can calculate aftermarketlifetime value and apply various improvementlevers—there are usually about 40 to 60 possibilities,depending on the industry. Most of these leversfocus on improving the core aftermarket business(Exhibit 2). For instance, OEMs could try to increaseproduct lifetime by re-marketing used equipment,re-pricing spare parts more dynamically, oroffering to overhaul and modernize a customer’sexisting equipment through hardware or softwareupgrades. OEMs must often implement multipleimprovement levers simultaneously because theyare interdependent. Some levers, such as thoserelated to modernizing systems, may induce extracosts and reduce EBIT.Typically, companies achieve the greatest impactfrom boosting lifetime penetration, especially ifthey can increase the number of contracts relatedto servicing aging equipment—an important sourceof revenue and one that is often overlooked. In ourexperience, OEMs that have applied appropriatelevers have doubled their aftermarket lifetimevalue within three to five years, despite intensecompetition from third-party parts manufacturersand independent service providers. They alsoincreased EBIT.Given the number of possible levers that OEMscan apply to aftermarket lifetime value, it wouldbe impractical to describe them all in detail. Toappreciate the variety of strategies available,consider the following three examples, which focus5
CDP 2017Priorities for a container shipping CEOExhibit 2 of 3Exhibit 2Companies can apply many levers to improve the elements ofaftermarket lifetime value.Maximum improvement observedTypical improvementElements of aftermarket lifetime valueSTARTCurrentaftermarketlifetimevalueLifetime penetrationShare oflifetime underOEM serviceENDAverage annualservice fetime value10 to 5–1 to 322–37AttachrateEBIT impact,2 percentage points220 to 21 to 5STARTENDObserved improvement of aftermarket lifetime value across industries,59% of product-sales price514416234510925Examplelevers5 Addresslate-cycleequipment Upgradetechnologycontinuously Control saleschannels Bundle servicecontractcoverage Maximize valuefrom partspricing Expand intonew serviceofferings Offeroverhaulandmodernization Re-marketusedequipment Optimizefield forcenetwork Outsource/partnership1 In the number ranges shown for improvement in aftermarket lifetime value, the lowest number represents typical improvement,expressed in percentage points. The highest number represents the most improvement observed with each lever.2 The change in earnings before interest and taxes (EBIT) is the average achieved when companies apply various improvement leversto the elements of aftermarket lifetime value.Source: McKinsey Aftermarket Lifetime Value Benchmarking database6
revealed that those that used distributors or a mixof channels had attach rates ranging from about30 to 50 percent, compared to 70 to 100 percentfor those that worked directly with customers(Exhibit 3). (The ranges are so large because ofvariations among industries.) Similarly, share oflifetime ranged from about 40 to 75 percent forthose who used distributors or a mix of channels,compared to about 50 to 80 percent for the directchannel. Overall, lifetime penetration was 1.5 to2.0 times higher for companies that sold directly tocustomers or used franchise channels, compared tothose that used distributors.on sales channels, customer segmentation, andspare-parts pricing.Gaining more control over after-sales channelsTo increase lifetime penetration, OEMs need tore-evaluate their current sales strategy, whichoften involves working with distributors. Witha direct route, OEMs can track who owns theequipment, how they use it, and translate thatCDP 2017into the right service offerings. This benefits bothPriorities for a container shipping CEOattach rate and lifetime share, the two elementsExhibit 3 of 3of lifetime penetration. For instance, our analysisof more than 40 OEMs across ten industriesExhibit 3Strong channel control significantly increases attach rate andshare of lifetime.Attach rate per dominant sales channel,1% of equipment sold (range)Share of lifetime under OEM service perdominant sales channel,1 % of productlifetime distributors ormix of channelsDirectFranchiseIndependentdistributors ormix of channels1 The analysis included 10 industries.Source: McKinsey Aftermarket Lifetime Value Benchmarking database7
In some markets, such as those where OEMs aretrying to reach numerous residential customers,distributors may be the only feasible sales-channeloption. But this does not mean OEMs should givethem complete freedom. Instead, they shouldset stringent rules that allow them to keep somecontrol of their customer base.Segmenting customers by need and securingtheir business with tailored contractsBy segmenting customers and creating tailoredcontracts for parts or maintenance, OEMs caneffectively increase lifetime penetration forthe entire installed base at each company thatthey serve. For example, customers with olderequipment are more cost sensitive than those withnew equipment, since repairs or parts may equalor exceed the value of a machine. To increase theshare of lifetime at such customers, OEMs couldoffer refurbished parts or even provide a buy-backguarantee for spare parts.As another example, consider how aircraft-engineand aircraft-equipment manufacturers canmaximize lifetime penetration by offering longterm service contracts that guarantee engineuptime—a critical consideration for airlines. Togenerate customer interest in such contracts,manufacturers need to make tailored offerings.For instance, one large aircraft-equipmentprovider segmented its customers based onthe age of their equipment and also consideredother unique needs, such as the predictability ofmaintenance costs or the need to have aircraftavailable at all times. For customers with olderaircraft operating short routes, it drafted contractsthat offered low prices but also specified that theOEM would assume minimal risk. These strategieshelped the aircraft-equipment provider increaseits long-term service-contract penetration ratefrom about 15 to over 50 percent over five years.8In addition to maximizing lifetime penetration,the company also improved its cross-selling orupselling efforts, since it now had deeper insightsabout client needs.Optimizing parts pricingAt most OEMs, parts sales typically providegross margins of over 30 percent, comparedwith an average of 10 percent for maintenanceservices—and that means they often make themost substantial contribution to average annualservices revenues. In consequence, many OEMsoffer maintenance services at no profit to increasepart sales. But these OEMs hesitate to ask for priceincreases for parts, since margins are alreadyhigh and they fear that their customers will object.Some OEMs also struggle to set the right price forSKUs that are not sold frequently, since it is moredifficult to estimate what customers are willingto pay for them. The benchmark analysis acrossten industries showed that OEMs can typicallyimprove EBIT margins by 3 to 10 percent byincreasing prices, even when they are already high.They may score particularly high gains if they usea data-based approach to pricing their numerouslong-tail products—parts for aged equipment, forwhich demand is low but constant.The first step OEMs must take to transformtheir aftermarket business is to understand theelements of aftermarket lifetime value and createa tool to measure them. But that is just one part ofa successful aftermarket transformation. At theorganizational level, OEMs must also establishand measure key performance indicators foraftermarket sales, such as the attach rate for aparticular product, and increase back-officesupport. Finally, companies must focus onexecution, since even the best strategies may falter
without a careful plan to implement changes,monitor impact, and achieve high growth. Together,these tactics will turn aftermarket services into amajor source of value.1Product lifetime is generally more difficult to improve thanlifetime penetration or annual services revenue.Aditya Ambadipudi is a senior knowledge analyst inMcKinsey’s North American Knowledge Center, whereAlexander Brotschi is a knowledge specialist andJames Xing is a senior research analyst. MarkusForsgren is a partner in McKinsey’s Stockholm office;Florent Kervazo and Hugues Lavandier are partnersin the New York office.
Contact for distribution: Kat KlasnicPhone: 1 203 977 6771Email: Kat Klasnic@McKinsey.comJuly 2017Designed by Global Editorial ServicesCopyright McKinsey & Company
Elements of aftermarket lifetime value may vary by industry. 1 Mainly reflects spare parts. 2 Average value. 3 Lifetime penetration is a function of attach rate and share of lifetime under OEM service. Typically most intra-industry variation is in lifetime penetration. Source: McKinsey Aftermarket ifetime alue Benchmarking database 20-50 18 .
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