The expense of supporting a product in the field can easily bankrupt unprepared companies. Every sale carries with it the liabilities of breakdowns, returns, parts inventories, legal action, call centers, training, etc, liabilities which lag - often by more than a financial year - the actual sale. Holding back a percentage of each sale to pay for those past sins is a sensible business practice, otherwise you'll find yourself scrambling to cover old debts with current money, kind of like today's big banks.
Financial reserves are funds held back from profits to cover future costs, like putting a little money in the bank for when your car breaks down. How much to take? That's the fine science: Too little reserve and you'll run out. You'll have to rob today's Peter to pay yesterday's Paul. Too big a reserve and you're cheating yourself out of profits you could have taken to the bottom line already. It's a fine line to walk. In the cell phone business, reserves typically run between 2 - 4% of OEM price, but those are products with a very short lifespan, typically twelve months under warranty and about three years total life. Infrastructure products are a different story entirely, with much longer lives, sometimes decades, and with far more complex support issues.
In principle, reserves taken at the time of sale should exactly match the cost a product is likely to incur over its lifetime. How do you know? Mature companies with extensive product history can usually guess right. Start-ups typically don't. If a product is new, but uses established technology, then experienced post-sale managers can make educated guesses based on history in the same sector. If the product is truly ground breaking, with no comparative history, then it falls to managers to meticulously track field failure rates, call-center activity and returns during prototype and roll-out phases, then QUICKLY adjust reserves to compensate. Obviously, extremes in product volume can be problematic on both sides of the equation: Too little volume = not enough history. Too large a volume = too late to fix mistakes.
Shipment volume contributes to problems in other ways, too: For example, rapidly increasing volume makes is easier to cover past reserve mistakes because the impact on current margin is less on a per-unit basis. However, a formula for disaster rears its ugly head when volume declines, particularly near end-of-life. Last year's unforeseen costs wipe out this year's profits when not that many units are now going out the door. What's worse? Managers who try to cover problems on products no longer made by 'borrowing' margin from today. That should never happen. Profit and Loss accounting should always be rigorously applied at the product level.
Disciplines borrowed from quality systems, like continuous improvement methods, keep post-sale liabilities in check. Simple feedback systems are a starting point. It's important to regularly push the top five field service problems back into the executive suite, communicating constantly to build organizational consensus. When the senior leadership agrees there's a problem, engineering and production will take action, particularly if individuals are tasked with corrective action and penalized accordingly. I know of one company that set a fixed warranty reserve of 5%, then doled out whatever was left over as a holiday bonus. Smart. . .
A big problem results when aggressive managers exploit a gap in financial oversight that lets them distort P&Ls by taking reserves to the bottom line too soon, in effect stealing from the bank of the future to paint a prettier picture today. Proper financial controls mean that NO manager should ever be permitted to tamper with reserves without sign-off from the reserve manager and CFO.
In a perfect world, every product would carry some kind of post-sale revenue activity to cover its post-sale costs. If fact, non-device revenue from extended warranty, software support, accessories, downloads, etc, does exactly that. A good target for non-device post-sale revenue is 30%, which nicely covers liabilities with plenty left over. A great idea is to bundle non-device sales across multiple products in order to leverage a greater opportunity. Best Buy's Geek Squad is an example of selling total coverage, peace of mind on entire sites, not just individual products.
Okay, so now your customers have signed up. What's next? In principle, at this point it's worthwhile to feed reserves and post-sale sold services into a new P&L devoted, not to a specific product, but to post-sale as a product itself, as a separate business. This is an especially good idea because it also insulates customer service from the tendency, as a cost center, to get chopped whenever money is short. When the whole customer experience is operated like a separate business, when it's isolated from specific products, its independent value becomes more visible too, adding to the total portfolio.
I cannot tell you how many times I've heard the complaint, always internally, that asking customers to buy sold services detracts from device sales. That is simply not true. People inherently value what they pay for. Also, getting sold services into its own P&L, and profitable, funds continuous improvement. Here's the truth; a good portfolio of post-sale, non-device offerings often provides cover for a deficient product. Even when the product itself is mediocre, as long as the aggregate customer experience is still positive, the 'Willingness to Recommend' metric, the most important customer metric of all, stays in positive space. Optimizing post-sale financial reserves and building a portfolio of sold services is a great way to extend product margins in commodity markets, to differentiate your company from competitors. Leading your customers to constantly interact with you is one of the best ways to build brand loyalty and the bottom dollar. - 15478
Financial reserves are funds held back from profits to cover future costs, like putting a little money in the bank for when your car breaks down. How much to take? That's the fine science: Too little reserve and you'll run out. You'll have to rob today's Peter to pay yesterday's Paul. Too big a reserve and you're cheating yourself out of profits you could have taken to the bottom line already. It's a fine line to walk. In the cell phone business, reserves typically run between 2 - 4% of OEM price, but those are products with a very short lifespan, typically twelve months under warranty and about three years total life. Infrastructure products are a different story entirely, with much longer lives, sometimes decades, and with far more complex support issues.
In principle, reserves taken at the time of sale should exactly match the cost a product is likely to incur over its lifetime. How do you know? Mature companies with extensive product history can usually guess right. Start-ups typically don't. If a product is new, but uses established technology, then experienced post-sale managers can make educated guesses based on history in the same sector. If the product is truly ground breaking, with no comparative history, then it falls to managers to meticulously track field failure rates, call-center activity and returns during prototype and roll-out phases, then QUICKLY adjust reserves to compensate. Obviously, extremes in product volume can be problematic on both sides of the equation: Too little volume = not enough history. Too large a volume = too late to fix mistakes.
Shipment volume contributes to problems in other ways, too: For example, rapidly increasing volume makes is easier to cover past reserve mistakes because the impact on current margin is less on a per-unit basis. However, a formula for disaster rears its ugly head when volume declines, particularly near end-of-life. Last year's unforeseen costs wipe out this year's profits when not that many units are now going out the door. What's worse? Managers who try to cover problems on products no longer made by 'borrowing' margin from today. That should never happen. Profit and Loss accounting should always be rigorously applied at the product level.
Disciplines borrowed from quality systems, like continuous improvement methods, keep post-sale liabilities in check. Simple feedback systems are a starting point. It's important to regularly push the top five field service problems back into the executive suite, communicating constantly to build organizational consensus. When the senior leadership agrees there's a problem, engineering and production will take action, particularly if individuals are tasked with corrective action and penalized accordingly. I know of one company that set a fixed warranty reserve of 5%, then doled out whatever was left over as a holiday bonus. Smart. . .
A big problem results when aggressive managers exploit a gap in financial oversight that lets them distort P&Ls by taking reserves to the bottom line too soon, in effect stealing from the bank of the future to paint a prettier picture today. Proper financial controls mean that NO manager should ever be permitted to tamper with reserves without sign-off from the reserve manager and CFO.
In a perfect world, every product would carry some kind of post-sale revenue activity to cover its post-sale costs. If fact, non-device revenue from extended warranty, software support, accessories, downloads, etc, does exactly that. A good target for non-device post-sale revenue is 30%, which nicely covers liabilities with plenty left over. A great idea is to bundle non-device sales across multiple products in order to leverage a greater opportunity. Best Buy's Geek Squad is an example of selling total coverage, peace of mind on entire sites, not just individual products.
Okay, so now your customers have signed up. What's next? In principle, at this point it's worthwhile to feed reserves and post-sale sold services into a new P&L devoted, not to a specific product, but to post-sale as a product itself, as a separate business. This is an especially good idea because it also insulates customer service from the tendency, as a cost center, to get chopped whenever money is short. When the whole customer experience is operated like a separate business, when it's isolated from specific products, its independent value becomes more visible too, adding to the total portfolio.
I cannot tell you how many times I've heard the complaint, always internally, that asking customers to buy sold services detracts from device sales. That is simply not true. People inherently value what they pay for. Also, getting sold services into its own P&L, and profitable, funds continuous improvement. Here's the truth; a good portfolio of post-sale, non-device offerings often provides cover for a deficient product. Even when the product itself is mediocre, as long as the aggregate customer experience is still positive, the 'Willingness to Recommend' metric, the most important customer metric of all, stays in positive space. Optimizing post-sale financial reserves and building a portfolio of sold services is a great way to extend product margins in commodity markets, to differentiate your company from competitors. Leading your customers to constantly interact with you is one of the best ways to build brand loyalty and the bottom dollar. - 15478
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