As I indicated in my previous post, the basic finance formula for determining the value of an investment is to assess the amount and the risk of future income streams. Of course, predicting the future is tricky business, so it is best to rely on historical trends as a proxy for future performance, along with a healthy dose of common sense. With that in mind, I have developed a simple, easy to remember mantra for service contractors to keep in mind as they consider strategic initiatives to increase the value of the business:
How many? How much? How long?
These three questions underpin the basic value-building fundamentals for almost any business.
“How many?” refers to how many customers the business services under a contract. It can also be how many locations or customer assets are under contract. Likely all three need to be measured. Any business that is overly reliant on a small number of customers, even if they are large customers, has higher risks associated with their future income streams. A single screw up or a change in management at the customer can put the entire company at risk. It is better to have many customers with many locations so that the risk and volatility of the revenue portfolio are lower.
At the end of every quarter and every year, you should measure how many customers or locations were serviced that quarter compared to the same period in the prior year. Do you have more customers and locations under contract now? How many customers that were serviced last year declined service or canceled their contract this year? How many new customers were added under contract and serviced this year? As a percentage, what type of growth does this represent? How much did you spend on sales and marketing to add those new customers (sometimes this is difficult to measure precisely because marketing spending tends to come well ahead of actual customer wins, sometimes by several quarters or even years)?
Here is my favorite chart for plotting the progress of the business in maximizing the how many? metric.
It shows the number of customers/locations serviced in the quarter, the number that declined service or canceled, and the number of new customers added. The customer locations lost and the newly added locations are plotted on the second axis because these may be small in a large, mature business with lots of customer locations under contract from years of servicing the market. Ideally, everything but locations lost is going up and to the right. The number of new customers/locations added should also exceed by a good margin the number that canceled. Otherwise, the “churn” in the customer base will eventually decimate your business if it continues over too many quarters.
“How much?” refers to the amount of revenue you can collect from a given customer or location. The higher the number the better, of course. There are generally two ways to drive this metric higher: 1) raise prices to charge more for what you do, and 2) do more for the customer. Investors love companies with pricing power in their markets. Companies that can raise prices without losing customers to the competition are valuable to shareholders. Customers love companies that can do more for them because their overhead associated with vendor administration is lower. It is also more difficult to replace a vendor that is doing many things, so your services are likely to be more durable in the face of a hiccup or challenging customer service situation.
Every quarter, you should measure the amount of revenue you earned from each customer and each group of customers relative to the amount of revenue you earned in the prior year period. Were you able to raise prices? Did customers respond to your solicitations for larger amounts of their business? Did they buy new innovations or suggested upgrades that you recommended?
I suggest that you break your customers up into groups or “cohorts” indicating what year they initiated the service relationship with your company. You can plot a view of how much money you are getting each year from customers that have been with your company for one year, two years, three years, four years, and so forth and so on. Ideally, you are growing within each cohort group for the first few years and then holding onto most of that business during subsequent years. Some churn after a number of years is understandable as companies go out of business, merge and change strategies, or experience other corporate disruptions that ultimately affect their relationship with you. However, if you can show strong growth from sales to existing customers along with staying power within accounts as a business pattern, a new investor will pay you a premium for that trend.
Here is a chart that shows how revenue breaks down by customer cohorts grouped into the year you landed the service contract with the customer.
Notice how the recent cohorts start smaller, grow over time, and then hit a steady state before a slow decline.
You should also measure how much? as a function of the type of revenue you are recognizing. I would suggest three different categories – contract maintenance or program subscription fees, planned repairs and upfits associated with quoted work, and unplanned repairs such as emergency service calls. You want to demonstrate a pattern over time of an ever increasing portion of your revenue coming from contract fees and planned work as compared with emergency service calls, which are typically associated with customer equipment malfunctions.
Planned work is more efficient and more scalable because the logistics can be meticulously coordinated. Customers benefit and your business benefits when you can plan the work to avoid excess travel time, expedited parts shipping, overtime expenses, and the general administrative stress associated with delivering service “right now.” Ideally, you can get the customers assets “under control” and minimize the service calls by quoting planned repairs to replace the risky equipment assets with more robust ones that are less prone to failure.
Here are a couple of graphic illustrations that demonstrate why you want to pursue a strategy that ultimately transitions your revenue mix from unplanned, service call work to programmatic contract work and quoted work.
The oscillating, sine-wave-shaped pattern represents demand associated with random equipment breakdowns when no programmatic approach is in effect across the customer base. If you scale up your technician workforce to deliver great service in the face of random peaks in demand, you will be losing lots of money as you keep that workforce in place during the random slack periods.
If you scale back your technician workforce to avoid the plunge in profits when demand tapers, you are at risk of delivering poor customer service during the peak periods.
The ideal situation is to get the customer demand curve “under control” on a customer by customer basis by putting them into a contract that incents both you and them to programmatically eliminate the risks that ultimately drive equipment failure.
In this case, customers pay more for your maintenance program and monitoring fees, and in return, they have less risk of failure and fewer unplanned expenses. If you do a good job demonstrating to them the story of their equipment via video and photo evidence, they will not have a problem with the program fees, and they will generally accept your advice regarding repairs, retrofits, and upgrades that further eliminate risks, disruptions, and unplanned expenses. The ideal situation, as always, is that you are getting “money for nothing” while the customer sees daily evidence through your digital wrap that they are indeed paying for “something” very valuable.
In addition to measuring how many? and how much? on a periodic basis, you also need to measure how long? which refers to the duration of your relationship with a customer. If you can create a really sticky digital wrap that reinforces the story of your brand throughout the service cycle, you should, in theory, be able to hold onto those customers forever. Ideally, you are actively working your pricing model to manage your portfolio of customers by raising prices on those customers that do not fit with your model and in other cases perhaps trimming prices or offering other value-added services at a discount with those customers that are your prized possessions. In fact, once you become comfortable in your marketing and sales strategy and the cost of attracting new customers that fit the model, you will probably begin actively firing customers that do not fit by not renewing their contracts or simply directing them to your competitors when they call for service.
Investors love sticky brands with repeat customers that pay up year after year on a subscription basis to continue receiving the terrific results from the relationship. However, investors are just like customers in that they generally do not want to pay for nothing. In this case, nothing refers to sales pitch platitudes that ultimately add up to “Trust me! It’s gonna be great! Just sign the check so I can cash it!” You have to provide the evidence that your “money for nothing” program really yields higher returns in the form of a predictable income stream. Show them the charts that you use to measure the business value you are generating. I bet they are impressed, and you might be surprised at just how much “money for nothing” you get if you ever decide to sell shares in your company.
The bar graphs in this post were created from data in ServiceTrade with Amazon QuickSight. Learn more about how you can use this Business Analytics tool to uncover insights in your own service data.