In our industry, the most-important area for the profitability and survival of the company stems from the recurring revenue in the service department. When considering the trends in our industry for the future, this topic deserves serious attention.—dealers that fail to secure the revenue stream properly are most at risk for failure.
What Does it Mean
When we are talking about securing the revenue stream, we are talking about creating a binding support agreement for the duration of the equipment lease. I know some dealers do not like to build the service into the lease, but failing to do so diminishes the value of the dealership and does not provide any future security for the company.
I am not suggesting pre-funding the service component of the lease, and most leasing companies no longer offer that as an option. When valuing your dealership, a pre-funded service contract is viewed as a liability rather than as an asset.
When you build your service contract into the lease, that recurring revenue positively impacts the value of your business to a bank or a prospective purchaser. Tying the service contract to the lease means that you can show the full value of the contract as future revenue. With a standard service agreement, you can only show the value of the time remaining until contract renewal.
The chart below shows the impact the two methods have on the potential value of the company. In this example, we’re going to assume that the equipment under contract is spread out evenly over a five-year lease. For the sake of easy math, we are going base the numbers on 6,000 machines with placements over the five-year period. We are also going to use $200 per month as the service revenue.
For annual renewals, we would have 6,000 machines with one month, 5,500 machines with two months, 5,000 machines with three months, etc. left on the contract. Based on the $200 per machine per month, the total contracted revenue would be $7,800,000 in future revenue.
For the same client base of 6,000 machines, with the contract built into the lease, the value of future revenue would be $36,600,000. We compute the value by replacing 100 machines per month for 60 months, so basing the current month on 6,000 machines, the following month 5,900 machines and so on through the 60th month only having 100 machines. The data is in the chart below.
Controlling the Customer
In addition to the valuation benefit, you also gain control over the client. Building the service contract into the lease makes the client liable for the entire contract, whether they keep the equipment or not. This process allows dealers to reduce the frequency of client upgrades and frees up the sales team to spend more time on growing the business rather than trying to upgrade equipment every 24 months.
If another vendor tries to upgrade your account, they would have to include the remaining service in the cost of the upgrade. Using the same assumptions as the previous example, if a competitor wanted to upgrade the client at 30 months into the lease, they would have to include an extra 6,000 dollars in cost to cover the remaining service. In most cases, this would make the transaction too expensive for the client, and your base remains secure.
The leasing company normally has a clause that allows the dealer to waive the remaining service. This allows the dealer to upgrade equipment as desired with a strong competitive advantage over other vendors. Extending the replacement cycle will typically also increase the service department profitability, since the department benefits from the escalation clause in the contract.
Too often dealers will write contracts with no escalation clauses. Lack of contract escalation is dangerous since a dealer’s costs will always go up during the lifespan of the contract. If the contract was originally mildly profitable, by the end of a five-year agreement, the dealer is most likely losing money on every page produced.
If the contract allows for an escalation, the dealer can always decide to reduce or even eliminate the escalation if the situation warrants. If there is not an escalation clause in the contract, then the dealer may be stuck with a contract that is losing ever larger amounts.
As an example of the benefit of proper contract escalation, look at the chart below. This analysis is based on a monochrome rate of .004 and on a single machine making 60K per month.
Over the course of the contract, there is a 30% difference in the revenue—over $4,300 on a single machine. If you have 1,000 units in the field like that, it is more than 4.3 million dollars. Can you afford to give up that much profit?
You will notice in the example I provided, the percentage of escalation changed the last two years. Increasing the escalation rate gives the sales rep the ability to discount the service when upgrading the equipment, while still maintaining acceptable service rates for the service department.
How to Secure it
One effective way to accomplish this is to quote a single payment that includes the equipment cost and the service cost for the estimated usage, and then an overage for copies more than the monthly allowance. Quoting a single rate also has the advantage of hiding the exact allocation of revenue from the competition.
Some dealers quote using a fairly high monthly allowance and then bill overage at a very-low rate. In many cases, when the customer is comparing quotes, they may believe that the overage is the rate they are paying for every copy.
Secure the Revenue, Secure Your Future
Securing and escalating the recurring revenue is one of the most important steps you can take to safeguard your company. Building the service revenue into the lease builds the asset value of your company, allows the sales team more time to grow your business and maximizes the profitability of your business.