As integrators see the number of installation contracts diminish in this recession and the market becoming more competitive, the need to offer service contracts is greater than ever, says Alan Kruglak, senior vice president at Genesis Security Systems and president of National Security Integrators. Most agree that service contracts can add value and stabilize cash flow by supplementing monitoring contracts in that highly sought-after category of recurring monthly revenue (RMR). Yet the successful implementation of a service contract requires a carefully planned pricing strategy.
The basic pricing formulas for service contracts suggested by Kruglak and John Brady, president, TRG Associates, look similar. Kruglak says, take seven to ten percent of the total installation cost, including labor and equipment. Brady’s basic formula starts at a $5 per month fee to cover labor â€” assuming a service call revenue between $45 and $85 and one visit per year â€” or a $10 fee for installations including more than 10 peripheral devices, and adding 10 percent of the equipment cost divided over 12 months. Brady adds that in general, commercial customers are more likely to want service contracts that include both labor and equipment, while some residential customers may want the option of a labor-only contract and pay for equipment when needed.
Brady makes another distinction between residential and commercial customers: the number of users is much higher in a commercial rather than a residential setting. With new employees coming in, integrators should worry about higher service activity in commercial installations. In all cases, it literally pays to ensure a well put-together installation that will require minimal service calls, he remarks.
With these basic models as a starting point, it is important for an integrator to factor in and analyze its costs, Brady says. The loaded labor rate is one such factor to consider. A level 4 NICET certified technician who operates in a high-traffic area and may only be able to accomplish four service calls in a day is much more expensive than a level 2 certified technician operating in a smaller city and completing eight service calls a day.
“The geography and demographics of an area and the reality of how efficient technicians can be” is a very important consideration, Brady notes.
At SecureNet, the prevailing philosophy is “to sell the customer what they want, not what you think they need,” says Brian Bergstrom, president, SecureNet. “We believe every service contract must be a good thing for our customer and a good thing for our company.” Bergstrom lists the most important factors to consider in pricing service contracts as customer needs first, followed by potential component failures and cost to replace or repair, and profit. The company derives between 7 and 10 percent of its revenue from service contracts.
Kruglak has observed “an inverse relationship between the value of the installation contract and service contract.” Smaller contracts cost more to administer, while in bigger contracts, cost is subsidized by moves, changes, etc.
Another important point to consider and establish very clearly with customers is what is covered and what is not within their service contract. The “act of God” clause is another source of great debate and a completely separate issue. Brady points out that whatever the company determines on those points of contention, being very straightforward with customers whether battery replacement or lightning damage is included in their service contract, for example, is key in maintaining a relationship conducive to many contact renewals.
Though the way service contracts are priced has not changed much over the years aside from what is included and what is excluded, there have been developments that make them more viable today. “Thankfully over the past 10 years, equipment has become far more reliable,” Brady says. “The equipment is not as big a risk now, especially on the wireless side. Ten years ago you put a wireless system up and you were back in six months.”
The final deciding factor, Kruglak and Brady agree, is “what the market will bear.” Competition from other companies and specific customer needs will have a significant effect on how a service contract should be priced. Brady warns against taking severe risks in pricing contracts to match a competitors’. “Add value with service contracts, but don’t go broke doing it,” he says. “If competitors are doing a $3 per month contract, don’t feel compelled to compete on that basis. Bigger companies have the cash flow to make the market. Their service department is looked at as profit center and not a net cost center.” It is important to have a clear understanding of a company’s costs to determine how competitively its service contracts can be priced.
Though it may seem a daunting task, companies that have established a detailed and proprietary pricing model have seen rewards. “Service contracts provide recurring monthly revenue to help the overall profitability of the company during downturns associated with the economy and dips in revenue created by temporary slowdowns in general business,” relates Bergstrom. “They are also useful by allowing a revenue generating service to absorb idle personnel during temporary slow downs in business. Annual or semi-annual maintenance services are scheduled when our personnel are between jobs, which keeps them allocated to a revenue generating task.”
While on the contract side, customization is what SecureNet advocates, the design of security systems can benefit from a homogenized approach, Kruglak believes. He advises to “standardize, standardize, standardize.” He comments that too many are tempted to offer increasing numbers of new products and that it is difficult for companies to offer quality services at low internal costs when they require having in place independent infrastructure for a great number of products. By standardizing product offerings, companies can provide more competitive service contract pricing while maximizing their profit and delivering higher quality service.
“The real question is, ‘Will there be deflation?’” Kruglak believes. “I just haven’t seen it yet. In service areas, the cost of delivering service has gone up, but there is a lack of high-quality service support. If service was commoditized and was great everywhere then you’d see prices to deliver great service drop.” He suggests that small- and mid-sized companies could increase their ability to train and carry and deliver higher quality service by limiting their product offerings. He adds that currently the only sector where deflation is possible is in government contracting, “where price is the determining factor, not quality.”
Whether integrators aim to generate customer satisfaction by completely customizing service contracts, being competitive in their markets, focusing on highest quality service within a standardized product framework, or all of the above, it seems clear that a successfully priced service contract must first provide value to the customer in order to add value to a company.
Demystifying Service Contract Pricing: What You Should Know
September 21, 2010