As you've no doubt seen elsewhere, service is becoming the differentiator between product companies, as it is increasingly difficult to differentiate based on the product alone. Apple is such a great case study on this trend, as their iPad hardware isn't so different from their tablet competitors, but it is the set of services that they've built around their iPad that has made that product, and the family of iOS products, such an enduring hit with consumers. One of the services that Apple adds to their iPads is AppleCare+, their extended warranty a.k.a. consumer service contract offering.

Service contracts are the vehicle for many B2B and B2C companies to provide services with their products that help them differentiate from their competition and deliver a complete experience to their customers. In addition, the margins on service contracts are often much better than can be achieved on the product itself. Automobile companies typically don't have much margin on the car or truck itself, but believe they can make up for that in the aftermarket and service contract area.

But how can you ensure that your service contracts are in fact profitable? How can you make sure that they become a reliable revenue stream with high renewal rates? These are a couple of the questions that we'll explore in this article.

What is a Service Contract?

A service contract is a set of service or product guarantees (also known as entitlements) that a company will make to its customers regarding their product or service purchase. Sometimes, those entitlements come in the form of a warranty (think of that as a prepaid service contract), or they are sold as extended warranties or straight service contracts.

Once the service contract is in place, then its up to the company to fulfill its obligations. Public companies will create a warranty reserve in their balance sheets in order to cover expected expenses for their product warranties. Service contract revenue is accrued throughout the life of the contract.

Good so far - what's the problem?

One of the biggest issues with service contracts or warranties is monitoring performance under those contracts and seeing whether they are profitable or not. When a company sells a $2,000 service contract for an automobile, they would like to know whether the contract is profitable, and if so, by how much? What about a medical devices company that sells a service contract that promises a set of services and products to a customer, such as part exchange, or certain number of labor hours, or other entitlements?

Essentially, you have two problems: are these contracts profitable throughout their lifecycle, and am I over or under delivering on the promises I made to my customer? In the first case, knowing profitability in real time will help make sure that the right kind of service is being delivered, and in the future will ensure that I properly price the contracts.

The more difficult case is the latter case - fulfillment of entitlements. Sometimes companies end up delivering services they don't track, which is leakage that costs money. Other times, companies will under deliver on certain entitlements and the customer decides at renewal time that they really don't need 100 labor hours and they can get by with 50. You've lost that revenue. Still other times you track and deliver 120 labor hours, and then get into a disagreement with your customer on paying for the additional 20 hours.

Real-time Performance Monitoring is the Answer

So, what can you do? Monitoring the performance of service contracts in real time will allow you to do trend analysis on specific entitlements, will ensure that you're meeting key promises to your customers, and will ensure that you can properly price these contracts so that you're always profitable. In most operations, profitability comes after quarter end or something similar, which means the ability to course correct is limited. It would be akin to trying to drive the train from the caboose. Real time service contract performance monitoring is something that you should demand to ensure that your service operation is able to become a sustainable profit center at your company.