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.

Reserves are an accounting trick to take some revenue offline, hold it from taxable income until such time as it’s either spent fixing problems, or taken back to the bottom line. What’s the right amount? Planning is everything. Too big a reserve, planning too conservatively, robs you of profits you could be taking today. Too little held back and you run the risk of running out early. It’s all product based, usually in the range of two to three percent of OEM price. Products with short lifespans are tolerant of reserve mistakes because warranty periods are short and the problem goes away faster. On the contrary, large systems and infrastructure can last for decades. Think about it: Under no circumstances do you want to be funding product support for a ten-year-old system with today’s money. Better plan accordingly. . .

Reserves should overlay liabilities as precisely as possible. Holdbacks should be just enough to cover trailing costs, no more. What’s the formula? Established OEMs with plenty of experience usually get it right. New companies sometimes forget reserves altogether. Big mistake. . . Getting the right answer is easy for established businesses with a history in a particular technology. For example, every Ethernet router manufacturer knows, almost to the day, the MTBF of a 16-port hub. On the other side, however, emerging technologies can be a real guessing game. In that case the trick is to constantly monitor every aspect of post-sale cost during ramp-up, then respond fast with adjustments in reserves, usually on a month-by-month basis. Obviously, step function changes in sales volume can mess up the best of plans on either side of the formula; Small sales mean not enough data. Big sales mean it’s too late, the horse is already out of the barn.

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.

Good things happen when companies are clever at alternative funding of post-sale liabilities, not with reserves, but with non-device sales. Extended warranties, sales of downloads, discounts on related products, service contracts, software maintenance, upgrades and the like, all play heavily into the ‘plus’ financial column. Many OEMs set sales targets of more than 30% for non-device sales, particularly in networked products. As an added bonus, non-device sales usually carry better margins that actual products. However, a thing is worth only what someone is willing to pay: Building enough value into your post-sale experience to extract that much non-device revenue sets the stage for umbrella, ‘peace-of-mind’ service offerings, big service plans that cover an entire technology experience, not just one product.

Great organizations run the post-sale customer experience as a business by itself, with its own P&L, thus decoupling financials from any single product’s success or failure. Fueled by reserves and sold services, the customer experience then settles into consistent expectations. Too often, in difficult financial times, customer service is the first ballast thrown out of the sinking balloon. Running it as a separate business keeps product managers honest, prevents them from offloading cost or otherwise faking the numbers.

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.

Tags: Biology and Technology