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Failure to Reserve for Long-Term Cost Wrecks Current Margins |
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Every time a product is sold it carries trailing risk: Risk of return, risk of failure, risk of lawsuits, warranty cost, call center support and a host of other factors. All this risk turns into cost. Trailing costs impact your P&L after the fact, often in successive financial years. So in addition to not controlling these costs, failing to properly reserve margin at the time of sale sets you up to eventually pay for past mistakes with today's money, kind of like a mini-bailout. Every time a product is sold it carries trailing risk: Risk of return, risk of failure, risk of lawsuits, warranty cost, call center support and a host of other factors. All this risk turns into cost. Trailing costs impact your P&L after the fact, often in successive financial years. So in addition to not controlling these costs, failing to properly reserve margin at the time of sale sets you up to eventually pay for past mistakes with today's money, kind of like a mini-bailout. There is a method to the madness. The real challenge is knowing exactly how much of each sale to reserve. If you don't hold back enough, you'll run out of money before all the liabilities fade away. If you hold back too much, that's money you could have taken to the bottom line today. Like walking a tightrope, balance is everything. Consumer products like cellular handsets carry post-sale liabilities of between 2-4%. Such products are relatively easy to establish reserves for because there is so much history and the technology typically changes incrementally. Also, lifespans are short; a year or two under warranty and about three years total, so even if mistakes are made they don't haunt you forever. Fixed products like transmitters, large machinery, telephone central offices, all live much longer, in the tens of years, which presents a totally different scale of the problem. Hold-backs should match lifetime liability exactly. How do companies get it right? Mature companies have enough history to estimate accurately. Established technologies like digital cameras have enough field data for a reserve manager to guess right, Products based on new, untried technology are the riskiest of all, especially in the hands of a start-up that may neglect trailing costs entirely. Without history, a wise policy is to constantly monitor, in detail, every aspect of post-sale cost, then rapidly adjust reserves - as often as monthly - to compensate. Incremental changes in shipping volume are easy to adjust for. However, large changes are a problem because significant damage is already done by the time you figure it out. The trick is to extrapolate future liabilities carefully. 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. Continuous improvement systems, like all quality methods, are the key to controlling post-sale liabilities. Mechanisms as simple as holding specific departments financially liable for the top five call center issues can make a difference. Post-sale managers who constantly push visibility of customer problems back into the enterprise - and enlist executive sign-up - shifting everyone's thinking back into proactive space, taking care of stuff before it leaves, have a profound effect on the bottom line. Design For Serviceability (DFS) is a product feature often neglected in the rush to get new products out the door. Remember that the cost of fixing a problem in the field can be 100x higher than fixing it in the factory. Big money. . . The worst scenario occurs when financial oversight breaks down and senior managers, especially those who know they're likely to move on, are permitted to take reserves to the bottom line well ahead of time in order to distort the current P&L, to fake better financial performance. Mature organizations require sign-off from the post-sale leadership and CFO to take reserves, particularly in 'Product Managed' organizations. 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. Okay, so now your customers have signed up. What's next? In principle, at this point it's worthwhile to feed reserves and post-sale sold services into a new P&L devoted, not to a specific product, but to post-sale as a product itself, as a separate business. This is an especially good idea because it also insulates customer service from the tendency, as a cost center, to get chopped whenever money is short. When the whole customer experience is operated like a separate business, when it's isolated from specific products, its independent value becomes more visible too, adding to the total portfolio. Good post-sale business execution translates directly into new product sales. When customers are happy - doesn't matter why - they come back. Wrapping a suite of non-device values around a commodity product like a cell phone differentiates you in a tough market. These days, with some consumer electronic margins below 10%, OEMs can't afford to make post-sale mistakes. Every penny counts. Brand equity hinges on your product standing out. The post-sale customer experience, in many cases, is what makes the difference. About the Author: Our recognized brand of small business consulting connects emerging companies with the right investors, both angel and institutional. Thomas Mezger, CEO,
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and John Sawinski, SVP,
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exploit sixty years of street-level skills getting companies ready for funding. In addition, investors come to TFS for fast, accurate, inexpensive analysis of investment targets. Contact us soon. |
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