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Utilizing Leverage for Cost Reduction

by Alexander Wolfrum & Sven Montanus, Barkawi

Reverse Logistics Magazine, Winter/Spring 2006

Through margin strength service and spare part offerings, enterprises of technology-oriented industries can improve their profitability in the long term if they are able to master the implementation of converting repair and guarantee operations cost optimally.

The tendency for investment volumes to drop off over the past years has lead to a prolongation of product utilization time. This in turn has created a continuous increase in demand for services and spare parts which are needed to maintain capital goods. For the manufacturers this opens up the possibility of partly compensating for the profit downturns with high-yield after sales offers in the traditional product business. According to recent trends, the following applies: Profit margins in the service and spare part industry exceed classic product business up to tenfold. With the history of western industrial nations placing about eight percent of the gross national product flow into the maintenance of goods and consequently, to the after sales industry, tremendous opportunities arise for manufacturers. The prerequisite for long-term success and lasting competitiveness in the after sales industry is the development and extension of an efficient service organization. Repatriation and the repair of defect parts, also known as reverse logistics, are increasingly moving into the spotlight as a solution. To some extent, the massive repair volumes are an indicator for the growing relevance of this sub-division in the context of after sales services. For example, the annual repair volume with leading manufacturers lies between 500,000 and five million units in the computer sector. Market leaders in the telecommunications sector must partly cope with annual repair volumes in the double-digit millions. At such orders of magnitude rationalization potential is high. Through the introduction of intelligent planning tools the repair factories capacities can be promptly coordinated with the current needs. Thereby avoiding under-utilization and reducing transmission delays. Workflow and tracing systems support and supervise repair circulation, whereby plan deviations are discovered in sufficient time.

Re-design of the worldwide repair network presents further rationalization potential. Depending on the value of the products to be repaired, logistics costs, defined transmission delays, as well as the technical repair requirements a central approach can lead to a considerably more favorable cost situation in comparison with a decentralized network structure. For a decentralized structure, in effect; numerous local repair factories, short transmission delays and low logistics costs speak for themselves. On the other hand, scale effects can be achieved with a centralized approach, meaning a small number of repair factories with global or at least regional responsibility, whereas this is not possible with a decentralized network structure. Very few repair factories experience an increase in repair volumes per location, whereby investments in the automation of processes or in qualification improvement of the staff pays off quickly. Cost savings of 15 to 20 percent of total costs can be obtained by a detailed trade-off management in this area on a product level in many cases. Distributing the complete repair area to external service providers also offers potential for cost reduction and improving quality. In Barkawi's assessment the outsourcing share lies in the high tech and telecommunications industry at considerably over 90 per cent. Meanwhile, all well-known manufacturers are making use of the after sales offers of specialized service providers. Besides the select repair of faulty products, some of these enterprises also offer comprehensive logistics services which range from the return of defective equipment to the provision of spare parts to the end consumer.

The return and repair of faulty parts is a central element of an ideal process chain in after-sales business.

Clear optimization potentials are visible in the often unsatisfactory warranty processing. It is frequently unclear whether a defective product can be taken back and repaired on the basis of the warranty or whether the time frame of the warranty is no longer valid. In the latter case the customer must pay for the repair and other services. In practice, the resulting effort for services and material is frequently credited internally to satisfy the customer with regard to future business. Comprehensive warranty management sets a clean definition and compliance with the warranty period in regard to the customer, as well as the reverse transaction of warranty cases in regard to suppliers. The numbers which were raised in the context of a study carried out by specialist publication "Warranty Week" shows that the correct warranty transaction does not always take place in practice. In the year 2004 the U.S. manufacturing industry incurred warranty costs in the amount of about 25 billion U.S. dollars because of this. For example, a leading printer manufacturer's share of warranty costs in the total turnover lies at over 8 percent which has a strong negative effect on company results and reduces the yield potential of after sales business to a minimum.

To drastically reduce the share of warranty costs in enterprise sales volume, the warranty period must be precisely defined in regard to the customer; these should be based on IT systems and firmly established in the business processes of the after sales area. At the same time it is necessary to assert existing warranty obligations respective of individual suppliers and, as the case may be, to harmonize warranty responsibilities and rights. Frequently, process responsibility is not clearly defined and the illustration of the relevant data based on IT systems does not take place in sufficient measure. The responsible organization units, among others sales, must be more strongly tied into responsibility. Success can be measured with the practical implementation of guarantee management through key performance indicators (KPI). Barkawi assumes that the net warranty costs can be reduced by up to 50 percent by a comprehensive guarantee management. To speak in absolute numbers: The U.S. manufacturing industry could save costs in the amount of up to ten billion U.S. dollar every year.

Alexander Wolfrum is Vice President After-Sales Services; Sven Montanus is Senior Consultant and Head of Marketing at Barkawi, an international management consulting company based in Munich.

Reverse Logistics Magazine, Winter/Spring 2006

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