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NEON- Ramblings on Service Contracts
The purpose of a service contract from the perspective of the buyer is to
eliminate the $ impact of unexpected repairs on their business cash flow. In
other words, it can be considered an insurance policy.
As the provider of the service contract, you need to assess the services you
will have to provide over the life of the contract. Since you are essentially
providing an insurance policy, you need to know the probability of failure of
each component of what you are covering under the contract.
Unless you have been tracking a large number of identical or similar
products, you do not have statistically data to base your financial
calculations. Insurance companies have "actuarial" tables to guide them....
You have your best "guestimate" on predicting the kind and frequency of
necessary repairs.
You might have a good "feel" about your own installation.... on the other
hand, you know nothing about someone else's installation.
The Service Contract business is based on servicing many service contracts.
You will win on some, lose on others..... Make money on the statistical
average. In your case, if I understand correctly, you are talking One service
contract. This situation is essentially gambling (should this one
installation fail, you don't have other installations to make up the loss on
this one repair). So your pricing needs to reflect your reflected odds of
failure. I suggest a "%profit" should the installation not require repairs
and "breakeven" should the installation require repair. Note that a service
company can accept a loss on a given site because of the ability of the other
sites to generate the necessary revenues for profitable operations.
Pricing the contract: 5-Point Empirical Approach..... No easy solutions.
1. competitive pricing
If you have competition, they set the market price. Your price has to be
positioned around these values and you have to explain your pricing within
the context of your competition
2. comparable pricing
If you customer talks about computer repair contracts or other type of
contract, as a % of purchase price, you can use these if they fit with your
"fair" pricing or you will have to explain why you have to charge more
3. desired profit
You can use probability theory to calculate a price based on projected actual
repair costs:
Price of Contract = (Probability of Failure Type 1) x (Normal Repair Charge)
+ (Probability of Failure Type 2) x (Normal Repair Charge) + ...
4. cost containment
Since this is a one-time deal, you should look at how much you are willing to
lose...... Ideally limit you loss to a zero profit on the repairs.
5. customer elasticity
Understand the customer's motivation for buying the service contract. Fixed
cost/zero headaches may be worth a lot to the customer. If the customer wants
immediate servicing, you should ask for a lot more.... and in the case of the
customer looking for 24 hours a day reliable operation, you can charge up and
beyond the initial cost of the installation. Tailor the contract to the needs
of the customer.
6. upper $limit sanity check
Obviously, the customer should not have to pay more than the cost of having a
team fly in and completely re-build the installation from scratch. Common
sense should prevail.
Setting Up Your Service Contract
1. list the specific services included and the conditions under which repairs
will be performed at no charge
2. specify the reponse time
3. specify what is excluded
4. specify the procedure for starting the repair cycle (i.e. phone call, FAX,
etc.)
Set up a reference scenario
Define a simple core service contract. $ per year to do the following........
including........
Add a number of options to allow for contract negotiation
Give yourself some leeway to adjust the contract price to the customer's
comfort level by adding or removing specific items/deductibles.... for
example: fixed transformer replacement cost of $50 after warranty period.....
lowers the cost of the contract. 72-hour service period instead of 24-hour
service period, lowers the cost of the contract....... Use your imagination
and add or eliminate the services you want/ or don't want to perform.
As for the legal aspect, save money, use a template as suggested by "Peace"
but make sure to have your lawyer to check the dots etc....
Happy Service Contracting.............