Key Takeaways
- An OEM strategy can help manufacturers unlock greater value from aftermarket services.
- Aftermarket lifetime value can reveal opportunities for higher margins and revenue.
- Customer segmentation helps OEMs tailor pricing and service contracts.
- Effective execution can improve lifetime penetration and EBIT.
Original equipment manufacturers (OEMs) continue to face an uncertain and challenging market environment. This raises an important question: what is the right OEM strategy? In industries ranging from agriculture and oil to commercial aviation, new-equipment sales have declined. These challenges are compounded by rising input prices, supply chain constraints, the consequences of years of shutdowns, and geopolitical factors. These pressures can also limit growth in emerging markets.
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As a result, industrial OEM leaders are placing greater emphasis on aftermarket services. These include digital assistance for their equipment, repair, maintenance, and parts. But why are aftermarket services becoming such an important part of OEM strategy?
What is OEM strategy?
An OEM strategy focuses on how manufacturers can create additional value from their equipment after the initial sale. In this article, that means evaluating aftermarket services and finding ways to increase their contribution to long-term revenue and profitability.
The key areas to evaluate are:
- Product lifetime: How long equipment remains in use, since longer lifespans can create more opportunities for aftermarket services.
- Lifetime penetration: How much of the installed base continues to use the OEM as its main service provider, including warranty, maintenance, repair, and parts contracts.
- Annual service revenue: How much margin each piece of equipment generates through its service contracts each year.
OEMs can then use these measures to identify where aftermarket value is being lost or underdeveloped. According to McKinsey analysis across 30 industries, the average EBIT margin for aftermarket services was 25%, compared with 10% for new equipment.
OEMs can also improve value through pricing, customer segmentation, sales channels, longer-term service contracts, and upgrades to existing equipment.
Industrial OEMs can use digital innovation, data-driven services, and the Internet of Things (IoT) to identify and develop aftermarket value opportunities.
Many companies are also investing in e-commerce platforms, automation, and other digital capabilities to improve their aftermarket operations. However, digitalisation has historically progressed more slowly in B2B aftermarket markets than in B2C markets.
At Taylor Wells, we believe that optimising aftermarket services can generate higher margins and more consistent revenue, making them an important source of value beyond new-equipment sales. We argue that OEMs should perform a detailed evaluation of their aftermarket value for each product line, as well as the profits from aftermarket services. This helps OEMs understand where aftermarket value is being created, improve forecasting, and identify opportunities that may not be visible when revenue is measured only on a per-customer basis.
What is aftermarket lifetime value in an OEM strategy?
After assessing aftermarket lifetime value, OEMs may discover that specific services outside their core operations generate more margin than expected.
For example, some OEMs initially expect digital processes to be their key source of growth. However, detailed analysis can reveal that core aftermarket services offer a much greater opportunity for expansion.
Some OEMs may also discover that they have too few long-term service contracts or other gaps in their aftermarket strategy. Benchmarking against competitors and companies in other industries can help identify these gaps and inform strategic changes. This is possible even if product lifetimes and annual revenues greatly differ in various markets.
Three factors can help generate aftermarket value:
- Product lifetime
- Lifetime penetration
- Annual service revenue
- Product lifetime is the duration of time that equipment is in use. In some instances, equipment originally expected to last 20 years can remain in use for up to 40 years, creating additional opportunities for aftermarket services.
- Lifetime penetration measures an OEM’s share of installed-base services over a product’s lifetime and is influenced by two factors.
- Attach rate represents the proportion of new equipment sales that include a warranty or service contract, such as a maintenance and repair contract or parts-supply contract. It indicates how effectively an OEM captures aftermarket service opportunities at the beginning of a product’s life cycle.
- Share of lifetime refers to the proportion of a product’s lifespan during which the OEM serves as the main service provider. After warranties and initial contracts expire, aftermarket revenue may decline. However, capable OEMs can expand their product offerings with customised, lower-priced options that also include maintenance services. This can enable OEMs to extend service relationships well beyond the initial contract period.
- Annual service revenue: The average revenue an OEM generates from aftermarket services for each piece of equipment each year, expressed as a percentage of the product’s initial sales price.
For example, equipment may have an initial purchase price of $2 million and generate $200,000 in aftermarket revenue each year under a service contract. That annual service revenue is equivalent to 10% of the equipment’s initial purchase price.
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OEMs vs. Third-Party Service Providers
Industrial OEMs may have advantages over third-party providers because of their long-term customer relationships and access to proprietary equipment-service data, helping them stay competitive and capture aftermarket value.
However, OEMs can face competition from lower-cost aftermarket parts and used components for older machinery. These parts come from independent service providers and third-party manufacturers. As a result, OEMs need to evaluate their performance across each aftermarket lifetime value category:
What Is the Right OEM Strategy? Examples
Aftermarket lifetime value is calculated as a percentage of a product’s initial sales price and excludes the time value of money to simplify the calculation.
For instance, introducing new services and bundling offers can increase aftermarket revenue while strengthening long-term service contracts.
An industrial-machinery company in Australia repriced its spare-parts SKUs, which helped improve its EBIT margin.
Another example is a global mining and construction equipment company that improved its services-sector EBIT after refining its market strategy.
Similarly, an aircraft with a 20-year lifespan could generate an aftermarket lifetime value of 50% if its cumulative annual service revenue reached at least half of the product’s initial sales value.
For instance, two types of energy equipment, wind turbines and gas turbines, frequently require routine inspection, maintenance, and repair because the equipment is heavily used under extreme conditions.
However, McKinsey’s analysis found that gas turbines had an aftermarket lifetime value of 75%, compared with 34% for wind turbines. Why is this?
One possible explanation is that the financial impact of downtime can be particularly significant for gas turbines, increasing power companies’ willingness to pay a premium for prompt service and constant uptime. In contrast, truck parts are more readily available than power-grid components, while competition from third-party providers is higher, which drives aftermarket prices down.
Third-party competition can put pressure on aftermarket prices. Wind turbines also have a shorter product lifetime than gas turbines, which McKinsey’s analysis estimates at 20–50 years.
Evaluating your performance to know what the right OEM strategy is
Most companies assess common financial measures, such as revenue and profitability, when evaluating aftermarket performance. However, a 2017 McKinsey analysis of more than 40 Fortune 500 companies found striking variations in aftermarket lifetime value.
For some OEMs, the aftermarket lifetime value was nearly equivalent to the price of the equipment. Some barely unlocked any aftermarket profit. The highest-performing industries had aftermarket lifetime values up to five times those of the lowest-performing industries, while the best performers within industries captured up to three times the aftermarket lifetime value of the lowest performers.
Customer segmentation in an OEM strategy
So, how do you increase product lifetime, annual service revenue, and lifetime penetration?
You need to develop digital solutions that help evaluate the installed base and individual pieces of equipment. For example, an Australian aircraft equipment manufacturer did exactly this. It further assessed the aftermarket lifetime value of individual aircraft.
As an OEM, you can then implement integrated and redesigned strategies after identifying your product lifetime, lifetime penetration, and average annual service revenue for your installed base. You could extend the product lifetime of your equipment by adjusting your prices and employing creative marketing tactics for used or older equipment to further strengthen your aftermarket business. You could also upgrade the software or hardware of a customer’s equipment.
Turning installed base insights into aftermarket value
Customer segmentation can further boost lifetime penetration for installed base services. OEMs can increase lifetime penetration by segmenting customers and developing customised maintenance contracts. Customers with newer and older equipment may have different price sensitivities, particularly when maintenance costs become significant relative to the equipment’s value. OEMs can use these differences to develop more targeted service offers and pricing.
For instance, customers with older aircraft or different operating requirements could be offered tailored service packages and pricing based on their equipment, usage and maintenance needs. OEMs could also offer redesigned components or a spare-parts guarantee to increase the proportion of the product’s lifespan that they serve.
Aircraft engine and equipment manufacturers offer long-term service contracts that ensure engine uptime while increasing lifetime penetration. Manufacturers must also adapt their offers to pique customer interest in such contracts. Over time, stronger long-term service-contract penetration can also create additional cross-selling and upselling opportunities.
Some system-modernisation initiatives may require additional expenditure and temporarily reduce EBIT. However, increasing lifetime penetration has the largest impact as OEMs expand their contracts by servicing older equipment. This is often an underestimated and important source of revenue.
In fact, McKinsey’s 2017 analysis found that OEMs that applied appropriate improvement levers doubled their aftermarket lifetime value within three to five years while also increasing EBIT. This was achieved even in markets with competition from independent service providers and third-party manufacturers.
Managing your after-sales channel: What is the right OEM strategy?
To maximise the available options, you need to focus on customer segmentation, sales channels, and your pricing. You must rethink your present sales strategy. This entails partnerships with distributors to enhance lifetime penetration by tracking equipment owners and usage. These details can then be used to direct customers towards the right services.
For example, McKinsey’s 2017 analysis found that companies that sold directly to customers or used franchise channels had 1.5–2 times the lifetime penetration of companies that used distributors.
However, distributors may be the only viable option for OEMs. This is especially true if you serve a large number of residential customers. At the same time, you need to establish strict guidelines that let you control your customer base.
Price optimisation
Maintenance services can generate lower margins than component sales, which can make OEMs hesitant to increase prices. Some OEMs may therefore bundle maintenance into broader service contracts or use it as a way to strengthen customer retention and increase lifetime penetration. They may hesitate to increase prices, fearing that their customers will not respond well. It is also important to understand customers’ willingness to pay for parts with lower demand.
Finally, OEMs must focus on execution. Even the strongest strategies can fail without effective execution. This is especially true if they lack a well-thought-out strategy for implementing changes, monitoring their impact, and achieving long-term growth. When combined effectively, these strategies can turn aftermarket services into a significant source of value.
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Bottom Line: What is the Right OEM Strategy?
OEMs should evaluate the EBIT generated by aftermarket services to understand their overall financial contribution. This requires innovative approaches and a better understanding of customers’ demands.
OEMs need to understand the three factors that influence aftermarket lifetime value and establish clear metrics to assess each one. Then you can begin defining key organisational performance metrics for aftermarket sales.
In fact, companies that improve their service businesses can achieve substantial financial gains. McKinsey research has found that industrial companies can increase services revenue by 30–60% within three to five years through better customer targeting, prioritising aftermarket sales, and strong execution.
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