May 28, 2009

OEM Extended Warranties:

Working with a manufacturer to sell service contracts is a little different from working with a retailer. The OEMs need more help with sales and marketing, and they want more failure data analysis to help them with product quality and parts planning. They'll also need just as much help as the retailers with risk management, compliance, and regulatory issues.

In the competition for the sale of service contracts, retailers and dealers are increasingly going to have to both compete and co-operate with the companies that manufacture the products they sell.

The biggest difference between a product warranty and a service contract is the money paid for the latter. The biggest difference between a manufacturer and a retailer is whose brand name goes on the box. But those lines are blurring.

Third party administrators, which have always worked closely with retailers and dealers, are increasingly also working with some of the major brand names, sometimes at the same time. Last year, on the occasion of signing Amazon.com as a client, Service Net Solutions president Chris Smith predicted that customers would prefer a manufacturer-branded service contract 10-to-1 over a retailer's own brand.

But Amazon.com is not your typical retailer. While it started out as an online bookseller at the dawn of the Internet era, way back in 1995, it has since then branched out into numerous other industries including music, software, electronics, toys, and even groceries. Along with eBay and a few other e-commerce pioneers, Amazon.com helped to revolutionize the retail industry.

Changing the Rules with the Kindle

But it was always retailing someone else's products. So at least in that respect, Amazon.com was following the traditional role of the retailer. Then in 2007 it launched the Amazon Kindle, an electronic book reading device developed by subsidiary Lab126.

At that moment, Amazon.com became an electronics manufacturer. Well, it doesn't actually physically manufacture the Kindle, but its name goes on the box, and it is responsible for the unit's one-year product warranty. So it's an OEM -- a company that sells the product of a second company under its own brand. And it also sells the extended warranties, which are administered by Service Net Solutions.

So in this case, Service Net is working with an OEM that's also the retailer, which is issuing the product warranty and selling the extended warranty. Of course, you need a Kindle to read an electronic book, so if Amazon.com wants to sell e-books, it has to get into the device business.

It's the same chicken-or-egg dilemma that's driven pioneers in the digital entertainment sector deeper into the device business than perhaps they'd like. No hardware? No software sales or subscriptions. But in terms of what can go wrong, one need look no further than Microsoft, whose interests in the hardware market extended no further than a PC mouse or two and some other gadgets until the Xbox came along.

Smith said the structure of the relationship between a manufacturer and an administrator has less to do with the industry, the technology, or the product in question and more to do with how much of the work the manufacturer is going to want to do itself. "It depends more on how much of the service infrastructure is going to be controlled by the manufacturer. That kind of dictates the relationship," he said.

Working Behind the Scenes

For example, with Lennox International Inc., Service Net has more to do with the paperwork and less to do with the actual repairs or the upkeep of the heating, ventilation, and air conditioning units. Lennox sells its air conditioners and furnaces through thousands of independent dealers throughout the U.S. and Canada.

Those dealers want to sell the service contracts, and they also want to perform the actual service. The best call themselves Dave Lennox Premier Dealers, and they pretty much want to be on a first-name basis with their customers, leveraging the Lennox brand's reputation for quality of product and their own reputation for quality of service.

"Most of our time with Lennox is spent on developing new products for them," Smith said, "and it's spent on a lot of data analysis on behalf of Lennox, so that we can make sure the service contract insurance is priced correctly. I don't dispatch their trucks, and I don't do a lot of things I might do for other OEMs, where I take more of an active role."

In contrast, for Asko Appliances AB, the Swedish manufacturer of high-end washers, dryers and dishwashers, Service Net pretty much does it all. "I take their calls, dispatch their trucks, do their claims, do the analysis, and develop the product," he said. "So it's more of a full-service relationship."

With Amazon.com, Smith said most of the actual selling of the service contracts is done by another company, which also takes most of the customer service calls. Service Net Solutions is the obligor, and is in charge of looking after all the local regulatory and compliance issues in the 50 U.S. states, Canada, and possibly in additional countries if sales widen.

"Of course, there's lots of risk involved when you're covering brand new technology," Smith said, "even though some of the components of that technology have been around for a long time. It's still a new device." That means early warning data analysis and root cause analysis will be all the more important.

Accidental Damage from Handling

Dan Tafel, Service Net's vice president of sales, pointed out that manufacturers are increasingly working with administrators to provide or integrate certain elements of service contracts with their in-warranty functions. For instance, while the product warranty covers defects, the customer may want to purchase accidental damage protection. "It actually wraps around the OEM warranty and uplifts it," Tafel said. "We have the ability to market that product. And secondly, we have the ability to understand the risk."

Paragraph six of the terms and conditions of the two-year extended warranty for the Kindle (2nd Generation) state that it automatically covers "Accidental Damage from Handling." ADH typically covers failures caused by handling, but it typically excludes damage cause by abuse or reckless behavior. ADH also allows no more than one replacement during the term of the contract. Tafel said this kind of careful wording helped Service Net convince most state insurance regulators to not automatically classify ADH as insurance.

Tafel said he thinks the OEMs generally need a bit more help with the sales and marketing functions than do the retailers. Traditionally, an administrator prices a service plan and the retailer does all the sales and marketing. After all, that's what the retailers are good at doing. But with an OEM, they're good at designing and manufacturing a product, not selling service contracts for it.

"The OEMs are relying upon us to market and sell that," Tafel said. "In most cases, the OEM isn't touching the end customer, like a retailer is. We take a much stronger marketing and sales role with OEMs than administrators that work with retailers."

Service Net's roster of OEM clients includes Sony, Lennox, Amazon.com, Asko, Dacor Inc., Samsung, Sharp, Toshiba, Maytag, Philips, and Sirius Satellite Radio. Almost all its business is conducted in the U.S. and Canada, although the Kindle account may expand its horizons.

Answering the Phone

Sirius Satellite Radio is another one of those OEMs that acts like the manufacturer but doesn't actually make the devices it sells. Either way, Service Net handles the entire warranty process for the satellite receivers the company sells through automotive as well as consumer electronics channels. "We handle the call and the fulfillment pieces, and then we handle the data analysis," Tafel said.

As it does for other clients, Service Net answers the phone in the name of the manufacturer, more or less submerging its own identity in the process. "Our goal is to promote our client's brand," Tafel added. "We try to stay out of it as much as possible. You'll very rarely see the name Service Net anywhere. If we're doing our job well, you won't ever see Service Net's name."

And then there are the purely commercial service contracts, which Service Net administers on behalf of the manufacturers and in conjunction with the dealers and value-added resellers. Lennox is a good example of that process, but of course commercial real estate is going through some rough times these days. A better example might be the Samsung flat screen monitors installed at the Dallas/Fort Worth Airport, which are covered by a service contract administered by Service Net.

"We're now supporting a number of OEMs' branded commercial plans," Tafel said, where a value-added reseller typically installs multiple flat screens in a restaurant, hospital, airport, or hotel. The VARs typically want to work with a specific manufacturer, and the customers typically want to buy a manufacturer-backed service contract.

"That's an area where we're seeing significant growth," he added. "They're more comfortable with a manufacturer-backed service level, so that they can actually pay one price to maintain those units, and they get rid of the uncertainty of repair and maintenance for those units."

Tafel said that while the typical consumer buys a retail service contract to achieve peace of mind and reduce the cost of unexpected repairs, the typical commercial customer is buying a service contract for different reasons. "At an airport, it isn't unexpected," he said. "These things will fail. So it's more of an ability to predict and have a set price for your service and maintenance, and have a set service level for those units. And there's more confidence in the manufacturer backing that as opposed to the local service shop."

Surprising Longevity of Service Contracts

Back in a purely consumer setting, Smith said Service Net is working with one manufacturer that continues to renew extended warranties on certain television products for as long as 18 years. Besides the obvious revenue benefit of such an annuity-like contract, there are also practical benefits in terms of spare parts optimization. "It not only helps them look at the extended lifecycle of that product, but it also helps them fine-tune their end-of-life parts planning, because we're giving them consumption of parts out to ten years and beyond on some products."

Without this kind of data, a manufacturer has to pretty much take their best guess as to how many spare parts they'll need after a given product is taken out of production. But with this data, they can hopefully make a more accurate prediction of future parts needs. "It can help them plan better," Smith said.

Retailers, meanwhile, don't really have to look at the long term. "They're in business to sell new product, not to fix old product," Smith said.

Tafel said he thinks the OEMs are thinking about the long term not only in pursuit of failure data and parts planning, but also to maintain brand loyalty and customer satisfaction. "Usually from a retail standpoint, once that service plan is sold, it's kind of a 'one and done,'" he said.

"You're not concerned about that customer any more. The retailer's sold it, and they don't follow it. From an OEM's perspective, they are very interested in providing them a service plan and also following that customer through the lifecycle of the product, and offering them a renewal plan, or some sort of enticement for an upsell. So it's not just about selling extended warranties. It's also about developing a service relationship with the customer.

"They care about their brand and their product, and it's more of a marketing approach when developing a service relationship. From a retail standpoint, it's more price-driven and commoditized. From an OEM perspective, it's more about developing brand loyalty," Tafel said.

Benefits of Data Analysis

Smith there are some other practical benefits for an OEM that works with an administrator on a manufacturer-branded service contract offering. First, it gives the OEM a longer time horizon in terms of product reliability metrics.

"They have a capture of how their product performs in year one," he said. "We have a capture of how a population of those products performs in year two onwards. And we can feed that data back to them, and give them component-level failure data, which then helps them to go back to their component-level manufacturers, and to understand their engineering and their manufacturing processes a little better."

Second, Smith said he doesn't think most manufacturers have a lot of in-house expertise on service contract compliance and regulations. "They do not have a good handle on how they should recognize service contract revenue. And since it's regulated at the state level, it takes quite a bit of work to make sure you're doing what you're supposed to from a regulatory perspective," he said.

Many OEMs seek only to outsource key functions where they lack the expertise and experience, Smith added. Some may seek to answer the first call from a customer in need of service, while outsourcing other key functions such as risk, compliance, and marketing campaigns. Some might want to outsource just the feature and pricing aspects of the service contract creation process. And then there are other OEMs that might want to retain the risk but outsource the service capabilities.

Completed Restructuring Today

Also this week, Service Net Solutions LLC was acquired by Service Net Warranty LLC, an affiliate of Bayside Capital Inc. and H.I.G. Capital LLC, completing a restructuring effort that began last year. All existing employees, service contracts and client/vendor agreements and obligations will be assumed by Service Net Warranty.

The magazine Louisville Business First reported in its May 15 edition that the assets of Service Net Solutions were going to be auctioned off on May 21. H.I.G. was the buyer in that transaction, which was completed this morning. H.I.G. had acquired Service Net in 2004 but sold it to GTCR Golder Rauner LLC in June 2007.

H.I.G. Capital has more than $7.5 billion of equity capital under management, and is an investor in over fifty companies in the U.S. and Europe with combined annual revenues in excess of $7 billion. Among those investments is a stake in Warrantech Corp., a service plan administrator based in Texas, and Encompass Group Affiliates Inc., an electronics repair and aftermarket service company based in New York.





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