AFTER-SALES SERVICE SUPPLY CHAINS: A BENCHMARK UPDATE of the NORTH AMERICAN COMPUTER INDUSTRY

August 12, 1999

Morris A. Cohen Vipul Agrawal

CONFIDENTIAL PRELIMINARY VERSION FOR DISTRIBUTION TO BENCHMARK STUDY PARTICIPANTS DO NOT REPRODUCE OR DISTRIBUTE WITH PERMISSION

Fishman-Davidson Center for Service and Operations Management The Wharton School University of Pennsylvania

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Executive Summary
This report summarizes a recent benchmark analysis of service parts logistics supply chains used to support after sales service in the computer industry. It is the latest, in a series of benchmark studies of service logistics carried out by the Fishman-Davidson Center for Service and Operations Management Center over the past seven years, (study III in Figure 1). The report is based on analysis of data obtained from major computer manufacturers and service providers, and focuses on service and financial performance in North America for operations in FY 1998. The data is based on a variety of inputs that include extensive interviews, questionnaires and site visits with six industry leaders and case studies of another six companies. Statistics are reported separately for Enterprise and Non-Enterprise service divisions of the companies whenever sufficient data points are available.1 Otherwise data is provided for all products together. Highlights of our findings are outlined in this section. We first describe the current status of service parts supply chains. We then review current initiatives for improvement and opportunities for further progress. Figure 1. Wharton Benchmarking Project Timeline
1992 1993 1994 1995 1996 1997 1998 1999

Benchmark I
Enterprise level benchmarking analysis (1992 data).

Benchmark II-A
In-depth II-B benchmarking analysis (1994 data).Enterprise level computer(1995, 1996 data).

III
Enterprise level: Service and supply chain strategy 3PL (1998 data).

a) Current Status
Service Standards There has been some improvement in the overall level of service provided to Enterprise customers. The observed range of 54% to 94% for on-time job completion within 24 hours, however, is similar to the range we observed in our last benchmark study, (based on 1994-1996 data). There are significant differences in performance across companies, for very rapid response to the Enterprise segment, e.g. in the range of 1 to 6 hours. Response time

Enterprise refers to high end products such as main frames, midrange systems, servers and data centers. Non-Enterprise refers to products such as PCs, desktop systems and peripherals.

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commitments have become more aggressive, when compared to our previous studies; with companies offering a variety of time/price packages to their customers. The service standard for the non-Enterprise segment, while lower than the Enterprise standard, has improved; to the point where next day service response is now the minimal competitive level. Service performance metrics have improved and are becoming more customer oriented, e.g. use of the Job Completion Rate instead of internal Material Fill Rate and tracking of Overall Customer System Uptime. A very high level of logistics performance is common (i.e. for warehousing and transportation processes).

Financial Performance The gross margin for after sales service continues to be high; with Enterprise margins generally greater than 50% and non-Enterprise margins around 20% Inventory turnover for service parts continues to be very low when compared to other types of inventory investments; at the level of about 2 (i.e. 25 weeks supply on hand). Turnover is lower for Enterprise businesses (1.3 to 2) and higher for non-Enterprise systems (2.6 to 3.5). Obsolescence is the largest cost component for managing parts inventories (up to 34% of the inventory investment), especially for the non-Enterprise segment. Companies with relatively lower inventory investment (relative to service revenue) also have high parts availability levels suggesting that better management practices can lead to both lower inventory levels and high customer service.

Supply Chain Structure Some companies use different service supply chain network designs to support the differential levels of service offered across the Enterprise and non-Enterprise segments. Current transportation system infrastructure permits attainment of non-Enterprise service standards without positioning parts inventory at locations that are very close to customers. This leads to fewer echelons (levels) and more centralization of inventory. Enterprise service standards are more demanding, however, (to support same day service), and thus require multi-level networks and forward positioning of parts inventory.

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The use of 3rd Party Logistics Providers to supply after sales service logistics is increasing, but most companies use it selectively (with specific functions outsourced to different providers). Pooling (sharing of inventory across locations at the same level), continues to be an exception rather than a planned support mechanism, despite of its potential to increase inventory turnover and customer coverage.

b) Improvement Initiatives
Customer Service All companies interviewed stressed the increasing importance of service in their overall competitive strategy. This is a consequence of the high value of after sales service as a source of revenue and as a distinguishing factor for customer demand loyalty. Companies are increasing the variety of the price/service options they offer. They are, in particular, targeting tightly focused market segments by providing enhanced service performance for some segments while cost effectiveness to others. Same day service levels are becoming more aggressive (faster with higher completion rates). Companies with same day service capabilities are attempting to migrate customers to a high margin same-day category from the lower margin next day category.

Supply Chain Structure The cost (margin) of providing differentiated service options can vary significantly in the computer industry. Such variation may be due, in part, to differences in the design and the management practices of each companys after-sales service supply chain. Consequently companies are seeking to improve performance through adoption of various supply chain improvement initiatives, such as: Direct shipments by vendors: Companies are aggressively pursuing direct delivery by part vendors to locations inside the network - not only to DC/Emergency Depots but sometimes to customer Field Locations themselves. This approach can be used in conjunction with vendor managed inventory (VMI) programs with a vendor owning the inventory or with the inventory consigned to the customer (the computer company). In vendor owned situations the vendor can use the stock for other customers, but they have to guarantee a pre-specified service level for the customer. Most companies have the capability for their vendors to access electronically their inventory levels in the network.

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Enhancement of the Repair process: There is movement towards integration of offsite repair processes with the parts distribution system, and to provide full visibility of the repair process. This includes visibility of the repaired, non-repaired and in-process inventory items. Companies are also pushing their repair vendors to hold failed/repaired parts inventory for them, (consistent with the direct shipment strategy noted above). Other improvements to the repair process include: - Increased spending on remote diagnostics monitoring tools and investment in selfhealing or self-maintaining product designs. - Use of centralized call centers to assess and respond to customer service requirements (i.e. identify part needs, assign CEs to customer jobs, effective use of substitute parts or sources of supply within the network). Strategic Outsourcing: The potential for high profitability from after-sales service delivery increases the value of maintaining it as an in-house capability. This conflicts with cost/investment motives for outsourcing and thus will drive some companies to less reliance on independent service providers. The choice to outsource service logistics is a strategic decision that will depend on factors such as current infrastructure capabilities and the companys overall competitive strategy.

c) Opportunities
Better Planning and Use of Information While planning and support tools for parts inventory management have gotten better, opportunities for significant improvement remain. Many of these opportunities are based on better access and use of information. Some specific opportunities in this area include: Optimization tools that account for the interactions between multiple parts, stocking locations and customer products. The greatest potential for such tools is to support inventory management and stock deployment for low demand parts. Mechanisms and incentives to support the sharing of parts (pooling) policies. Forecasting and demand management methods improvements have taken place in the areas of data access, user interfaces and report generation. Opportunities to improve forecasting exist for estimation of low demand usage requirements, at a part/location level and to make use of information on the installed base of customer machines and their historical failure rates. eCommerce initiatives to enhance coordination, flexibility and productivity by linking data bases and decisions processes of customers and suppliers across all stages of the service parts logistics supply chain. This could lead to adoption of a collaborative forecasting and planning business model for service parts supply chains.

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The definition of service performance standards and prices for different service support options is often viewed as a marketing and product development prerogative. Both manufacturing and service support functions are affected by these decisions, however. Integration across the marketing, design, manufacturing and service support functions is critical in the computer industrys competitive environment especially for: Monitoring the complete repair cycle, i.e., move from internal focus service measurement to customer focused metrics such the job completion rate and response time to customers. Conducting detailed exception analysis to identify key problem areas in customer service such as CE Response Time and Fix Time (with tracking of both repair time and parts delivery exceptions.) Design for Serviceability, i.e. to link product design decisions to service support consequences. Such initiatives could reduce proliferation of part numbers and increase backward compatibility.

The remainder of the report contains data highlights for the following areas: Customer Service Strategies and Performance Supply Chain Design and Management Operating Financial Performance Use of 3rd Party Logistics Providers.

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I. Customer Service Strategies and Performance

1. Customer Service Segmentation: Most companies offer three broad types of service packages (depending on the product and customer) 1. Same Day on site service for mission critical and enterprise level applications, (deliver parts to customer/repair sites and repair equipment within 1, 2, 4 or 6 hours) 2. Next Day (on site repair or system replacement) service 3. 3-5 Days (remote repair) service There appears to be service parity in the quality of service delivered to the next day service segment by the major computer companies. We did see service differentiation however, for the same day mission critical segments, where the response time or fix time guaranty ranges from 1 hour to 8 hours. With the increasing role of enterprise and centralized computing in customer applications, along with reduced hardware costs, companies are realizing that customers in this segment are less price sensitive and more service demanding. Therefore service differentiation has become a key component of the competitive strategy for enterprise computing system suppliers (for example 99.95 % up-time guarantee for mission critical systems). Some firms differentiate their service guarantees based on geography, (e.g. x hours within y miles), while others offer a uniform service irrespective of customer location. 2. Measurement of customer service: Customer service measurement should reflect total customer downtime, rather than internal operational performance such as warehouse part availability and on time delivery (see Figure 1). Sophisticated, customer oriented measures are now being use to monitor customer service at the highest (product/customer) level, especially in the same day and faster segments. Companies are moving away from internal response time objectives such as (CE + part shipment) reaction time to total system down time or job completion time. Companies are monitoring the complete repair cycle as shown in Figure 2 with objectives for total repair cycle (machine down) times as well as for individual elements of the cycle. Sample Performance Measures that are currently being used include: Total Downtime/Machine/Year; Service Job Completion Response Time; % Repeat Calls; First Contact Time; Fix Time.

Specification and maintenance of service standards that are comprehensive and customer satisfaction oriented requires integration across the marketing, design, manufacturing and service support functions. Some companies have close integration of these functions while others do not.

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7 Figure 2. Field Service Repair Cycle

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Job completion Time (downtime)

CE Response Time

Fix Time

Parts Delivery Time Parts Availability Remote D iagnosis O n -site diagnosis W arehousing (pick, pack) Transportation T im e On-site repair

Customer calls

CE orders parts, if necessary CE arrives with som e or all of the required parts

Parts arrive

M a c h ine fails again

M achine fails/ M achine calls

Repair job completed, m achine is up

Figure

3.

Hierarchy

of

Service

Measures

% on-time job completion: Percentage of repair orders that were completed (i.e. machine was restored to up condition) within the promised time to the customer.

1. % on time CE response: Percentage of time the CE arrived and made the diagnosis (or a remote diagnosis was made) within the stipulated time. 2. % on-time Fix: % on-time parts delivered: Percentage of part demands that were delivered to the customer location within the required time from the time the part request was made. % parts availability: Local off shelf Fill rate Backup location off shelf Fill rate % on-time transportation delivery: Percent of orders that the transportation providers delivered within the promised/required time window. % on-time warehouse order fill: Percent of orders that were filled at the warehouse within the promised/required time window, given the parts were in stock. % warehouse order fill accuracy: Percent of orders that were filled accurately at the warehouse. % on time CE repair

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There are three ways to measure product customer service performance from a customers perspective as shown in Figure 2: a) % on time service (job) completion; b) average job completion time, i.e., average time to complete the service (average downtime); c) job completion time distribution i.e. fraction of service calls that were completed within successive time windows. The first performance measure is a relative measure that compares the on time performance compared to the target. The second and third are absolute measures of customer downtime. Therefore, in order to compare performances of different companies we chose the % On time job completion measure (as shown in Table 1). Figure 3 presents the hierarchy of performance measures that collectively influence the % on time job completion. It is important to note that most companies now measure and monitor % on time job-completion rate. The ranges of observed job completion rates in Table 1 are quite wide and overlapping (with respect to Enterprise and non-Enterprise segments). Measurement of service parts availability: Traditionally, service in after-sales logistics systems has been measured at the part level. Part availability is, of course, a key driver of customer/product service. Hence all companies continue to closely monitor fill rates of all parts within their logistics networks. Table 1 provides the range of performance on % on-time parts availability. The ranges in Table 1 again illustrate overlap of Enterprise vs. non-Enterprise performance for this metric. Measurement of logistics system performance: Our data showed parity among the companies interviewed, in terms of transportation and warehousing performance. On-time and quality performance was in the high 90 percent range. For transportation providers, the standards are 99% on time delivery within 1 hour for customers within a 20-30 mile range. Most companies rely on 3rd Party Logistics Providers for transportation and warehousing performance information, although some companies are starting to set up systems to independently monitor transportation and warehousing time performance. Table 2 illustrates the uniformly high (undifferentiated) standards for these processes.

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9 Table 1. Service Performance

Performance Measure

Enterprise

Non-Enterprise

Achieved % On-Time Job Completion: (Same Day) % On-Time Parts Availability (Same Day) Worst Best Worst Best 54% 94% 76.3% 91.6%

Target 80% 98% 75.5% 100%

Achieved 34% 92% 69% 94%

Target 80% 95% 70% 98%

Table 2. Logistics Performance Performance Measure % On-Time Transportation Delivery % On-Time Warehouse Order Fill % Warehouse Order Fill Accuracy Company Worst Best Worst Best Worst Best Achieved 96.2% 98% 88% 99% 97% 99.8% Target 96% 100% 95% 100% 100% 99%

Note: Target values and Achieved values correspond to the same company. Same Day refers to repair jobs that have to be completed within a time window that falls within one day, such as 2, 4 or 8, 12 hours from the time of job initiation

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II. Supply Chain Design and Management

This description and analysis is based on interview data from 10 companies in the North American computer industry. 1. Logistics Network Almost all the companies are engaged in restructuring of their Service Logistics Networks. Two approaches to organizing the logistics supply chain have emerged: A) Integrated Supply Chain Model: A common logistics network is used to satisfy same day or next day (or later) customers. One of the following multiple echelon structures (see Figure 4) associated with this strategy was observed: 1. Three Echelon System (Distribution Network 1 and 2): The role of some of the DC/Emergency Depots in Network 1 to is to make both replenishment and emergency shipments to field locations while for others they are dedicated to emergency shipments. In Network 2 the CDC is eliminated. We also observed that there are two approaches towards the use of Depots Vs Field locations, i.e. in a forward parts deployment strategy with few DC/ Depots but more Field Locations, or in a delivery-intensive centralized approach with a higher number of DC/Depots and fewer Field Locations. 2. Two Echelon System (Distribution Network 3) This network design is used by many medium sized companies and some large companies with a focused product line. The Depot and Field Locations in the previous model are collapsed into one level. Companies are able to cover their entire customer base with less than 100 (2 hour coverage) Field Locations, while some companies use as few as 40 (4 hour coverage). B) Tailored Supply Chain Model: Some companies use one of the above models for providing same day service. Next day demand, however, is fulfilled exclusively by the CDC or from a dedicated (separate) warehouse. No next day demands are filled from stock stored in the Field Locations. Future CDC-less Model: We observed that some companies are contemplating further rationalization of their service supply chains by increasing the role of outside parts vendors in replenishing stock throughout the network. Therefore a partial shift is seen from Distribution Network 1 to Distribution Network 2 (Figure 4) for large companies or a shift from Distribution Network 2 and 3 to Future CDC-Less 2 for smaller operations. The barriers to the adoption of this strategy include: the low volumes at Field Locations that must be located close to customers for same day service; the need for high inventory safety stocks since emergency pooling is not used extensively to share risk; the long lead times from some external vendors. The choice between design options (tailored structure or an integrated structure) depends on the combination of product attributes, customer attributes, product/part cost and service requirements (e.g. consumer vs. corporate, PC vs. high end/main frame, 1 hour vs. next day response). We noted in particular that companies with a complex mix of consumer

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and corporate customers and/or a large variety of end products, are more likely to use a differentiated structure strategy. The need for tailored structure comes from differences in cost and service standards, and parts deployment strategy for the same day versus the next day segments. It is not necessary for a company to have physically distinct supply chains for different market segments in order to effectively serve their customers. There are definite synergies in an integrated supply chain, especially when there is a high level of commonality of products in different service segments. But a company operating with a integrated supply chain has to ensure that they have tailored processes to operate in different cost-service segments.
Distribution Network-1

Distribution Network-2

Em. Depot

CDC

DC

Suppliers DC/Em. Depot Field Locations

Suppliers DC Field Locations

Distribution Network-3

Future CDC-Less

CDC

Suppliers Field Locations

Suppliers Field Locations

Emergency support Replenishment source

Figure 4. Alternate Distribution Network Designs While some companies manage a tailored supply chain under one service organization, other companies have created distinct global organizational entities for different product/ market segments in order to facilitate a higher level of integration with corresponding manufacturing and marketing divisions for those segment. Planning Software Used Improvements in interfaces, data base management and linkages to enterprise software systems have occurred. Most companies are using separate software solutions for planning and deployment Forecasting and demand management methods have improved, but continue to be a challenge. Primary improvements are in the areas of data access, user interfaces and report generation. No one can accurately forecast low demand service requirements at a part/location level with a degree of accuracy. Optimization algorithms are still elementary in most cases.

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III. Comparison of Operating Financial Performance

1. % Gross Margin for After-Sales Service: After-sales service can be a very profitable business with gross profit margins ranging from 10% to 64% of the service revenue. Gross margins on the enterprise side are much higher (generally greater than 50%) than gross margins for the non-enterprise segment, (around 20%), for all companies. The data indicates that the high cost of delivering enterprise service is more than compensated for by service revenue. 2. Transportation Costs/Service Revenue: Transportation costs range from 2.2% to 11.4% of service revenue. We observed no significant difference in this ratio between the enterprise and non-enterprise segments. Note that although transportation cost are higher for enterprise business, service revenue is also higher. 3. Warehousing Costs/Service Revenue: Warehousing costs range from 1.2% to 4.6% of service revenue. 4. Obsolescence cost/Inventory Investment: Obsolescence costs are high, ranging from 9% to 34% of inventory investment. These costs are higher for the non-enterprise segment. 5. Comparison of Inventory investment vs. Service level: COMPANY Inventory Investment/ Service Revenue (%)
10% 23% 40% 17%

Service Level (% on time Parts Availability)

91.6% 88% 88% 90%

1 2 3 4

6. Inventory turnover: Companies reported inventory turnover in the range of 1.3 to 2 turns for same day enterprise business and 2.6 to 3.5 for non-enterprise. This is a small improvement over the results we observed in our past benchmark studies (now 3-4 years old). Our experience, however, suggests that turnover data comparisons require detailed investigation due to differences in accounting methods. 7. Gross Profit/Inventory Investment: The ratio of gross profit to inventory investment ranges from 2.2 to 4.9 for enterprise businesses. This ratio generally is lower for the non-enterprise segment.

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IV. Use of 3rd Party Logistics Providers

We observed three different strategies associated with the use of third party logistics providers in the context of service parts support supply chains. These strategies are: a) Network management by one supplier. This is also sometimes referred to as 4th party logistics. In this system the inventory planning and network design decisions are made by the manufacturer while one supplier takes care all the logistics functions including selection, contracting and management of all the 3rd party providers. b) Outsource specific functions to different providers (a network manager for each function). Firms have tried to divide their logistics service requirements into functions based on synergies and expertise of the 3PL providers. Each function is outsourced to one supplier who may further use other 3PL providers if there is not enough in house capability. A sample of functions outsourced separately to one supplier each include: Same day transportation (from Depots\Field Locations to customer), Depot\Field Warehousing (sometimes combined with same day transportation), Next day emergency transportation, Ground transportation from CDC to the Depots\Field Locations, CDC warehousind, repair. c) Outsource specific functions to different providers (multiple sources for each function). This is the approach followed by most large companies that operate in diversified product/market segments. It leads to a diverse set of supply contracts and relationships. Coordination and the achievement of synergy across suppliers, locations, functions and different market segments is a challenge that typically requires direct management by the manufacturer. The only companies currently using a) have product lines that are narrower and are of smaller scale. Options b) and c) are the most common solutions that we observed. Companies use option b) for different functions e.g., some for warehousing, others for transport supply, etc. Currently, companies with large scale, complex service support supply chains are using option c). Main concerns of 3PL Users IT/integration i.e., Can the provider integrate their management and control systems with the company? This is still an important implementation hurdle. Gain Sharing and Improvement Incentives: Identification of improvement (cost or process) opportunities was lacking and a cause of concern with the companies interviewed. Providers are expected to leverage off of knowledge they can derive from multiple customers and then use their in-depth, specialized experience to identify improvement opportunities for their customers. We question if doing so is compatible with the incentives of theseproviders in the absence of appropriate gain-sharing mechanisms. Strategic Fit: In the current environment, where product and service offerings are changing rapidly, companies are looking for 3PL partners who have the flexibility to change the distribution network structure. Consequently, large 3PLs who are willing to make investments and share them across many clients, can offer cost effective and broader service packages.

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References
Cohen, M. A. and S. Zhang, Benchmarking Service Parts Logistics: An In-depth Analysis, Project Report, Fishman-Davidson Center for Service and Operations Management, The Wharton School, University of Pennsylvania, March, 1997. Cohen, M.A., Agrawal, V., and Zheng, Y-S, Service Parts Logistics: A Benchmark Analysis, IIE Transactions, Special Issue on Scheduling and Logistics on Supply Chain Integration and Coordination, Vol. 29, No. 8, August 1997, pp. 627-639. Cohen, M. A. and H. Lee, Out of Touch with Customer Needs? Spare Parts and After Sales Service, Sloan Management Review, Vol. 31, No. 2, Winter 1990, pp. 55-66.