Preventive maintenance agreements add up

MICHAEL C. ROSONE MECHANICAL CONTRACTOR AS SERVICE PROVIDERS we know that preventive maintenance reduces energy consumption, increases equipment life, reduces downtime, increases occupant comfort and so on. But do you really know the true impact that preventive maintenance agreements have on your business? Typically, general repair and emergency service work beyond the contract is awarded to the preventive

MICHAEL C. ROSONE
MECHANICAL CONTRACTOR

AS SERVICE PROVIDERS we know that preventive maintenance reduces energy consumption, increases equipment life, reduces downtime, increases occupant comfort and so on. But do you really know the true impact that preventive maintenance agreements have on your business?

Typically, general repair and emergency service work beyond the contract is awarded to the preventive maintenance provider that has the agreement for the facility. There is a direct correlation between the agreement and the amount of additional service revenue expected from an account.

To truly appreciate the real economic value of a preventive maintenance account, you must determine the ratio between your preventive maintenance contract base and the additional service revenue derived from those agreements. To get that ratio, divide the total service revenue (exclusive of capital improvement projects) generated from all preventive maintenance agreements by the total contract value.

For example: If the contract value of all your preventive maintenance agreements is $500,000 and the service revenue (T&M, quoted repairs, emergency service, etc.) produces an additional $1 million in revenue, the service to PM ratio would be 2: 1 ($1,000,000 ˜ $500,000).

Please note that the above example only calculates general service repairs (exclusive of capital improvement projects or "construction" work). To truly appreciate the total economic value of a PM agreement, take the total revenue (inclusive of construction work) and divide that by the total contract value of your preventive maintenance base.

A recent survey of the 47 independent mechanical contractors that make up The Unified Group (a national organization of service providers, www.theunifiedgroup.com) shows that the general service-topreventivemaintenance ratio ranges between 0.7:1 and 2.75:1. When construction work was factored into the equation, the ratio got as high as 7:1.

Some preventive maintenance agreements will include emergency service labor and/or materials and that will affect the ratio because they are included in PM revenues, not service revenues.

Once you have your service-to-PM ratio, you must assess the cost of acquiring new preventive maintenance agreements and the return on investment. The accompanying chart, developed by Jerry Hurwitz of J&J Air Conditioningand me, will help in this process. In order to assess the true acquisition cost and the subsequent ROI you must know the following:

  • The gross profit percentage of your preventive maintenance contract billings (total annual contract billings minus the direct cost to perform the inspections, divided by the total annual contract billings);
  • The gross profit percentage of the service revenue generated from the preventive maintenance contract base (total annual service revenue minus the direct cost to perform that work, divided by the total annual service revenue); and
  • The service-to-preventive-maintenance ratio.

The example we've used illustrates the projected revenue, gross profit, sales expense and profit/loss associated with acquiring $100,000 in preventive maintenance agreements. This is a hypothetical example and is based on the general service ratio (exclusive of construction work). Your results will vary.

This example shows the return based upon selling $100,000 of preventive maintenance agreements per year for three years. Assuming your general service-to-preventive-maintenance ratio holds up year after year, the real economic value of a new preventive maintenance account is far greater than you might have thought. It is much greater if you factor in construction work generated from PM accounts, especially because the sales expense associated with renewing the agreement is typically a fraction of the cost of obtaining the agreement originally.

Because we understand the true value of preventive maintenance accounts, Mechanical Service's business model is based on aggressively growing our contract base. Some of the benefits we have derived from this approach are:

Diversification. With a broad contract base we are insulated from being dependent on any one account.

More predictable cash flow. Spreading the cost of the agreements over an extended period provides a more predictable cash flow.

Better labor planning. Knowing the amount of labor hours and cost associated-with each agreement and the subsequent service generated allows for more accurate labor planning and forecasting. We use this spreadsheet to help determine when we need to add technicians. If you know what your labor cost is as a percentage of the PM agreement (and subsequent service sales), you can calculate how much revenue you need in PM sales to warrant bringing on another technician.

As service providers, we can't afford to not have business development representatives aggressively selling new PM agreements. Preventive maintenance agreements are worth much more than the face value of the contract itself. They are one of the best marketing tools we have, and PM salespeople are one of the best investments we can make in our businesses.

So, how much are preventive maintenance agreements really worth to your business? Do the math and you may be pleasantly surprised.

Michael C. Rosone is president of Mechanical Service Corp., Whippany, N.J. He is a member of The Unified Group, a best practices group comprised of independent mechanical service contractors. He can be reached at 973/884-5000, ext. 111, or at [email protected].

Preventive Maintenance Agreement Acquisition - ROI
Desired Annual PM Agreement Sales $100,000 A Enter Information
Annual Service to PM Ratio 2.50:1 B Enter Information
Gross Profit % of PM Agreements 61% C Enter Information
Gross Profit % of Service Sales 59% D Enter Information
PM Renewal Rate (%) 98% E Enter Information
Sales Expense
Compensation $45,000 F Enter Information
Benefits $8,000 G Enter Information
Auto, Training, T&E, Misc. $7,500 H Enter Information
Total Sales Expense $60,500 I F + G + H
Revenue - Year 1
PM Agreement Sales (contract value) $100,000 J Enter Value from "A"
PM Billed In The First Year $50,000 K J divided by 2
Service Sales Generated From PM Agreements $125,000 L K times B
Total PM & Service Revenue $175,000 M K + L
Gross Profit
Gross Profit from PM Contract Billings $30,500 N K times C
Gross Profit From Additional Service Sales $73,750 O L times D
Total Gross Profit $104,250 P N + O
Profit/Loss

Total Gross Profit

$104,250 Q Enter Value from "P"
Sales Expense $60,500 R Enter Value from "I"
Net Profit/Loss - Year 1

$43,750

S Q minus R
Revenue - Year 2
First Year PM Renewals $98,000 T J times E
Second Year Billed PM Contracts $50,000 U A divided by 2
Total PM Revenue $148,000 V T + U
Service Sales Generated From PM Agreements $370,000 W V times B
Total PM & Service Revenue $518,000 X V + W
Gross Profit - Year 2
Gross Profit from PM Contract Billings $90,280 Y V times C
Gross Profit From Additional Service Sales $218,300 Z W times B
Total Gross Profit $308,580 AA Y + Z

Profit/Loss - Year 2

Total Gross Profit

$308,580

BB Enter value from "AA"
Sales Expense $62,315 CC R times 1.03
Net Profit/Loss - Year 2 $246,265 DD BB minus CC
Revenue - Year 3
First Year PM Renewals $96,040 EE T times E
Second Year Billed PM Contracts $98,000 FF A times E
Third Year Billed PM Contracts $50,000 GG A divided by 2
Total PM Revenue $244,040 HH EE + FF + GG
Service Sales Generated From PM Agreements $610,100 II HH times B
Total PM & Service Revenue $854,140 JJ HH + II
Gross Profit - Year 3
Gross Profit from PM Contract Billings $148,864 KK HH times C
Gross Profit From Additional Service Sales $359,959 LL II times D
Total Gross Profit $508,823 MM KK + LL
Profit/Loss - Year 3

Total Gross Profit

$508,823 NN Enter value from "MM"
Sales Expense

$64,184

OO CC times 1.03

Net Profit/Loss - Year 3

$444,639 PP NN minus OO
3 Year Total
Total Revenue $1,547,140 QQ M + X + JJ
Total Gross Profit $921,653 RR Q + AA + MM
Total Sales Expense $186,999 SS R + CC + OO
Total Profit/Loss $734,654 TT RR minus SS