by David Whitehead
Pre-paid maintenance agreements have been an important part of our business for the past 30 years, but it wasn’t always that way. Many contractors began business as installation-only contractors. Service was viewed as a necessary evil, needed only to take care of warranty work on new jobs installed by the construction side of the business.
As HVAC contracting sales increased, more service technicians were needed to handle warranties and start-ups. To keep these technicians busy, the concept of maintenance agreements was developed.
In the late 1960s, our company sold maintenance agreements so that both installers and service technicians would have work during slow times. It became apparent, after some discussions with other contractors, that the concept of pre-planned, paid-in-advance maintenance would be a way to smooth the seasonality of our business while providing cash flow during traditionally lean periods.
This led to an emphasis on maintenance and the eventual establishment of a maintenance department.
Today we know how important maintenance is to the entire company for both service and HVAC installation sales. The many fringe benefits include:
- Maintenance customers see us two or more times per year — providing opportunities to sell additional services. There is a relationship between maintenance sales volume and the incremental business that maintenance customers provide. This relationship can be as high as a 1:1 ratio for some companies.
- The gross margin on prepaid maintenance agreements is the highest of all our departments.
- The maintenance department provides a spot for entry-level techs from trade school to get their start with the company.
- The maintenance department is also the entry point for an HVAC installer to upgrade his skill set for eventual promotion to service technician.
- The additional maintenance technicians have a neighborhood presence that, with good truck graphics, provides additional advertising.
- Maintenance becomes the third key component of a successful full service contracting company.
A Full Service Company
This conversion from an installation only company to a service company has changed every aspect of our business. We provide emergency service, planned maintenance, and new installations. To be successful as a full service company (an Ideal company) the three key departments, installation, service, and maintenance must work interdependently. In some circles, this is known as the golden triangle and is the key to providing womb to tomb lifetime service to our customers.
If any one of the three legs of the company are missing or not working, the chance for long-term success is reduced. Clearly a company that just performs new construction may be successful in the short term, but if there is a slump in the new construction market and there is no service or maintenance base, the company’s chances for long-term success are slim.
In the boom days of the 1980s there were many new construction companies that ignored the potential for future service and replacement sales — as soon as the new construction boom ended so did many of these companies. We all know of companies that are good at one of the three and ignore the other two.
How Ideal is Your Company?
In our business, one way of measuring how ideal we are as a full service company is to compare the gross margin generated by recurring revenue to overhead expenses (recurring expense). Our source of recurring revenue is pre-paid maintenance agreements.
We operate at about 30% of ideal. That is to say that 30% of our overhead expense is paid for by gross margin from maintenance. We check this percentage on a regular basis to see how we’re doing.
In other words, on January 1st, we know that we already have 30% of our annual overhead paid for by the gross margin generated from pre-paid maintenance agreements. We also calculate how many more maintenance agreements we need to sell to get to our ideal level.
Note: There are some areas in the northern part of the country where it’s not possible to do maintenance on an air conditioning system until very late in the spring. In these areas, contractors will have a difficult time with a large number of maintenance visits due when the first hot spell hits. Their ideal level may not be attainable from selling pre-paid HVAC maintenance agreements. In the milder southern climates we can do the air conditioning maintenance visit as early as March.
The Mechanics of Maintenance
If you plan to get into the maintenance business there are some basic rules that should be considered:
1. Pre-Paid: Make your maintenance agreements pre-paid annually. The agreement should spell out the number of visits (two visits is most common; although we have several agreements that call for three or more visits per year — some are even monthly).
Develop an agreement that details exactly what will be done on each visit, what is and is not covered (in most cases there is a discount on emergency service and preferential treatment to maintenance customers).
2. Renewals: Make the renewal process similar to renewing an insurance policy (even though in most cases we are selling maintenance only — not a full service agreement that covers all repairs). Send out just an invoice — keep it simple. The key is to get your customers to renew.
3. Maintenance Technicians: Every maintenance visit is important. Don’t let your technicians run through them. The customer should feel that they are receiving value and not just a filter replacement. The tech should interact with the customer. When we lose a maintenance customer, we follow up and try to determine why they didn’t renew. In most cases, the customer didn’t feel they were receiving value: “All he did was run in and change the filter and run out.”
Our service manager goes bananas when he hears that.
4. Departmentalize: The maintenance department should be set up as a complete department in your company. You should be able to track from top line sales through gross margin. Even though your techs will most likely be doing demand service and possibly installation work, you need to be able to break out the labor and materials for the maintenance department. Most HVAC specific computer systems can do this.
5. Escrow: Since you are collecting money up front for future services, you will need to establish an escrow account. Each time a call is done, money is taken from the escrow account and posted as a sale. Again, a good information system will track this. However, I have heard of several companies that have hundreds of agreements and no funds in escrow to cover the costs of doing the work. The future work becomes an un-funded liability.
Here is a formula that will help estimate how much money should be in the escrow account
R = Total annual pre-paid maintenance agreement revenue in dollars
A = The total number of active pre-paid maintenance agreements
V = The total number of visits contained in A
E = Escrow funds in dollars needed to complete all outstanding maintenance visits.
Following are the assumptions necessary for using this escrow formula:
A. For each maintenance agreement, the first visit is done shortly after the renewal (within two weeks).
B. On average, at any given time during the year, you are about half way through the active contracts. This would be the case when both renewals and new maintenance agreement sales are happening every month.
C. Renewals are sent out at the end of the contract period rather than after the last visit.
In some companies the only pre-paid maintenance agreement sold is a two-visit contract. For this special instance V=2A and the escrow formula further reduces to:
This is why many look at the
escrow account and say it’s in the ballpark if it is at least 25% of the
annual pre-paid revenue.
6. Sales: Selling maintenance agreements is something that everyone in the company should be involved with. Service technicians can sell agreements on large repair jobs by quoting the maintenance agreement repair price and the regular price (assuming you are using a flat rate book that has both prices). In many cases the difference in the repair cost can go a long way toward paying for the agreement.
With training, customer service representatives can sell maintenance agreements over the phone when scheduling a service call. Some companies include a maintenance agreement with all new systems installed. This is an easy way to build a maintenance base.
If you want your business to stand the test of good times and bad times, we suggest you consider building a maintenance department. When the slow times hit we know we will have thousands of customers expecting us to take care of their system, suggest new improvements, and replace older inefficient equipment. These customers have become the lifeblood of our company.
They are helping us build the Ideal Full Service Company.
David R. Whitehead is the location president at Brody Pennell Heating and Air Conditioning, a Blue Dot Services Company. He’s been in the heating and air conditioning business for over 30 years. Starting out as a research engineer for Sperry Rand, Whitehead later joined his father, S. G. Whitehead when they purchased Pennell Heating and Air Conditioning in West Los Angeles. Active in many industry programs, David has served as president of the Institute of Heating and Air Conditioning and as president of the local Rotary Club. He is a member of both ASHRAE and RSES. He can be reached by email at: [email protected].