Until a few years ago, many aerospace and defense (A&D) companies treated the aftermarket as an afterthought. Other industries have learned how aftermarket services can be a critical component of the sales mix, with the potential to accelerate revenue growth, improve profit margins, and strengthen customer relationships—all without a significant investment in capital expenditures. Recently, however, some A&D companies, such as engine providers, electronics-systems providers, and other tier 1 and tier 2 suppliers, have begun to obtain a significant share of their revenues and margins from aftermarket and use mature contract schemes to monetize their services.
These early movers often struggle to capture value along the full value chain, however. Their difficulties span all areas, from assessing opportunities to converting service revenues into cash. That is a key finding from a recent McKinsey survey of approximately 50 senior executives at major A&D companies in Canada, the European Union, the United Kingdom, and the United States.
By taking a structured, quantitative-based approach to identify service opportunities, supported by the right algorithms, companies can understand their scope. From that point, they can focus on implementing an aftermarket strategy, well supported by organizational resources and management attention, that focuses on five dimensions: people, operations, offers, digital tools, and external partners. Through this approach, A&D players can build a successful aftermarket business, with the potential to increase service sales by up to 40 percent for some underpenetrated areas in only a few years.
A structured approach to assess the aftermarket opportunity
One of the greatest aftermarket challenges involves assessing the opportunity. Among our survey respondents, more than one-third struggle to capitalize on their existing portfolio and installed base to target the right customers and equipment (Exhibit 1). What’s needed is a structured, data-driven approach to quantify the market potential from services and identify commercial opportunities. This may seem self-evident, yet it is rarely applied in practice. Less than half of companies in our sample say that they use this approach on a regular basis.
Identifying and capturing opportunities in aftermarket services requires a high level of rigor, discipline, and detailed knowledge because the business tends to be extremely fragmented. Companies must have a very disciplined approach to optimize value capture from the installed base, possibly involving the support of solid data sets and advanced analytics.
The aftermarket also tends to get overshadowed by higher-profile sales of new units. To gain more clarity about this segment, companies would benefit from making it a priority to size the maximum theoretical service potential for their current base of customers. When doing so, they should consider market-specific factors such as availability of other servicing options, customers’ propensity to outsource, and geopolitical issues.
Three steps are involved in sizing the potential from aftermarket services:
- creating a reliable data set on the installed base, which may entail collecting and consolidating decades-old information, particularly for longer life cycle platforms, which is often spread across multiple sources and data owners
- understanding customer maintenance cycles by conducting targeted interviews of salespeople, sector experts, and clients
- matching historical service orders with the installed base to build a comprehensive view of actual service penetration across the installed base
After conducting these steps, A&D companies will have a clear understanding of the additional market potential that they can capture, segmented according to the most significant dimensions for each player (for example, broken down by client, end user, product/system/platform, or country). From that point, company leaders can make more informed decisions about all subsequent steps—setting sales targets, allocating resources, and determining the best approach to capture the sales opportunity.
Sizing the aftermarket will require a dedicated effort to collect, cleanse, and match data before analyzing them using advanced-analytics algorithms. Implementing these algorithms is a baseline requirement for aftermarket success—not just in sizing the opportunity but also in supporting the members of the sales force by making them more prepared, showing them how they can proactively propose new service opportunities, and measuring their performance. Companies should keep in mind that the implementation process may sometimes be challenging, however. In our survey, respondents cite this as the top reason why A&D leaders struggle to quantify the size of the market opportunity.
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Beyond a solid process for assessing opportunities, companies that want to excel in the aftermarket should take several steps to transform their businesses. First, they should ensure that their operations are state of the art and well-orchestrated across all technical and support functions (for example, sales, procurement, operations, quality) as they expand from selling new units to delivering service. For instance, they could create the opportunity for retrofitting older products, upgrading them, or both. Companies must also encourage a complete mindset change—one in which employees begin to look at the aftermarket as more than just a business requirement and perceive it as a major opportunity to boost growth, profitability, and customer satisfaction.
Five pillars of a successful aftermarket business
With a clear idea of the market potential, A&D companies can take the steps required to win across five pillars: people, operations, offers, digital tools, and external partners.
People
Commercial excellence in aftermarket services requires organizational focus, but the service business is sometimes overshadowed by new unit sales within A&D sales teams. In our survey, 58 percent of A&D respondents note that their companies have created a dedicated sales team for services—40 percent have created dedicated training plans, and just 32 percent have service-specific incentives (Exhibit 2). Companies can capture the potential from aftermarket services only if they allocate the right level of human capital to the initiative, suggesting that more companies should consider creating dedicated sales units or teams.
Operations
Setting up operations and ensuring competitive lead times are the most mentioned challenges in our survey, cited by 60 percent of executives. Highly customized spare parts with long lead times are a perennial challenge, requiring that companies put the right supply chain and operations strategy in place to balance operational costs, working capital, and responsiveness to market requests. To address these challenges, many companies optimize operations by grouping products and services into clusters based on customer needs and supply constraints. They then define the best supply chain strategy for each cluster. The decisions for specific clusters are informed by advanced-analytics algorithms that consider historical and prospective demand, lead times, inventory rotations, and coverage ranges, among other factors.
Offers
Another key pillar involves developing a compelling service offering—a task that 40 percent of executives in our survey deem a central service-related challenge. To resolve this issue, companies could develop need-based solutions—tailoring the offer to meet the requirements of specific end users. In our survey, 56 percent of respondents say that their customers expect need-based solutions, and 66 percent say that this approach is becoming a key element of a compelling service offering (Exhibit 3).
Implementing need-based solutions requires companies to acquire a deep and structured understanding of customer needs. They can then segment those customers into groups with similar needs profiles and develop modular service offerings that consist of standard packages. Software tools, such as configurators, can suggest the most suitable packages and even support dynamic pricing based on market conditions.
In addition to traditional service offerings, multiple companies across industries are exploring service-based business models by transitioning existing products to “as a service” (aaS) models or by building new native aaS businesses. A&D still lags behind other industries in this area, however, with only 6 percent of companies offering aaS services or pricing products/services based on outcome or subscription-based models. There are clear structural reasons for the low adoption rate, especially the long life cycle of products and cybersecurity-related constraints. But A&D companies also tend to have a low appetite for risk, which limits their willingness to make the investments needed to support aaS offers. Their hesitation could hurt their bottom line, since A&D businesses can unlock significant value and achieve incremental top-line growth of 10 to 25 percent, coupled with increased customer loyalty and satisfaction, through aaS offerings.
As they develop aaS businesses, some companies have rolled out advanced contract schemes such as performance-based service contracts. Among survey respondents, approximately 50 percent consider these to be key elements of a compelling offering. Although performance-based contracts are becoming more widespread, for both platforms and equipment, they have sometimes fallen short of expectations, partly because the right conditions aren’t in place. To improve performance-based contracts, companies will benefit by ensuring that the following conditions are met:
- The OEM/supplier needs to have unique assets that end users can’t access, such as patented technologies, technical expertise, complex machineries, or more solid financials.
- Customers must be sufficiently mature, and the equipment in question must be mission-critical and complex to maintain.
- A&D players must have the right expertise in areas such as contract execution, advanced analytics, legal, and corporate finance; most important, they must focus on the end-to-end customer journey and ensure full accountability for system performance.
When these prerequisites are in place, performance-based service contracts help to ensure better equipment/platform performance at lower and more predictable costs for end users. Simultaneously, they allow companies to achieve higher margins and sign longer contracts, while providing them with an enhanced knowledge of end users’ needs.
Digital tools
Digital tools also unlock value from aftermarket services and, according to our survey, respondents highly value them (Exhibit 4). For instance, data-driven deal prioritization tools use advanced analytics and machine learning to help the sales force evaluate opportunities in real time. This software can learn from sales force feedback and apply the new knowledge to future opportunities, becoming more accurate and effective over time.
Using digital tools can entail challenges. A&D players are struggling across the board, in areas such as data preparation and cleansing, and many lack the appropriate internal capabilities and cybersecurity measures. In our survey, the most pressing concern involves identifying the right software partners within the ever-growing landscape of established players and new, more agile start-ups. This area might benefit from more attention in the future (Exhibit 5).
Network of external partners
As A&D players span national borders and become increasingly global, it’s critical to create productive relationships with local third parties. In our survey, approximately 30 percent of respondents consider a network of local partners as a source of competitive advantage. This stems from companies’ desire to extend their commercial presence and field-service coverage, as well as their desire to meet local content requirements in countries where offset rules apply.
To develop a strong network, companies will benefit from a robust selection process that follows all business and trade requirements. They may also want to improve the recruitment of local partners and enhance performance management.
The power of a commercial ‘command room’
A&D players can address the obstacles across all five pillars by launching a transformational growth journey that incorporates new tools and new ways of working, rigorous implementation across a range of initiatives, and obsessive performance management. To drive momentum and ensure that the program achieves its goals in terms of top-line growth, companies typically implement a commercial “command room”—a dedicated, cross-functional team that includes leaders from sales, marketing, and program management and meets at a regular cadence to identify key service deals and determine the best way to pursue them.
Technology is a component of the command room as well. Specifically, a digital dashboard gives the team transparency about the company’s current situation and targets. Analytics can inform negotiations with customers, track performance across actionable metrics, highlight next steps for decision makers, and increase overall speed.
Changes to commercial processes are a critical first step, but they aren’t sufficient to generate meaningful change. As customers require shorter lead times and more flexibility, A&D companies also need to make their service operations more efficient and responsive. For example, a comprehensive mapping of ongoing processes and involved entities can identify inefficiencies and quick wins that can shorten order-to-delivery lead times. In addition, rethinking the inventory strategy can help companies overcome structural constraints, using commercial data to identify the most problematic parts and create a strategic stock for expedited delivery.
After delivery, it’s essential to continue engaging with clients until payment is received. Because the services market is fragmented and contractual terms can be so complicated, delayed payments are common. A dedicated accounts receivable dashboard, with details of next actions and relevant owners, can help improve performance.
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Aftermarket excellence in action
Several A&D players have successfully embarked on service-excellence transformations. First, during the diagnosis and design phase, they mapped the installed base and the size of the opportunity. They then created a strategy to attack the most attractive or underpenetrated value pools. Then, during testing and rollout, the companies implemented specific initiatives, including tailored commercial campaigns and renewed service offerings. Finally, the companies captured the opportunity through a commercial command room and dedicated task force that executed the identified initiatives.
This approach can deliver results quickly. For example, a defense systems player launched a comprehensive, 18-month effort that led to 40 percent growth in service orders in one year and to the tripling of service orders in three years. In another case, an aerospace player planned a dedicated program to increase penetration of advanced contracts, including service revenue on its commercial fleet, by 30 percent in five years.
The aftermarket represents a clear and largely untapped opportunity for A&D companies. As our survey results show, there are some common challenges across the industry, starting with a lack of data and a related inability to size the market accurately. A structured approach to capture the right data on the installed base and quantify market potential—including the use of a dedicated algorithm—is essential. After that step, companies can transform across five pillars: people, operations, offers, digital tools, and external partners. While the challenges are real, solutions are readily available—making the aftermarket business a prize for the taking.
