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Exploring Your Options

By Richard E. Crandall, PhD, CFPIM, CIRM, CSCP | July/August 2012 | 22 | 4

Why manufacturers should consider the service business

The North American Industry Classification System (NAICS) uses the following codes to classify businesses: 01-09—Agriculture, Forestry, and Fishing; 10-14—Mining; 15-17—Construction; 20-39—Manufacturing; 40-49—Transportation, Communications, Electric, Gas, and Sanitary Services; 50-51—Wholesale Trade; 52-59—Retail Trade; 60-67—Finance, Insurance, and Real Estate; 70-89—Services (professional, health care, education, accommodation, and entertainment); and 91-99—Public Administration (governments and nonprofit organizations).

Manufacturing is considered one of 10 major divisions, or classifications, of businesses. While the first two—Agriculture, Forestry, and Fishing; and Mining—can be viewed as extractive businesses, Construction and Manufacturing are transformative. All the classifications listed after Manufacturing can be grouped into a broad category of services.

Manufacturing is “a series of inter-related activities and operations involving the design, material selection, planning, production, quality assurance, management, and marketing of discrete consumer and durable goods” (Blackstone 2010). It involves taking the outputs from farms and mines and transforming them into facilities or products.  

While manufacturing is concerned with making a product, services focus on enhancing the product’s use. This involves making it more accessible and more meaningful to the user, whether that be another business or an individual consumer. The APICS Dictionary defines the service industry as “an organization that provides an intangible product (e.g., medical or legal advice)” and “all organizations except farming, mining, and manufacturing” (Blackstone 2010). 

Now, consider the definition of supply chain: “the global network used to deliver products and services from raw materials to end customers through an engineered flow of information, physical distribution, and cash” (Blackstone 2010). From this, it is obvious that a supply chain spans all the industries included in the NAICS. The supply chain concept also offers an opportunity for manufacturers to add services to their operations.

There are two main categories of customers for manufacturing companies: other businesses and individual consumers. When selling to other businesses, manufacturers have a direct connection. When selling to individual consumers, manufacturers often go through distribution companies such as wholesalers and retailers. Therefore, the link with consumers is less direct. But this is changing as more manufacturers move to online sales of products, with the subsequent direct link with consumers.

Why would manufacturers be interested in providing services? Would that not move them from their core competencies or shift their strategic objectives? Actually, in many cases, adding services not only strengthens core competencies, but also helps the business focus on strategic objectives. Following are some of the reasons manufacturers should add services to their product portfolios.

Increase sales and profits. Perhaps the most attractive reason for adding services is the prospect of boosting revenues and profits. “Post-sale service is one area of the supply chain where profit potential still remains untapped by many manufacturers. But that may be changing with mounting evidence of its impact on a company’s bottom line” (Vigoroso 2011). 

Increase product sales through support of customers. Many manufacturers have found they can increase sales if they provide added support to their customers, especially in the form of financing. Thomas Edison, the founder of what became General Electric, recognized this opportunity early. His company invested in small, private electric utilities to assure there would be a readily available supply of electricity to homeowners, to whom General Electric wanted to sell electrical appliances (Rothschild 2007). Today, as retailers often are larger than their manufacturers, the manufacturers have refocused financing efforts upstream toward their own suppliers.

Enhance relationships with customers. Manufacturers are becoming more customer-centric. As they move from a “make and sell” to a “sense and respond” strategy, they will enhance the sale of their manufactured products and solidify their position as a viable and contemporary business (Halleck 1999).

Evaluate product performance after sale. Providing repair and maintenance services to buyers of their equipment enables manufacturers to evaluate how well products perform in an industrial setting. They can assess durability and serviceability—and selling spare parts adds to the manufacturers’ knowledge about critical design points.

Search for new product opportunities. Being closer to customers often provides new product opportunities. Servicing equipment implies a physical presence in the customer’s facility. This enables the manufacturer’s employees to cultivate relationships with the customer’s staff, perhaps leading to the early identification of customer needs. It also makes it possible to observe a competitor’s equipment and its strengths and weaknesses.

Search for additional profitable business. As products reach the mature stages of their life cycles, profit margins decline because of increased competition from other companies or new products. If a manufacturer doesn’t have a continuing stream of new products, it may find its income eroding. It is tempting for management to look for added business with higher profit margins, sometimes found in the service sectors. IBM saw its manufactured product line erode as small computers replaced the large mainframe computers at which IBM dominated. While it took an outsider, Louis Gerstner, to lead the transition, IBM transformed itself into an almost completely service-oriented company, with emphasis on consulting and systems management.

Potential service businesses 
When manufacturers sell products to other organizations, they can consider providing producer services, such as repair, maintenance, spare parts, and facility management. When manufacturers sell to individual consumers, they can consider providing personal services.
Figure 1 illustrates some of the services that can be added to support or expand revenues. The services on the upper portion have been classified as tier 1, tier 2, and tier 3 to indicate different levels of attractiveness, with tier 1 being the most attractive, tier 2 somewhat attractive, and tier 3 the least attractive.
Exploring Your Options
The service sectors are color-coded to indicate potential attractiveness of the specific service business. Green services indicate a logical extension because they are linked directly to the product. Yellow services indicate reasonable extensions if the manufacturer has technically qualified people or a strong financial position. Orange services indicate the manufacturer should use caution before entering; they represent a real stretch. At the bottom of the diagram, social services are coded in red to indicate that most manufacturers should leave these matters up to nonprofit organizations and governments. The logistics functions also are probably not a good area because of the specialized nature of the process and the highly competitive industry. 

Tier 1 services
One of the most obvious services for manufacturers to add is providing replacement parts for their products. Replacement parts often have a larger profit margin, and original equipment manufacturers are in the unique position of knowing more about the component parts of their product than anyone else, at least in the early stages of the product life cycle. In addition to attractive profit margins, the sale of replacement parts can provide some useful information about durability. GE has long sold replacement parts for its jet engines. In addition, it has maintained a presence in the nuclear power business by selling replacement parts for reactors built in the 1960s (Rothschild 2007). Caterpillar is another company that stresses the importance of having fast response to customers who need replacements for heavy equipment (Caterpillar 2012). 

Another logical extension for manufacturers is providing repair and maintenance services. This is most important for manufacturers of equipment that requires professional-level repair and maintenance, such as nuclear power plants or sophisticated medical imaging machines. It also is appropriate when the user organization does not have qualified personnel to maintain more mundane equipment, such as air conditioning, copiers, and elevators.

Tier 2 services
Tier 2 services represent a bigger challenge, but may be even more rewarding for manufacturers in terms of increased income and closer customer relationships. While these services extend manufacturers’ product knowledge, they tend to be less specific to a product and more concerned with higher-level decision making. Examples include facilities management, project management, process consulting, and financing.

Facilities management could involve the management of a distribution center for a retailer or the management of an automated people-mover system for an airport. Project management may include performing the return on investment analysis for building a nuclear plant and then managing its design, installation, and operation. An example of process consulting is a manufacturer working with a customer on design of packaging to protect the product and reduce cost.

Providing financing to customers has long been a service that well-financed manufacturers have pursued. Some examples include paying a supplier for tooling used exclusively for the manufacturer, stocking consignment merchandise at a retailer, or buying airplanes and leasing them back to the airline. GE started lending money to private electric utilities in the 1870s and later consolidated its financing business under GE Capital, which today is a major component of GE’s business (Rothschild 2007).

Tier 3 services
Providing tier 3 services would be a severe challenge for most, if not all, manufacturers. These include specialized professional services, such as government relations (lobbying and political activism), insurance, auditing and tax, legal services, and banking. It also may include other services that are outside the ongoing scope of a manufacturer’s business and likely beyond the core competencies of most organizations. While some companies have tried the banking route, two notable withdrawals include General Motors and Sears. 

Businesses to avoid
Moving product is a more complex process today than a century ago. At one time, automobile manufacturers delivered their finished cars to dealers. Today, many are using third-party logistics providers such as UPS and Ryder to move their cars. With the strength of existing companies in the industry and the complexity of government regulations, it does not appear to be an attractive service area.

Clearly, manufacturers should avoid entering services that are beyond their core competencies. Even GE, with one of the finest in-house managerial training programs, found that some of its ventures exceeded capabilities. The company found that a good manager could not always effectively manage a business in which he or she had no experience. One of its market opportunities was designing and building housing communities in the 1960s, an unsuccessful venture that was vacated after finding that land acquisition was a critical step in the process, but one GE had missed (Rothschild 2007).
As shown in the bottom half of Figure 1, social services may be too far from a manufacturer’s comfort zone to be viable. Most of these services fall into the realm of nonprofit organizations, state-funded organizations, and regulatory agencies.

Making the move
There is considerable evidence that manufacturers are successfully moving into services. The previous examples from GE and Caterpillar illustrate their commitment to service businesses. GE Capital, the financing arm of the company, represents approximately one-third of revenues. In addition, each of its product business segments have major service elements (GE 2011 10-K). Total service profits represent more than 50 percent of GE’s revenues for the past several years (Mergent Online 2012). 

Caterpillar has expanded its service operations, and the company has this to say about its customer and dealer support group: “When our customers need to build out, dig down, or power up, Caterpillar is there to support their needs. Our Seed-Grow-Harvest Business Model is built upon a foundation of delivering valued quality products, services, and solutions to our customers, which in turn provides them with the lowest owning and operating life cycle costs. This begins with building sophisticated, quality machines and then supporting the customer in a variety of ways: employee equipment training on job sites, supply aftermarket parts and service support, and offering eBusiness and Equipment Management solutions” (Caterpillar 2012).

Although not yet a major consideration, the sustainability movement may portend the need to consider not only the product and service life cycles, but also the recovery life cycle that is almost certainly just over the horizon. See Crandall (2012) for a fuller discussion of these life cycles.

Finally, just as manufacturing companies are moving into services, some service companies are moving into manufacturing. But that is another story.

  1. Blackstone, John H. 2012. APICS Dictionary. APICS The Association for Operations Management. Chicago, Illinois.
  2. Caterpillar Customer and Dealer Support. (2012). caterpillar.com/cda/layout?m=389975&x=7&ids=3366549.
  3. Crandall, Richard E. 2012. “An Expanded Perspective on Product Life Cycles, Ten Attributes for Success,” APICS Magazine. 22(3), 20–23.
  4. GE 10-K. 2011. Products and Services. ge.com/products_services/index.html.
  5. Haeckel, Stephan H. 1999. Adaptive Enterprise: Creating and Leading Sense-and-Respond Organizations. Harvard Business School Press. Boston, Massachusetts.
  6. Immelt, Jeffrey R. 2011. Letter to Shareholders, GE 2010 Annual Report.
  7. Mergent Online. 2012. General Electric Co. mergentonline.com/companydetail.php?compnumber=3597&pagetype=synopsis.
  8. NAICS Association. 2012. naics.com/search.htm.
  9. Rothschild, William E. 2007. The Secret to GE’s Success. McGraw-Hill, New York, New York.
  10. Vigoroso, Mark W. 2011. “Manufacturers Profit from Post-Sales Service,” Industry Week and Servigistics Manufacturing Roundtable.

For a free bibliography of more than 60 articles on this subject, contact the author at crandllre@appstate.edu.

Richard E. Crandall, PhD, CFPIM, CIRM, CSCP, is a professor at Appalachian State University in Boone, North Carolina. He may be contacted at crandllre@appstate.edu.

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