There's value in service and warranties

Guest Commentary
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Wednesday, June 1, 2005

There is a truism in the security alarm industry that says, "You should run your business today, like you plan to sell it tomorrow." Tomorrow may seem like a long time from now, but it will come quicker than you think.
Most of us would agree that the primary value of our business is alarm monitoring contracts. If, however, we do not provide good maintenance service for those contracts, we will have higher attrition, collection problems and an unhappy customer base. Poor service means a smaller value for those contracts and greater difficulty selling them when tomorrow does come. This can mean a discount in value of as much as 30 percent or more for such contracts in the marketplace.
Most companies provide an installation warranty of 90 days to 12 months for parts and labor, but what happens after that? Typically, we charge the customer an hourly rate, plus parts, perhaps with a trip fee. Some companies now sell an extended warranty to the customer, which they self insure, and often bundle with the monitoring payment so the customer only sees one amount for everything. This deludes the dealer into thinking that his combined rate is real RMR valued as if it were all monitoring RMR. It also blurs the actual monitoring rate to the customer and diminishes the value of the service warranty. In that case the alarm dealer is betting that he will make more money from the warranty than it will cost him to service the customer. Industry after industry has found that to be a bad bet and the alarm industry is no different.
We make it clear in our monitoring contracts that we are not an insurance company. So, does it make sense to flip that logic when it comes to extended warranty contracts? Of course, it doesn't! That's why big public companies like Best Buy, Staples, Ford and GM have their warranties insured by an insurance company and, thus, rid themselves of the inherent contingent liability. Extended warranties have become a $24-billion industry with more than 70 percent penetration of certain sectors of the consumer electronics industry. Consumers, in general, do not have the know-how to repair their own electronic appliances and fear the added cost of paying someone else to do so.
In an insured extended warranty policy, we can cap our liability with the premium payment and add value with the mark-up of the policy to the customer. Additionally, we are reimbursed by the insurance company for each service call at our normal rates so we can build profitability into our service department. Finally, we have happier customers because they have a predictable cost of service and the peace of mind of knowing the alarm company has the support of an insurance company to provide certainty of service for their needs.
The difference between the wholesale premium for the policy and the price the customer pays becomes true RMR, because it adds to cash flow without additional liability and, therefore, has a multiple value. Insured extended warranties that cover virtually all the components of an integrated security and fire solution are now available to the alarm industry. This is timely because more than 30 state insurance commissioners are attempting to enact regulations that will prohibit us from providing self-insured warranties.
Now we can add real RMR value, profitable service departments and satisfied customers to the overall value of our companies. Insured extended warranties will add cash flow to an alarm dealer today and deliver a premium when he sells tomorrow.

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Tony Smith is the founder of Security Finance Associates, Inc. an investment banking firm, located in Pasadena, Calif. He can be reached at tsmith@securityfinance.com.