Directing an HVAC business requires a keen focus on service quality, but the necessity of managing...
For the last decade there has been a fanatical focus within the HVAC industry on creating membership programs. The focus has become so pronounced that it’s emerged as a key business pillar… with even Private Equity groups expecting it in acquisition targets.
And at surface level, Membership programs have a lot going for them: increased customer loyalty, steady revenue streams, and the promise of longevity for HVAC installations. They are sold as a win/win for Firms & Members alike, plus have the added benefit of keeping techs busy during shoulder months.
If you break out the core drivers of a successful maintenance program, there is certainly a lot to like.
- Enhanced Loyalty: You stay top of mind with your customers with constant check-in, keeping you top of mind when a real maintenance need arises.
- Consistent Revenue: In a business that kills what it eats, it’s nice to have some baseline level of predictable and reoccurring revenue to bank on.
- Longer Equipment Life: properly performed and timely maintenance should enable equipment to last longer, giving customers both peace of mind and reducing warranty claims.
Cracks in the Foundation
I’m always weary when something reads as too good to be true. With all things in life, there are no solutions, only tradeoffs. Sometimes those tradeoffs are worth it, but there is no free lunch. That doesn’t mean memberships are ultimately not effective, just that we should test the assumption instead of accepting it at face value.
Putting my Skeptical CFO hat on, the first question I ask is what parameters I would use to measure program success. Said differently, how can we go about effectively validating that our program is working as expected; what series of indicators (financial & operating) should I be tracking. Once determined, how would I determine if they are functioning as expected, and what action would I take if they are heading in the wrong direction.
It’s worth pointing out that we should avoid getting stuck in our spreadsheet and missing the bigger picture (Daryl Morrey is the poster child here, more on that another day). We don’t need perfection in our analysis, we are just looking for clear directionality; however, ignoring the numbers altogether is akin to operating blind. Only by combing both our analytics & industry insights do we ultimately create the alchemy that converts bronze into gold.
In attempting to measure the quality of our membership program, its best to avoid recreating the wheel. Instead, let’s simply borrow some best practices from the software industry (SaaS), which has extensive expertise in managing recurring revenue contracts.
First up, let’s try to compute the value generated by memberships. Ultimately, memberships are designed to keep us close to our customer (via improved loyalty), for the purposes of securing future service/install work. Said differently, the goal of our membership program is to increase the amount of money we earn per customer.
SaaS firms refer to this LTV or Customer Lifetime Value. Effectively, this represents the value of all revenue (or margin) generated per customer over their life with the firm. Imagine starting with a list of all your customers which includes your profit per customer (since day 1). Now simply take the average of that customer profit, and you have your firms LTV.
Why LTV matters in the context of Memberships is that the longer you can retain customers (ala loyalty), the more you can generate per customer over time, thereby increasing LTV. Ultimately, improving LTV via Membership should be cheaper than the cost of acquiring new customers (referred to as CAC or customer acquisition cost, more on that later).
Clearly when considering LTV, the most important element is ensuring customer loyalty over time, ala we want to ensure members stay within the membership program for as long as possible. As you probably guessed, there’s a SaaS term to measure this as well, introducing Customer Churn Rate. Churn Rate is the rate at which customers stop doing business with a company over a given period (normally annually). It can be thought of as the % of members who cancel or don't renew their memberships. Churn Rate provides a quick sense of how much our members value the membership benefits. The faster they leave (or churn out) the less opportunity we must monetize that relationship. Ultimately, if Customer Loyalty and Closeness is a core tenant of Memberships, Churn Rate% is the numeric representation of that Loyalty. As the Churn rate increases, LTV decreases, as we are unable to capture future revenue opportunities upside for those customers. High churn rates can signal underlying symptoms that need to be addressed, but we will expand more on that later.
Finally, the last piece of the puzzle is the actual memberships program Net Profit. Effectively we need to understand the fully loaded cost to deliver memberships. This isn’t as straight forward as one would thing, as it not only includes tangible elements like the technician’s time, truck, and materials, but also less visible intangible costs like Customer Discounts and Business Overhead.
Discounts represent a critical, and often overlooked, calculation as many customers buy the memberships solely for the discounts on service. It’s important to keep in mind that these discounts are much more expensive than they sound, as they represent a dollar-for-dollar reduction to the bottom line (100% fall through in finance speak).
To illustrate the impact, increasing prices of my services by 10% does NOT increase dollar profits by 10%, but upwards of 50%. An example may help to clarify this point. Assume I charge $100 for my service and generate $20 of profit (20% Net Income Margin). If I raise prices by $10, assuming no other change in cost structure, my profit goes from $20 -> $30 (a 50% increase). Unfortunately, this also works in reverse, and a 10% discount can represent a sizeable % reduction in profit.
The next element intangible program cost to account pertains to Overhead costs. These costs exist whether the tech performs billable work or maintenance visits. The entire back office overhead expenses (Mgmt., Warehouse, SC, Accounting, CSR, etc.) doesn’t disappear depending on the type of job the tech is dispatched to. As such, membership or not, all jobs/programs need to ensure they are recovering the cost of the overhead functions. As such, understanding overhead costs is an important consideration with assessing total membership program performance.
As a contrarian point here, there's an intriguing counter argument to be made regarding work performed in shoulder months. If a technician might have been idle during these times, is there really any incremental cost of sending him out for a maintenance visit (less gas and mileage)? This consideration nudges us towards a deeper exploration into cost allocation methods, such as the difference between incremental and fully loaded P&Ls, which might be a conversation best saved for a dedicated article.
Measuring Success:
Now with our 3 key metrics defined, LTV, Churn, and Net Profit, let’s dig a bit deeper into how they are computed, what’s the general industry trend results are, and what it means if they are heading the wrong direction.
- Customer Long Term Value (LTV):
As noted previously, this represents the average amount of dollar margin each customer generates for their firm (on average). Getting the necessary data to compute can take some work as you’ll need to combine operational and financial data.
Assuming you use ServiceTitan, you would need to start with an extract of all your Membership clients, along with the total gross margin each has generated (across all Job Types). Worth reiterating here that we want total Net Margin, not Revenue. Revenue is a vanity metric; margin is money in my pocket. Computing Net Margin can be tricky, so work closely with your accounting team. Ideally, if you have been running Job Costing, you can back into this number painlessly.
Worth noting that it’s easy to get bogged down in details, but approximations will work perfectly fine. If you have Gross Margin values (via Job Costing), simply include an Overhead Allocation Estimate (% of Revenue) to get you to the estimated Net Margin. If more info is required on the difference between Gross and Net Income computations, I’ll do another blog post on it.
One you have the Net Margin per Member; all that’s left is to compute the simple arithmetic average. You now understand the lifetime value of your membership clients. Next step is to compare this number to that of non-members (a bit more work for your finance teams) to validate that your LTV is trending up within your membership cohort.
If you are not seeing your LTV improve with Member customers, it could be a symptom of a bigger issue. Keep in mind that if you’re new to membership, this issue could be a sampling bias, as your membership isn’t old enough to yield dividends yet. Otherwise some more difficult questions will need to be asked.
Some common causes of LTVs not improving within Membership programs can boil down to either high Customer Churn rate (more in the next section), or potentially you are maintaining the units so well that it’s pushing back maintenance events. That’s necessarily a program weakness (equipment life extension is the design intent after all); however, we need to ensure we aren’t burning money supporting a program that only yields value to the customer (it should be a win-win after all).
Whatever the numbers are, own them and ensure they align with your expectations. Worth noting that we have yet to account for the Net Profit (or Loss) the Membership program generates (more on computing this shortly). If your membership loses money, and simultaneously fails to improve LTV, we have a problem on our hands.
- Customer Churn Rate:
As noted earlier, Churn Rate is that rate at which customers exit your membership program over a year. You can compute it by dividing the number of members who canceled (or didn’t renew) by the total number of members. This computation yields value ranging from 0 – 1 (0 meaning no members canceled, and 1 meaning all members canceled).
If you are using ServiceTitan, this can be easily derived from the existing membership reporting; however, as always check with your finance team for support. Ideally this number should be as close to 0% as possible; however, acceptable SaaS churn rates come in at 5%-7% (per year.) As noted earlier, Churn rates are linked to LTV. Specifically, if a customer leaves the program quickly (ala high churn), LTV uplift will be depressed, significantly putting a damper on the economics of the membership program. Ultimately, the intent is to keep members around long enough to build loyalty and future revenue. Unfortunately, it’s not unusual within our industry to see membership churn rates between 30%-50%.
When analyzing the root causes for high membership churn, the culprit normally manifests as a combination of bad sales strategies and poor membership structure. It’s all too common for techs to sell the Discounts when pushing Membership, effectively selling the prospect on immediate cash back. As such, these members do not stay with the program long term, as the primary driver was the immediate membership savings.
One could argue that ultimately, we are trading money now (discounts on service), in exchange for hitting a vanity metric (namely Membership Count). While great for bragging rights, most people would never consciously make this trade.
Side bar, but many firms have pursued memberships under the guise that Private Equity likes them. To be clear, any Finance Investor appreciates the allure of recurring revenue. It gives them certainty when underwriting the deal that some degree of cash will materialize irrespective of outcome. With that said, PE isn’t stupid, and no one wants a liability simply because it has recurring revenue. PE is getting wise to this, and in some cases even reducing sales prices due to bad membership program design. Ultimately, make sure you are chasing the right metric here -> Profit first, always.
- Membership Net Profit:
Finally, what we want to know is how much the program makes (or loses) to run on an annual basis. Ideally this should be more than the LTV Uplift we discussed earlier. If your LTV for Members goes up $5K over 10 years, but it costs $500/year to deliver, then the entire initiative is simply breaking even.
To analyze the actual cost, you should have a separate class/business unit in your accounting and operational systems to help delineate these costs. Again, Finance can help here, but you will likely need to pull some additional elements together to get the full picture. As noted previously, you want both tangible (trucks, tech, parts) & intangible (discounts, overhead) costs to derive a complete picture.
One of the trickier elements here is the value of discounts offered to a member. Unfortunately, many accounting configurations have discounts showing up as negative revenue, instead of a cost. As such, capturing the value from your Accounting System may be tricky. If you are using an operational tool like ServiceTitan, you should be able to extract a report which can be combined with your Financials. Worst case scenario, you’ll need to resort to some back of the envelope math (some insights are always better than no insights).
Next step will be the Overhead Cost associated with memberships. I’m a big fan of the KISS model (Keep It Simply, Stupid) and would recommend not getting overly scientific here. Just some up with a % split, and then allocate based on Revenue.
With all these elements in hand, you’ll be able to finally determine the actual Net Profit (Loss) of your Membership Program. Don’t be surprised if this is a loss, that’s not uncommon. At the end, you can consider the Membership Program as just another marketing program, so long as it generates value (ala LTV) then it’s okay for operate at a loss (even better if it can be profitable).
Just be careful not to take this train of thought too far. All marketing programs need to be measured on the value they generate, normally computed as Customer Acquisition Cost (CAC) / Revenue. In fact, an interesting way to think about losses generated from your Membership Program is to compare them to your firm’s internal CAC. If your Membership Net Loss / Member Count is Great than your Customer Acquisition Cost on new clients, it may not be the most effective return on invested capital.
Final Thoughts
Now with all the numbers, it’s important to take a step back and consider what source of actions can be considered in the event the numbers are not living up to expectations. The starting point is what can be done to stop the hemorrhaging of cash. The starting point here is Program Design (and Cost), some questions to ask oneself.
- Can the frequency of visits be reduced without impacting customer loyalty?
- Can visits only be scheduled/performed during slow periods (effective idle capacity).
- Is there anything that can be done remotely that would replicate the feel of in person.
- Mailing Filters every 6 Months
- Offering Remote Monitoring & Notifications
- Quarterly Phone Call Follow up (ISR)
Here’s a novel idea, what if we simply offered membership for free, like a Grocery Store. We would remove all physical visits and % discounts, and instead offer them more scalable offers like free future warranty diagnostics, quarterly email/newsletter, bi-annual filter replacement reminders (maybe even affiliate links to purchase). Since the benefit was free, maybe we could avoid needing to incentive them through expensive values like discounts and visits.
Once the design has been reassessed, we then need to ensure members stick around by managing churn. A key point here is to ensure that techs are trained to sell value over cost savings. Part of this may mean clawing back bonuses for customers who don’t renew membership (or cancel quickly). Ultimately, we don’t need every customer to be a member, just the ones who will stick around use us in the future (loyalty).
In the end, there is a counterpoint that member checkups/visits ensure we stay connected with our customers as humans. In addition, they have the added benefit of keeping our trucks on the road and fueling top of funnel brand awareness. I’m not negating or disagreeing with this; I’m only noting that we should ensure we treat Memberships no different than any other Marketing Spend. You can’t manage what you don’t track.
As always, your mileage may vary. The world is nuanced and there’s no universal truths. This is just my current thinking based on my observations.
The Skeptical CFO
