Costing depends on contract periods

Vinay Deshmukh, CEO, Forbes Facility Services takes us into the nitty-gritties of how budgeting depends on the duration of contract and how the diversity within the manufacturing segment makes diverse demands on service providers.

Give us an idea of the Capex investment a service provider has to make before working at a manufacturing facility.

As a thumb rule, if it is an industrial contract with a major mechanised cleaning component and the monthly value of the contract is x, our Capex investment for that facility will be 5x-8x, whereas if it is a commercial facility, this investment will be x only (max 1.5x). This is why the contract period has to be at least three to five years; otherwise, if it is just for a year, the value of the product becomes tremendously high and may be unviable.

How do spends on machines evolve over the course of the contract?

Once our relationship with the customer is established, we may have to repair or replace machines, but it is not a completely new contract. For example, out of five machines, let us say one needs to be replaced; this would typically be needed and done after a year or more. We can take this in our stride with longer contract periods, but when we are just establishing our relationship with a client, Capex investment becomes very important, especially with manufacturing clients.

Do you abide by a minimum contract period for manufacturing clients? What is the reasoning behind this?

Onboarding happens only when the agreement is signed for at least three years; our costing is done according to this. Let’s say the monthly contract value is x, and our investment in machines is 6x. If the contract is for just a year, the monthly cost of the machine is 0.5x. The total cost becomes 1.5x; this is not viable. But if it’s a three year contract, this comes down to 1.15x, which is more favourable.

Customers who ask for a one-year contract and expect us to invest in the machines should understand that we cannot take such a risk.

In what other ways can long term commitments bring down machine costs?

Machine costs consist of three components: the AMC after the warranty period is over, replacement of parts that wear out like brushes, and EMIs to repay a term loan that the service partner may have taken for the cleaning machines. All of these need to be built into costing.

Typically, the only factor that is variable is the EMI component. The longer the contract period, the lower is the EMI. This is especially relevant to customers who have fixed spending ability and will find the difference in total cost (influenced by the EMI component) financially significant.

Are management fees also influenced by the contract period?

Ultimately, the management fee is a fixed percentage of the total cost. If the total cost is curtailed by signing for a longer contract period, this fee will also work out to be proportionately lower.

How does the level of Capex investment change based on the type of manufacturing facility?

Mechanisation will be higher where the waste generation is higher. For example, in automobile manufacturing, in the gear making areas or where shearing machines are used, a lot of oil and grease tends to spill, requiring a higher level of mechanisation.

On the other hand, in pharma – especially where intravenous or liquid products are manufactured – not much waste is produced. But this industry has its own set of restrictions, because we cannot take machines from one area to another, which also increases machine requirements.

Even in a bottling plant, there may be breakages; glass or PET cannot be picked up by a normal vacuum. These specialised machines require heavy investments.

Every facility needs some personnel to remain constant, and at least some of them should be service partner employees. They ensure continuity and will know details like which areas are prone to leakage and other important facts. On the housekeeping side too, they will know which areas are difficult to clean, which time of the day, week or month sees the most traffic and so on. The longevity of the team at the site is important for service continuity and quality.

At the beginning of every contract period, there’s a six to eight month period when the service partner gets to know the client and understand the site. If the service partner changes after just a year, the client has to go through this process all over again.

What would you say to potential clients who are hesitant to continue with the same service partner for a longer period, despite being satisfied with the partner’s performance?

The industry is no longer vaguely regulated as it used to be. Today, it is well protected by laws, and the judicial system has come a long way in protecting the interests of all parties.

Clients should take cognizance of this change. And we all know that however long the contract period is, every contract has an exit clause with a predefined or mutually agreed exit period.

In general, what trend in contract retention have you observed?

Almost 75% of our customers have been with us for over three years. 56% have been with us for over five years. There are many customers who have stayed with us for a decade or more.

After the initial period of three years, most clients tend to extend contracts by a year or two at a time. Since our machinery is already in place at the site, this suits us as well