A few months ago, my wife and I decided to tackle that nefarious task of cleaning out the basement for a garage sale. "Honey, how much for this?" my wife asked as she held up a stainless steel boat propeller that I'd purchased years ago. How much indeed. I bought that propeller for over $500 and never used it. What is it worth now? "Oh, just list it for 50 bucks," I said. Maybe I'd get $25 for it. Which made me wonder, would I be making $25 or losing $475? And at the end of the garage sale, when our cash box is clinking with quarters, nickels, and dimes, will we be making money by selling these items at such low prices, or should we mark the prices higher based on their current market values?
So it goes with the pricing of service parts, which has been more of an art than a science, a reactive process rather than a proactive one, a tactical process rather than a strategic one. In fact, most OEMs formulate pricing decisions by calculating the relationship between incurred costs and desired profits, a cost-plus approach. But this antiquated approach fails to provide visibility and pricing management across all markets. It also lacks the ability to measure the effect of price changes upon demand or competitive response to price moves; allows for little collaboration with procurement, sales, and partners; and fails to understand, track, and incorporate competitive prices and gross margins. Leading companies that have integrated new pricing technologies into their practices have appreciated enormous — and almost immediate — returns on investments, which can be tracked and measured, unlike the 'profits' from a garage sale.
Consider the following example of parts pricing improvement. An agricultural and construction equipment business relied on the cost-plus method to determine the price for service parts on its construction equipment. Its formula was simple: Every three months it increased the service parts prices; however, over time, it noticed that demand began to drop considerably. The company found that the vast majority of its service parts were priced well above the market averages across all categories. This overpricing attracted competitors to the market. And those competitors were beating the company because of the lower prices. Why buy an OEM part if there's one that's cheaper?
To increase demand for its parts, the OEM began conducting market research on a quarterly basis. However, research was 'set and forget,' as there was no tracking of competitive response over time. Therefore, the spreadsheets were left to collect dust after just one use.
With the new pricing software solution in place, the construction equipment manufacturer now systematically measures and calculates price sensitivity. In addition, the collected data is used to forecast demand, and the technology solution determines how much sales volume would increase by lowering a part's price.
During a recent company status update, the aftermarket parts segment realized a $2.8 million revenue increase for the quarter using a single large pricing policy. In the second quarter, the company realized over 3% in increased revenue, or over $40 million across all parts. Over $2 million can be directly attributable to increasing prices up to market levels for the handful of parts that turned out to be priced below competitive prices.
Improve Your Service Contract Pricing
Service contract pricing is another aspect of parts pricing that is frequently mishandled. Whether it be purchasing a new car or a new server, there's often a disconnect between sales and operations. So when the salesperson throws in a discounted service contract with your new office phone system, the company cannot determine if it's losing money or making money from that service contract. That's because the contract includes not only the price of the service parts, but also the cost of the field technician's time and expertise. With a pricing solution, companies can track previous contracts and then forecast to determine the profitability of the future contract.
Another benefit of parts pricing optimization is the link between customer satisfaction and price adjustments. For example, a leading truck manufacturer gave away more than $60 million in sales allowances associated with dealer complaints, but the manufacturer had no idea whether the price adjustments increased or decreased profit on these sales allowances. With parts pricing optimization, the truck manufacturer now has the ability to tie dealer complaints to competitive data points that will track the level of satisfaction and sales with each price adjustment.
Couple pricing with service parts management and service workforce management, and OEMs have the recipe for transforming service operations from cost centers to profit centers. In terms of selling my own service part at the garage sale, I ended up checking online, and my discontinued, never-been-used, stainless steel boat propeller was selling for $325. Maybe selling to my local neighborhood isn't the right strategy.
Mike Landry is founder and chief technology officer for Servigistics. He can be reached through the company Web site at www.servigistics.com.