In this article, the authors present pricing strategies that pricers in the off- highway vehicle industry can employ to increase profits and cut costs in the fluctuating global economy. This industry- specific analysis provides pricing strategies and advice that can be applied by pricers in multiple industries. Antoine Weill is a Partner Elect in the Global Heavy Equipment Practice at the Simon-Kucher & Partners Frankfurt office. He can be reached at antoine.weill@simon-kucher.com. Jan Yang is Managing Director at the SKP Bejing office. He can be reached at jan.yang@simon-kucher.com.

The Pricing Advisor, March 2016

The global off-highway vehicle industry has been facing severe headwinds in the last few years. China, the global growth engine in the last decade, has considerably lost steam. Sales of construction equipment, for example, is expected to dip year-on-year into the next five years. Other major markets such as Europe and North America are recovering only slowly. The near future of the industry is uncertain and fraught with challenges, especially in terms of topline growth. Overcapacities in production inherited from periods of fast growth, coupled with sluggish global demand, are causing original equipment manufacturers (OEMs) of off-highway-vehicles serious problems.

To navigate the difficult time ahead, many OEMs are taking measures to streamline production processes and slash costs. Unfortunately, they have not paid sufficient attention to the revenue side ‒ the actual core of the issue. One source of topline growth that is largely overlooked is the aftermarket, which will play an increasingly important role in maintaining topline and profit growth for the entire industry for the years to come.

Spare parts, and specifically spare parts pricing, is one of the largest levers to drive aftersales performance, and the potential in many OEMs remains largely untapped. It is no easy job and takes a lot to manage the pricing of spare parts effectively. Just imagine there are a hundred thousand stock keeping units, multiple price levels and thousands of customers to be checked and maintained each year.

Leading OEMs in the industry manage to achieve >65 percent gross margin on spare parts while keeping their distribution network financially healthy. They master spare parts pricing by focusing on the following four essential elements: pricing strategy, list price setting, dealer discounts and customer discounts.

Pricing strategy

OEMs need to have a set aim when carrying out spare parts pricing. Do they want to support sales of goods overall (in other words with low cost of ownership) or do they intend to maximize aftersales profits? The aim will determine the approach. Often OEMs are very much linked to original equipment and services providers (OESs) or independent aftermarket prices, when it comes to competitive positioning. There is no doubt that we will see plenty of ultra-low prices of parts from unidentifiable sources. If that is the base for price decisions, price reductions are inevitable.

Leading OEMs segment their parts into product groups and determine the price strategy of each product group based on a set of pre-defined criteria such as safety relevance, price image, competitiveness etc. (See Figure 1). The resulting price positions are reviewed and validated on a regular basis.

List price setting

This appears fairly straightforward. Let’s assume, for example, the cost for manufacturing and logistics of a company is

$100. A 30 percent markup seems decent. So the part is priced at $130. Is it easy? Yes. Is it correct? No, because it does not take market factors, especially customer willingness to pay, into account. There are many well-known examples in the vehicle industry, where OEMs and OESs set prices for their innovations too low and regretted it.

Pricing is about value extraction. When it comes to list price setting, one needs to really understand which value drivers determine the intrinsic value (list price) from the customer perspective. Take v-belts for example: the primary value drivers are length and number of belts (single vs. double). Thanks to the regression technique, among other analytic methods, the discrepancies in existing prices can be revealed and corrected to re-construct the should-be prices (See Figure 2).

It should be emphasized that list price setting is very important for professional pricing, as it sets the starting point of what is known as a pricing waterfall (a scheme that depicts all prices along the transaction chain, from list price to end customer price).

Dealer discounts

OEMs of off-highway-vehicles rely on dealers for distribution and customer care. Dealer discounts can be used as an effective tool to influence dealer behavior. Unfortunately, in many cases dealer discounts are historically grown and lack logic of any kind. Either there is no differentiation across parts categories or there is huge discount variation for no apparent reason.

There is no one-size-fits-all system. The one that fits is the best. That said, a good discount system comes from knowing what you as an OEM want to achieve and understanding how to get your dealers help you achieve it.

Leading OEMs tend to break down discretionary discounts into discount elements that are clearly linked to certain market indicators and dealer performance. Depending on the parameters of the market indicators (e.g. degree of competitive pressure and dealer performance, realized sales volume), dealers will “earn” the discounts they deserve. In the meantime, they will have the incentive to work harder to earn greater discounts. See Figure 3 for an example.

Customer discounts

Customer discounts form the last step of the price waterfall. In the majority no direct control over street prices. Frequently, customers with similar user profiles in different regions end up paying very different prices for the same spare parts because the dealers do not always think alike ‒ one of the root causes for a grey market. This also often leads to unsatisfied customers.

Although OEMs may not wish to meddle in their dealers’ business, best practice shows that OEMs can bring about positive changes to customer and dealer satisfaction, by recommending customer discounts that are, for example, based on explainable customer-specific discount drivers such as sales revenue, sales potential, industry type or historical payment behavior. See Figure 4 for example.

Spare parts pricing is a multi-faceted topic requiring considerable time and effort to manage effectively. But simply put, the main target is to increase prices without harming customer satisfaction, sales of goods overall, and market share. To do this it is important to be aware of where prices are sensitive and where they are not. This is much like pressing a fakir into a bed of nails without hurting him – some parts are more vulnerable, others can take more pressure.