Welcome to Thomas Insights — every day, we publish the latest news and analysis to keep our readers up to date on what’s happening in industry. Sign up here to get the day’s top stories delivered straight to your inbox.
In the U.S., about 10% of all businesses are large and employ professional pricing experts to prepare both major quotations and set most product and service list prices. The remaining 90% of U.S. businesses are SMBs — small to midsize businesses. They task their sales, marketing, and service executives, with assistance from their CFO, to set all their prices. This and the next article in this series are offered to the 90% who set prices as one of their many responsibilities.
In yesterday’s article, we discussed the methods and considerations used to arrive at a spare parts price list that will satisfy most people who look behind the pricing curtain.
Today, we discuss real-world issues and considerations which make spare parts pricing more than just an academic exercise.
What About B2C Parts Pricing?
In the B2C world, the markup added to the cost of either B or C parts may be (much) higher than you would consider for B2B parts. This is because B2B buyers are skilled in determining the price they would pay for a part if they purchased it directly from the source.
B2C buyers generally buy replacement parts from either a big box store (Home Depot, Lowes, or Walmart) if they are doing the repair themselves or from a service person who determined that a defective part has to be replaced and the equipment is partially taken apart.
In either case, the buyer generally follows the recommendation of the sales or service person and does not shop around before moving ahead with the repair.
The Spare Parts Business Is Important to Your Business — and Your Customer’s Business
Spare parts purchases are usually OpEx, which are heavily monitored by the financial department because they are considered “controllable.” When money starts becoming tight, the message usually comes down from the CFO: “Cut your expenses.”
Even if spare parts are being purchased to repair a piece of CapEx, the financial people are trained to give service people a scary stare when they do not reduce their monthly OpEx costs as the CFO asked. So, if you want your relationship with your customer to blossom, you should create a pricing scheme that balances list price and company gross margin contribution.
There are three more variables to look at before thinking about pricing individual items:
- What is the context when a purchase is being made for stock or for immediate use? Think about these two scenarios:
- An automobile final assembly line in Tennessee, not Michigan, goes down. The maintenance technician quickly identifies the part causing the stoppage. He checks his stockroom and finds out there is no replacement part in the whole facility. Forget your list price. How much more do you think the plant would pay to have the part show up in 15 minutes? 1 hour? 1 shift?
- An automobile final assembly line in Tennessee, not Michigan, goes down. The maintenance technician quickly identifies the part causing the stoppage. He checks his stockroom and finds out there is one part in the stockroom. After installing the part and getting back to full production, he looks at past usage and determines that this was the first failure of that part in 18 months. He quickly calls the OEM to order a replacement part. How much extra do you think the plant would pay to have the part show up in 15 minutes? 1 hour? 1 shift?
- We see that the value of a part is significantly influenced by when it is needed.
- Most business’ parts pricing is based on delivering within a stated period of time (scenario B above). In a case where an extraordinary effort is needed to meet unusual requirements, the OEM usually adds an expediating charge that is large enough to cover all additional expenses (or their value).
- Will the part be new, or refurbished, or remanufactured and made equivalent to new (ETN)?
- Long before the circular economy was a thing, many companies refurbished or remanufactured parts returned by customers. In many cases, this was just a functional test or a quality control final inspection. In other cases, the part had to be extensively cleaned and re-machined. But no matter what had to be done to make the returned part saleable, the pre-owned part usually sold for less than a new part, even though they both performed the same job.
- There is one exception to what I just described. Some industries, and some businesses, define a category of spare parts as “equivalent to new” (ETN). The returned part goes through an enhanced process to ensure that not only will the ETN part perform like new, but that it will have the same remaining useful life as a new part. In those cases, a careful look at the sales and services terms and conditions will show that the seller reserves the right to use either new or ETN parts and that both carry the same warranty. And both carry the same selling price.
- If you are requiring a defective part to be returned, who pays shipping and how much credit will you give the customer?
- When a replaced part is being returned, the OEM usually includes a shipping label in the box with the replacement part. The customer is instructed to use the same shipping box for the return trip and to ship it within a reasonable delivery time. In most cases, there is no need to ship a defective part with overnight delivery but certainly within 3 to 5 days would not cause your customer any issues. And don’t forget to issue an RMA number and have the customer add it to the label.
- The credit you issue must be determined using some sound judgment. The best way is to work backward from your new part list price. First, subtract the used part credit to arrive at a used part list price. Next, collect all the company’s costs to prepare the part for resale. Plug these two numbers into the previous selling price formula and calculate your total margin. Finally, compare the margin to your target margin and adjust the selling price as necessary. Apply your judgment by considering both competitive and strategic pricing discussed above.
You Can Now Develop Your Spare Parts Price List
Here are the steps you will take to complete your spare parts price list:
- Step 1: Decide and agree on what your total spare parts sales ($) and margin (%) will be in the planning year.
- Step 2: Divide your spare parts list into the three types (A, B, and C). Model your projected planning year sale for each part number (quantity and standard cost) or work on an average number for each category.
- Step 3: Using these three totals, decide the revenue and margin each type of part must contribute to achieving your revenue and margin target.
- Step 4: Use the margin for each part number and the appropriate costing method to calculate the new list price.
- Step 5: Compare the new price with the prior year's price to make sure customers will not suffer sticker shock when they are quoted the new price. Adjust if necessary.
Don’t Forget to Adjust Prices for Inflation
During our business lifetime, inflation has been reasonably steady, and materials scarcity has been insignificant. Therefore, we have increased the prices of our services by somewhere in the 1-4% range every year. Our customers understood why we were making these changes, and, in fact, they did the same thing with their customers.
However, now and for the next year or two, economists are projecting an elevated level of inflation. And materials scarcity will increase the cost of some, but not all parts by a greater amount.
For example, oil prices recently hit a seven-year high. That means petroleum-based products like plastics and shipping costs are likely to increase by more than the 1-4%. Depending on your internal analyses, you have a few options:
- Do nothing and absorb the extra costs. Your customers will appreciate your decision, but you will be setting an expectation that you may not be able to repeat the next time there are significant price increases.
- Raise prices for the affected parts and explain why, as necessary. Your customers will understand, but they will be worrying if you will repeal the increase when the cause passes.
- Keep the existing prices in place but add a temporary surcharge. Your customers will understand and will be able to see that you stop the surcharge when appropriate and, if not, they will have less of a hassle pushing back on prices.
And what will you do if your standard cost drops? Will you still increase the list price, keep the price unchanged, reduce the price a little, or reduce the price to what you calculate is the true new list price? Remember that the C parts are available from other sources, so customers can see their prices. These are usually the least expensive parts and reducing their cost will not have a major impact on your margins.
The A and B parts are more expensive, and customers will notice a small price reduction. In fact, you may decide to place a short “note” in your order acknowledgment indicating a price drop because you are passing along part of your cost reductions. Then, when you have to increase the price you can point out that ”the pendulum swings both ways.”
Don’t Forget About Extraordinary Circumstances
All the previous ideas were premised on routine or normal business situations. But sometimes there are special situations that cause us to relook at a subset of our spare parts price list.
In my experience, significant supply chain interruptions like we are being subjected to in mid-to late-2021 cause sellers to boost prices when items are scarce, and demand remains steady or even increases (hoarding).
Another situation occurs when a supplier acquires a significant quantity of the world’s supply of something and demand is steady or drops. If the vendor doesn’t want to hold the inventory and let the market work down stock levels, they may offer exclusive deals to monetize the excess inventory.
In either case, all the pricing analyses you did went out the window in the desire to balance sales levels and on-hand inventory. And that is what makes pricing and inventory management interesting.
Sam Klaidman is the founder and principal adviser at Middlesex Consulting. He helps his B2B product manufacturing clients grow their services revenue and profitability by applying the methodologies and techniques associated with the Customer Value Creation and Customer Experience professions to assist his clients as they design and commercialize new services and the associated business transformations. Contact Sam here.
Image Credit: Andrei Kholmov / Shutterstock.com