How to increase profit margins: The 5 key value areas to drive growth in spare parts pricing
While the economic principal of supply and demand is eternal for manufacturers, there are parts pricing complexities in the age of big data that require one to dig deeper. When it comes to pricing spare parts there are subtleties and nuances that can make a significant difference in margins and profitability. If you are not considering these following five strategies, you are leaving money on the table.
How to grow a spare parts business
1. Profitability Analysis:
Provide visibility into key performance metrics across the entire business utilizing price waterfall and price volume mix. By understanding all the drivers of pricing, finding root causes of poor performance, and identifying areas of improvement, you can increase profitability.
Negative margins are often a low-hanging fruit opportunity as they can be systematically eliminated with the right software. After an initial review, one of our customers recognized their on/off invoice adjustments were causing more than $200,000 in negative margins. By eliminating those sales, their net revenue decreased by $364,000, yet their profit increased by $220,000.
2. List Price Alignment Analysis:
Identify list prices that are out of alignment with comparable items. This could mean moving the price up or down depending on comparable items. Moving the price up means more revenue, of course, but moving the price down might move more products instead of being left unsold. Over time, this will uncover opportunities to incorporate strategic price differentiation.
During a recent engagement, we simulated the impact of rationalizing pricing on low-profit products. For each product group, we calculated the average margin of each product and compared it to the group average. Products with above-average prices were left untouched, but below-average prices were raised to reach the average margin for the group. While we do not recommend using this approach solely to set prices, it does offer a rough magnitude of range in pricing opportunities.
3. Customer Price Spread Analysis:
Find misalignment between customer characteristics and effective discounting policies. One way to classify customers, for example, would be by total sales – in every business there will be a distinct gap between the four or five classes of customer. From there, a simple analysis and comparison of the profit margin will often reveal some interesting data.
In one case, while drilling in to review the net revenue and discount percentage by customer, we discovered a large spread in discounts both within and across customer classes. There were strong indications the company may have been over-discounting with little consistency, meaning they left profit on the table.
4. Margin and Cost Analysis:
Identify uncaptured margin for improved supply cost structure, and/or delayed response to cost changes. Understanding shifts in key metrics, such as average unit cost growth and average list price growth, from a given time, often uncovers opportunities. The key is to identify and understand the impact of delayed response to cost increases from month to month.
We showed one of our customers how they were losing revenue due to their costs growing faster than their list prices. Effective pricing software utilizes alerts to proactively identify when there are shifts in key metrics, and then automates the price update to quickly adjust to market levels.
5. Buyer Trend and Market Analysis:
Identifying large shifts in volume, while simultaneously seeing market share opportunities based on similar customer buying patterns, may indicate changing market dynamics. There may be an opportunity to increase customer spend within part lines by comparing the average spend percentage across all customers to each individual’s actual spend percentage.
Through the analysis mentioned above, one of our automotive customers found a customer subset whose actual spend percentage was more than 20% less than all customer average spend percentage. This subset represented an addressable opportunity of more than $2.6 million.
Value Identification Program
These five value areas are a sample of the analysis options used to identify profit opportunities for manufacturers in spare parts pricing. Syncron offers a free, no obligation Value Identification Program (VIP) assessment which identifies growth opportunities with an effective pricing software solution. Having an optimized pricing strategy can lead to increased profit margins and market share, plus higher customer satisfaction.