Optimizing Returns with Smarter Product Segmentation – Part 1

It’s no secret that accurately segmenting your service parts will produce the best results when setting prices. However, doing spare parts segmentation “right” is another thing altogether, especially when pre-determined categories created by engineering and product development tend to shape much of the strategy. So, while product segmentation is a popular pricing method that’s commonly used in the spare parts business, there are lots of different approaches you should consider.

In this advanced series for more seasoned pricers, we’re sharing best practices and what we’ve learned from working with the world’s biggest OEMs all over the world.

This first post will explore the background thinking and prerequisite strategizing needed before diving in and doubling down on the particular segmentation and pricing methods that will work best for your business and specific market.

Let’s start with goals

In terms of business objectives, part segmentation is a great way for OEMs to identify underpriced items and discover where you can tap into additional margin potential. It also helps you understand where you’ve overpriced items as well as target those parts with a smaller market share to increase revenue.

There are a few things you need to do before you start segmenting. You need to determine the best pricing method to use and establish a baseline for all the various methods. For example, value, technical attribute, or competition-based; kit and bill of material; and supersessions. You need to find price differentiation opportunities and understand the price potentials within these opportunities. You may also need to look at local market commercial conditions and how you can adapt.

You might also need segmentation for analytics and reporting needs, which helps with understanding how categories develop across segments. And finally, you need to find a balance between the right level of segmentation detail and your organizational capabilities. The goal is to segment in the most optimal way, but going to extreme detail might lead to a lot of administrative issues later on. Figuring out what works best and what you can do can be a challenge.

Pricing methods

Next, let’s look at the various pricing methods you can use with segmentation.

The most common method is value-based pricing, which is best used with products where you have a unique position. You can also do this for other types of products using technical attributes. On the plus side, value-based pricing is logical and easy to explain. On the negative side, it can be labor intensive to collect the parts data needed – so you’re better off using it on a limited scope of items where it makes the most sense; not on your entire catalog.

For products where you take a follower approach, competitive-based pricing works best. This method can help you reduce over- and underpricing and adapt to market share. However, finding competitor data and linking parts can be challenging.

Advanced cost-based pricing makes it easy to set prices for the bulk of your products, making it a good method for when you need to price all your products without spending too much time on each item. The advantage here is that it’s resource effective. The disadvantage is that it uses a basic cost-plus approach, which means that you’re inevitably not extracting the greatest profits and margins possible from each part.

Kit-based pricing may be used by a one-stop shop providing a preconfigured set of items, for example, in a repair operation. To price the kit, local market prices of the items are summarized and priced. You might also have to use reference-supersession pricing, linking items together to improve quality. You could have statistical-based pricing in the background, using historical commercial information to negotiate prices. And you might want to do supply-driven pricing where you differentiate prices based on what’s in stock and your ability to deliver—with long lead times affecting prices.

Which pricing methods you use will have a big impact on what your segmentation looks like and the best way to move forward.

Price differentiation

How do you choose the right basis for differentiation? From a high-level perspective, in the aftermarket business, we typically define items as either captive or commercial. A captive item is one that’s proprietary – it’s designed by the OEM and can’t be found outside of their network. Commercial items, on the other hand, are more widely available through different distributors and suppliers. And then we have aftermarket specific items such as factory kits, warranty items, and remanufactured parts.

Within each of these high-level categories, you can get more specific and further differentiate.

Captive products can be sub-divided into “captive consumable” and “captive simple,” which has to do with the amount of competition you have. Captive consumables are used up on a regular basis – for example, a milling head or roller that’s specifically designed to fit within an application hose. You probably won’t be able to find those parts on the market, unless someone has re-engineered it, and that generally only happens for high-volume items – meaning, even if your high volume captive consumables don’t have competition now, over time they might. Likewise, captive simple items, such as wear sleeves or brackets, are relatively easy for customers to get re-engineered at a local workshop if you can’t deliver.

Since you’re the only supplier offering these parts, there’s generally a greater opportunity to capture higher margins using value-based pricing, because there’s no downward pressure being applied to those prices by third parties.

On the commercial side, we can categorize parts as “commercial unique” or “commercial commodity.” As an example, many hydraulic cylinders are standard items you can buy off the shelf – these are commercial commodity parts. But if you have a specific hydraulic cylinder with a stroke length that is outside of the standard dimensions and so it must be custom built, that’s commercial unique. You can still buy it from a supplier, but it’s not a standard part.

If you group them together in one family called “hydraulic cylinders,” you’re missing the opportunity to identify the parts where you’re really providing value through uniqueness. By contrast, on the commodity parts, you have relatively small value. You need to benchmark these parts against the competition to understand if customers will be able to find alternatives elsewhere.

This is a good example of the commercial considerations that you need to take in and the price differentiation capabilities to keep in mind when designing your operation.

In Part 2, we’ll dive into defining segments and building structure, and in Part 3, we’ll pull it all together with some final thoughts. To find out how Syncron can help you evolve your pricing beyond a cost-plus strategy, check out Syncron Price™.