AberdeenGroup

Maximizing Profitability with Optimized Service Parts Pricing

A Benchmark Study

Business Value Research Series

March 2005

Maximizing Profitability with Optimized Service Parts Pricing

Executive Summary
acing such pressures as heightened customer expectations, increased management focus on service operations profitability, and thinning product-based profit margins, leading companies are honing in on service parts pricing as a critical lever to overall profitability. In many industries, where products useful lifecycles span decades, the sale of replacement parts and components represents a monumental revenue and profitability opportunity. In fact, many manufacturers earn more revenue and profit margin on post-sales service and parts than they do on initial product sales. Aberdeen research indicates that a key determinant of a companys ability to capitalize on the post-sales revenue and profitability opportunity is its approach to service parts pricing.

Key Business Value Findings

Fully 83% of companies surveyed by Aberdeen reported that effective service parts pricing is important or extremely important to the financial health of their companies. But less than 20% of companies are confident that their current service parts pricing methodology is maximizing service parts revenue and gross profit. Survey respondents cited such business and technology challenges as inadequate software tools to make use of competitive intelligence, limited visibility into competitive and comparable part pricing information, and lack of internal strategic focus on service operations. Companies that approach service parts pricing in the same way they approach retail pricing are running into challenges as well. Supply, demand, and competitive dynamics in the service parts market differ greatly from those in the original product supply chain, so retail pricing strategies and solutions miss the mark for service parts pricing. For instance, the independent aftermarket for service parts is very active and puts intense competitive pressures on original equipment manufacturers (OEMs).

Implications & Analysis

Nearly half of companies surveyed by Aberdeen rely too much on what is termed costplus pricing tactics for their service parts, and another fifth are worse off, lacking any systematic approach to parts pricing at all. The cost-plus pricing methodology derives part prices from a standard percent markup from part purchase price or manufacturing cost. The problem with cost-plus pricing is that it does not take into account current market conditions for each part. For this reason, cost plus pricing invariably leads to lost revenue and margin, customer dissatisfaction, increased competition, and lost market share. The preferred alternative to cost-plus is price optimization, whereby a company monitors the market and measures the price elasticity of each discrete part and applies this to determine the one price that maximizes gross profit. Aside from driving profit margins, companies that take this approach can solidify customer relationships and compete more

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The Field Service Optimization Business Value Research Series

successfully against other part sources. Yet less than 6% of companies are currently optimizing part prices in this fashion. Taken as a whole, best-in-class companies those that scored highest on average across five maturity categories service part pricing process, organizational structure, part data visibility and management, technology support, and performance measurement -- outperformed companies that exhibited average and laggard characteristics in the critical areas of service parts revenue growth and service parts gross profit improvement (Figure i). Figure i: Overall Pricing Maturity Maps to Profit and Revenue Gains

14%
% change in service parts revenues

9% -1%

11%
% change in service parts gross profit Best in Class Average Laggard -5% 0% 5% 10% 15%

6% 4%

Source: Aberdeen Group, March 2005

Recommendations for Action

By some estimates, companies that are ineffectively pricing their service parts are missing out on millions or even billions of revenue dollars that would immediately impact their top and bottom lines. Regardless of industry, competitive maturity, channel sales strategy, or depth of technology experience, every company can take specific actions to improve its approach to service parts pricing and significantly impact its financial and competitive positions, by doing the following. Build case for service operations focus: At 63% of the companies surveyed by Aberdeen, executive management assigns secondary or no importance to the service parts operations potential impact on revenues and profitability. Service parts managers should take the time to track the recent trajectory of original product-based profit margins and revenues, and by comparison, begin to piece together the story of how strategic service parts management can impact a companys overall top- and bottom-line performance.

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Maximizing Profitability with Optimized Service Parts Pricing

Chart technology evolution strategy: Backed by this executive buy-in, service parts managers should evaluate pricing technology solutions that provide dynamic views into part-specific price elasticity and help to optimize parts prices for maximum overall profitability. As indicated by survey respondents, the capabilities of spreadsheets and ERP systems fall short in this area. Many best-inclass companies have leveraged service parts price optimization solutions to unlock significant profits and revenues hidden within their service parts. Understand your demand patterns and lifecycle stages: A critical element to pricing service parts effectively is understanding how your customers are purchasing and using parts. It is highly likely that certain subsets of your customer base have widely differing requirements and sensitivities when it comes to deciding from which companies to buy service parts. Understand and track the competition: Pricing service parts without adequate visibility into competitive and comparable part prices is flying blind. On a partspecific basis, companies should always have an up-to-date view into the competitive landscape, which should serve as a critical input into parts pricing and marketing decisions.

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Maximizing Profitability with Optimized Service Parts Pricing

Table of Contents
Executive Summary .............................................................................................. i Key Business Value Findings.......................................................................... i Implications & Analysis ................................................................................... i Recommendations for Action..........................................................................ii Chapter One: Issue at Hand.................................................................................1 Service as Strategy........................................................................................ 1 Market Pressures .......................................................................................... 2 Chapter Two: Key Business Value Findings .........................................................4 Challenges..................................................................................................... 4 Plans of Attack............................................................................................... 7 Cost-Plus Pricing..................................................................................... 7 Market Adaptive and Optimized Pricing .................................................. 8 Chapter Three: Implications & Analysis.............................................................. 10 Process........................................................................................................ 13 Organization ................................................................................................ 14 Knowledge Management ............................................................................. 14 Technology .................................................................................................. 15 Performance Management .......................................................................... 16 Pressures, Actions, Capabilities, and Enablers (PACE)............................... 17 Chapter Four: Recommendations for Action ...................................................... 19 Tips for Laggards......................................................................................... 19 Tips for Average Companies........................................................................ 20 Tips for Best-in-Class Companies ............................................................... 21 Author Profile ..................................................................................................... 22 Appendix A: Research Methodology .................................................................. 23 Appendix B: Related Aberdeen Research & Tools ............................................. 26 About AberdeenGroup ...................................................................................... 27

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Maximizing Profitability with Optimized Service Parts Pricing

Figures
Figure i: Overall Pricing Maturity Maps to Profit and Revenue Gains................... ii Figure 1: Market Pressures Driving Service Part Pricing Initiatives......................2 Figure 2: Service Parts Pricing Challenges ..........................................................5 Figure 3: Foundational Service Parts Pricing Strategies ......................................7 Figure 4: Service Parts Pricing Approaches .........................................................8 Figure 5: Overall Pricing Maturity Maps to Profit and Revenue Gains................ 12 Figure 6: The Latent Service Parts Pricing Opportunity ..................................... 13 Figure 7: Parts Pricing Approach Maps to Performance Gains .......................... 14 Figure 8: Part-specific Data Management Drives Profits and Revenues............ 15 Figure 9: Pricing Software Spurs Performance Gains........................................ 16 Figure 10: Service Parts Pricing Key Performance Indicators............................ 17

Tables
Table 1: Service Parts Pricing Competitive Framework...................................... 10 Table 2: Best-in-Class PACE for Service Parts Pricing Optimization.................. 18 Table 3: PACE Framework ................................................................................. 24 Table 4: Relationship between PACE and Competitive Framework ................... 25 Table 5: Competitive Framework........................................................................ 25

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Maximizing Profitability with Optimized Service Parts Pricing

Chapter One: Issue at Hand

Key Takeaways Eighty-three percent of companies surveyed by Aberdeen reported that effective service parts pricing is important or extremely important to the financial health of their companies. Leading companies identified three critical market pressures that are driving service parts pricing initiatives: 1) Demanding or dissatisfied customers, 2) Increasing pressure from competing parts suppliers, and 3) Senior management mandates to raise profit contribution from parts operations. eading companies in many industry sectors are responding to waning finished good sales and shrinking profit margins by building service-based revenue models that harvest long-term high-margin value from installed bases of customers.

In finished goods, hidden profit margin holds tremendous opportunities for companies to boost financial performance, but as competitors smarten up and launch increasingly aggressive pricing programs, margins will continue to shrink. Companies that are feeling this crunch on the finished goods side of their business are turning to their aftermarket business in general and service parts pricing in particular to drive customer loyalty and profitability to new levels and to gain significant competitive advantage.

Service as Strategy
Service parts managers are playing an increasingly critical role in a widely-adopted strategic approach to service operations. More than three-quarters of companies participating in a recent Aberdeen study currently run or plan to run their service operations as strategic business units with revenue and profitability objectives.1 Optimized networks, mobilized field technician teams, and integrated financial and customer relationship processes have delivered higher levels of productivity, increased revenues, and healthier profit margins. Now, senior executives in competitive marketplaces are looking for more, and are turning to service parts managers to extract more revenues and gross profit from the aftermarket. It is no secret that one of the most effective revenue and profit drivers is pricing, so many companies are reevaluating their service part pricing strategy in the hopes of springing new revenue streams and contributing more to gross profit. In fact, 83% of companies surveyed by Aberdeen reported that effective service parts pricing is important or extremely important to the financial health of their companies.

The Field Service Optimization Benchmark Report (June, 2004)

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Maximizing Profitability with Optimized Service Parts Pricing

Market Pressures
Best-in-class companies participating in this study identified several market pressures that are driving them to focus on service parts pricing (Figure 1). These pressures include the following: 1. Dissatisfied or demanding customers Forty-six percent of best-in-class companies said that dissatisfied or demanding customers are the primary reason they are adjusting their service parts pricing strategy. Thanks to globalization, economic pressures, and the Internet, customers are now armed with more product and pricing information; more options and alternative sources; and less brand loyalty than ever before. This new empowered customer is having dramatic effects on retailers, manufacturers, and the entire service chain -- especially service parts. To compete, companies must provide requisite information and sales support to guide customers to the appropriate product and solution. Figure 1: Market Pressures Driving Service Part Pricing Initiatives

Dissatisfied/demanding customers Competing parts suppliers Sr. mgt. profitability mandates Escalating inventory costs Shrinking productbased profit margins Best in Class Average Laggard 0% 10% 20%

46% 22% 30% 40% 40% 43% 42% 18%

30% 27% 28% 27%

20%

33% 33% 40% 50%

30%

% of respondents reporting high influence

Source: Aberdeen Group, March 2005

2. Increasing pressure from competing parts suppliers The second most influential factor best-in-class companies identified as sharpening their service parts pricing focus is increased competition from other aftermarket parts suppliers. On-shore and off-shore manufacturers are fueling a viAll print and electronic rights are the property of AberdeenGroup 2004. 2 AberdeenGroup

Maximizing Profitability with Optimized Service Parts Pricing

brant independent aftermarket for spare parts by producing and selling OEMquality parts at reduced prices. Original equipment manufacturers (OEMs) that ignore the market impact of these substitute parts stand to lose sales and market share. 3. Increased pressure by senior management to raise profit contribution from parts operations Executives at leading companies have watched sales and profit margins from finished goods dwindle in recent years, and are increasingly relying on aftermarket parts to pick up the slack. Related Aberdeen research suggests that aftermarket parts total 20% to 30% of revenues and 40% to 50% of profits at some companies. Correcting price by 1% results in a 7.8% increase in gross profit, all else being equal.

Management teams are zeroing in on pricing for good reason. According to a recent study by McKinsey & Company, increasing prices has a disproportionately positive impact on gross profit when compared to increasing unit sales or decreasing cost of goods sold (COGS). Correcting price by 1% results in a 7.8% increase in gross profit, all else being equal, while decreasing COGS by 1% yields a 4.9% gross profit increase and increasing unit sales by 1% results in a 2.8% gross profit spike. Not surprisingly, service parts managers noted this pressure from executives as the third most influential factor in driving attention to parts pricing.

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Maximizing Profitability with Optimized Service Parts Pricing

Chapter Two: Key Business Value Findings

Key Takeaways Leading companies reported that the three most formidable challenges they are facing in service parts pricing are 1) limited visibility into competitive or comparable pricing information, 2) inadequate software tools to make the best use of competitive intelligence, and 3) insufficient price optimization training or capability. Almost 45% of companies employ a cost-plus methodology for service parts pricing, and nearly another quarter reported that they do not have any systematic approach to service parts pricing at all.

ricing service parts effectively presents a unique set of challenges, which even bestin-class companies struggle to overcome. The most common pricing approach todays companies take is termed cost-plus, which unilaterally applies a standard percent markup derived from part purchase price or manufacturing cost. By this method, price adjustments occur infrequently and only when part costs change. Cost-plus invariably results in prices that are too low -- leading to lost profits -- or too high -- leading to dissatisfied customers, decreased loyalty and ultimately lost market share.

Challenges
What is so difficult about pricing service parts? Leading companies surveyed by Aberdeen reported that limited visibility into competitive or comparable pricing information, inadequate software tools to make the best use of competitive intelligence, and insufficient price optimization training and capability are the three most formidable challenges they are facing (Figure 2).

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Maximizing Profitability with Optimized Service Parts Pricing

Figure 2: Service Parts Pricing Challenges

Limited visibility into competitive/comparable pricing Inadequate softw are for competitive intelligence Insufficient price optimization training Fragmented distribution channels Lack of strategic focus on service chain

49% 26% 43%

49% 39% 40% 36% 42% 42%

33% 7% 20%

33% 43% 52%

10% 20% 30% % of respondents 40% 50% 60%

Best in Class
Average
Laggard

0%

Source: Aberdeen Group, March 2005

Other characteristics of service parts that make them uniquely challenging to price profitably include the following: 1. Fragmented distribution channels On average, companies surveyed in this study collect about half of their service parts revenues by selling directly to the end-user, oftentimes via the Internet. But, across the survey sample, 35% of parts revenue comes through stores owned by the OEM, 30% comes through wholesale distributors, 27% through retail dealers, and 15% through independently owned stores. Depending upon the depth and quality of relationships an OEM has with its channel partners, it can be extremely difficult to maintain visibility into part demand, customer satisfaction and other critical business data. Further, at least one tier removed from the OEM, the end-users experience with the OEMs product and brand rests largely in the hands of another party. Not surprisingly, nearly 90% of best-in-class companies Aberdeen surveyed said that collaborative win-win relationships with channel partners has had the greatest positive impact on the effectiveness of service parts pricing at their companies. 2. Variable competition

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Maximizing Profitability with Optimized Service Parts Pricing

With service parts, the competitive landscape differs dramatically by individual part. Some parts are captive -- facing no competitive alternatives while others are competitive facing any number of comparable or imitation options. The proliferation of imitation parts by manufacturers the world over has spawned a lively and often intensely competitive aftermarket for many service parts, placing intense competitive pressures on OEMs. Further, for some competitive parts, the OEM is the price leader and for other parts, it is a price follower. To address these pressures adequately, OEMs must approach pricing on a partby-part basis, which is a monumental challenge, even for one India-based IT products company that manages less than 1,000 discrete product numbers, including peripherals, components, and network products. This company approaches service parts pricing differently depending upon whether a part is captive or competitive. In the case of the former, the company stocks and marks up parts based on average cost, but in the case of the latter, it prices parts more dynamically, in response to market pressures. 3. Variable price elasticity By their nature, service parts support the use and health of a primary product or category of products, and are sold into a vast array of markets and market segments, commercial environments, and geographies. As a result, depending on the market served, demand trends and price elasticity can differ significantly for a single part. Price elasticity is not a fixed attribute for a certain part. Rather it is entirely situational, so two parts that are similar by all outward appearances can have significantly different elasticties.

Price elasticity is not a fixed attribute for a certain part. Rather it is entirely situational, so two parts that are similar by all outward appearances can have significantly different elasticities. So even a part-specific approach to pricing can lose profits or market share for an OEM, if the unique market conditions of an individual deployment are not considered. 4. Evolution of part attributes over lifecycle Especially when the primary product has a lengthy serviceable life, service parts progress through various stages during their lifecycles. For instance, early in a parts lifecycle, there is no price sensitivity because the part is fully covered under warranty. But as time passes and the warranty mix declines, price sensitivity rises. It rises even more as the competitive landscape heats up, and the value of the primary product degrades. These and other temporal forces create a fluid marketplace for most service parts, to which OEMs must be responsive in order to remain competitive.

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Maximizing Profitability with Optimized Service Parts Pricing

Plans of Attack
To begin to tackle the challenges of service parts pricing, leading companies are charting a series of foundational strategies that set the course for their service parts operations and provide context for the specific tactics service parts managers are taking to drive profits and revenues. Best-in-class companies reported that the top three foundational strategies are to adopt a customer-centric approach to service delivery, implement or improve demand tracking and forecasting processes, and redefine service requirements over the entire product lifecycle (Figure 3). Figure 3: Foundational Service Parts Pricing Strategies

70% Adopt customer-centric service delivery approach Improve demand tracking/forecasting Strengthen ties between logistics and service pros Redefine service requirements over product lifecycle Deploy service parts technology solution 0% 10% 20% 30% 51% 47% 61% 37% 39% 61% 35% 32% 56% 58% 39% 50% 60% 70% 64% 59% 67%

Best in Class Average Laggard

40%

% of respondents

Source: Aberdeen Group, March 2005

Cost-Plus Pricing Regardless of overarching strategy, the most commonly used tactic for pricing service parts is cost-plus. Almost 45% of companies participating in this study employ only a simple cost-plus methodology for service parts pricing (Figure 4). Nearly another quarter reported that they do not have any systematic approach to service parts pricing at all. As mentioned previously, a cost-plus pricing approach determines prices by applying a standard percent markup -- derived from a parts manufacturing or purchase cost. By nature, cost-plus is a static approach executed in isolation and does not account for two fac-

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Maximizing Profitability with Optimized Service Parts Pricing

tors critical for service parts: 1) prices from competitive part sources, and 2) part-specific price elasticity of demand. The result: parts that are priced with the cost-plus methodology are guaranteed to be over- or under-priced, sacrificing gross profit, or market share and customer satisfaction respectively. What is more, the opportunity to improve service parts market share or profitability over time using a cost-plus approach is like shooting in the dark. Companies cannot detect or respond to changing market dynamics, nor can they quantify the effects that price changes have on any individual part demand. Market Adaptive and Optimized Pricing Less than one-third of companies Aberdeen surveyed are currently considering these two critical inputs competitive prices and price elasticity when they price their service parts. The majority of this sub-population is utilizing a market adaptive approach to service parts pricing, whereby the primary driver of parts prices is the desired market price position. That is, companies using this approach monitor current market prices for a particular part and then establish their own prices based upon where they want to position themselves relative to the competition. A small segment of this group of companies amounting to less than 6% of the overall survey sample are utilizing an optimized approach to service parts pricing, where partspecific profitability is the foundational principle upon which part prices are determined. Price optimization analyzes the intricate relationship between a parts price and the propensity of the buyer to purchase that part -- i.e. demand and calculates on a partspecific basis what the optimal price should be at any given point in a parts lifecycle in order to maximize revenues and profitability. Figure 4: Service Parts Pricing Approaches
45% 40% 35% 30% 25% 20% 15% 10% 5% 0% Cost-plus Market-adaptive No systematic approach Optimized 6%

44% 27% 23%

% of respondents

Source: Aberdeen Group, March 2005

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Maximizing Profitability with Optimized Service Parts Pricing

The companies having the most success with market adaptive and optimized pricing approaches are spending ample time and resources segmenting their service parts by attributes, market position objectives, profitability objectives, and the like.

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Maximizing Profitability with Optimized Service Parts Pricing

Chapter Three: Implications & Analysis

Key Takeaways Companies employing market adaptive or optimized service parts pricing strategies have seen 13% and 11% increases in service parts gross profit and revenues, respectively, which tracks very closely with performance gains exhibited by overall best-in-class companies. Companies that are leveraging market price databases, pricing applications, and other service parts solutions are seeing results on the top and bottom lines that dwarf those of companies using outdated tools.

ost enterprises service parts pricing capabilities fall into one of three categories Laggard, Industry Average, or Best in Class based on a weighted summary of their characteristics in five key categories: process, organization, knowledge management, technology usage, and performance management (Table 1). Table 1: Service Parts Pricing Competitive Framework Laggards
No systematic approach to service parts pricing

Industry Average
Over-reliance upon costplus (i.e. percent markup from part purchase price or manufacturing cost)

Best in Class
Market adaptive (i.e. derived from demand trends, competitive/comparable price points) in combination with Optimized (i.e. measuring price elasticity of each part to determine the one price that maximizes gross profit) Executive focus on deriving revenues and profits from service parts.

Process

Organization

No executive focus on deriving revenues and profits from service parts

Strategies for servicedriven revenues and profits are secondary to product-driven strategies

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Maximizing Profitability with Optimized Service Parts Pricing

Laggards
Limited or no view into part-specific demand trends or competitive/comparable part prices

Industry Average
Track part purchase prices for purpose of calculating standard markup percentages

Best in Class
Single, real-time, normalized view into partspecific demand trends and competitive/comparable part prices. Able to correlate price changes with their effects upon volume and profit. Primary tools are thirdparty service parts pricing software, or homegrown pricing software, integrated with the supply chain to drive demand. Service parts pricing effectiveness measured on business process- or enterprise-wide basis, and used to help control demand and better manage the supply chain.

Knowledge Management

Primary tools are spreadsheet

Technology

Primary tool is Enterprise resource planning (ERP) or comparable solution

Performance Management

Service parts pricing effectiveness not consistently measured

Service parts pricing effectiveness measured on a functional unit basis

Source: Aberdeen Group, March 2005

Taken as a whole, best-in-class companies those that scored highest on average across all five maturity categories outperformed companies that exhibited average and laggard characteristics in the critical areas of service parts revenue growth and service parts gross profit improvement (Figure 5).

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Maximizing Profitability with Optimized Service Parts Pricing

Figure 5: Overall Pricing Maturity Maps to Profit and Revenue Gains

14%
% change in service parts revenues

9% -1%

11%
% change in service parts gross profit Best in Class Average Laggard -5% 0% 5% 10% 15%

6% 4%

Source: Aberdeen Group, March 2005

This affirms that forward-looking service parts pricing strategies, coupled with savvy management, diligent execution, and adequate technology support, leads to results of which any CFO would be proud. Turns out a large portion of companies Aberdeen surveyed are lagging in four out of five competitive maturity categories: Service part pricing process, part data visibility and management, technology support, and performance measurement (Figure 6).

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Maximizing Profitability with Optimized Service Parts Pricing

Figure 6: The Latent Service Parts Pricing Opportunity

Service part pricing effectiveness not consistently measured Spreadsheets or ERP is primary part pricing tool Limited or no view into part-specific demand or competitive prices Cost-plus or no pricing strategy

56%

66%

45%

66%

0%

10%

20%

30%

40%

50%

60%

70%

% of total respondents

Source: Aberdeen Group, March 2005

Process
Service parts pricing process, when analyzed as a single company attribute, has a similar impact on company performance as does overall maturity. In fact, companies employing market adaptive or optimized service parts pricing strategies have seen 13% and 11% increases in service parts gross profit and revenues, respectively, which tracks very closely with performance gains exhibited by overall best-in-class companies (Figure 7).

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Maximizing Profitability with Optimized Service Parts Pricing

Figure 7: Parts Pricing Approach Maps to Performance Gains

% change in service parts gross profit

13% 6%

11% % change in service parts revenues 9%

0% Market adaptive or Optimized Cost-plus

2%

4%

6%

8%

10%

12%

14%

Source: Aberdeen Group, March 2005

Similarly, companies employing only a cost-plus pricing approach tracked closely with companies in the overall average maturity category. However, it is safe to say that the profit and revenue gains afforded by cost-plus approaches of 6% and 9% respectively are overly bullish numbers to take to the bank, especially in certain industries where service parts demand and competition are dynamic and intense, like automotive, aerospace and defense, and high technology. Another important attribute of leading service parts pricing processes is a consolidated price management approach that controls price policy across all markets and channels, to prevent gaps in pricing that create arbitrage opportunities.

Organization
The foundation for any successful service parts pricing strategy is solid executive backing and a corporate focus on growing the business and improving efficiencies on the shoulders of the service operation. About 36% of companies Aberdeen surveyed have built this foundation, reporting that their companies executives are focusing on deriving revenues and profits from service operations. Another 43% reported that there was some focus on the service parts business but that it was still secondary to the finished goods business. And about 21% of companies said that the notion of service-driven revenues and profitability was getting no executive attention.

Knowledge Management
As stated earlier, the single greatest service parts pricing challenge among even best-inclass companies is gaining visibility into part-specific demand information and comparable and competitive pricing data. Not surprisingly, just 11% of companies participating in

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Maximizing Profitability with Optimized Service Parts Pricing

this study have been able to establish a single, real-time, normalized view into partspecific demand trends and competitive/comparable part prices. Fully 45% admit to having limited or no view into part-specific demand trends or competitive/comparable part prices. And another 44% are slightly better off, tracking part purchase prices for the purpose of calculating standard markup percentages. Those companies that are systematically gathering and analyzing part-specific demand and pricing data are reaping the rewards, according to Aberdeens research. In fact, these companies reported a 14% improvement in service parts gross profit due to their parts pricing efforts, dramatically higher than the 1% reported by those companies with no visibility into part specific data (Figure 8). Figure 8: Part-specific Data Management Drives Profits and Revenues

% change in service parts gross profit

14% 1%

% change in service parts revenues

12% 5%

Track part-specific data No visibility into partspecific data

0% 5% 10% 15%

Source: Aberdeen Group, March 2005

Technology
The sheer volume of service parts, when compared to finished goods inventories, requires that companies leverage technology solutions to capture data inputs like part demand trends and price elasticity in various markets and competitive price information. About half of companies Aberdeen surveyed currently manage more than 10,000 discrete service part numbers. And almost one-fifth of the total survey sample manage more than 100,000 service part numbers. Processing the wide array of rapidly changing and interdependent inputs across such vast and varied inventories to determine the optimal price for each part at any given time is next to impossible without sufficient technology support. Yet, nearly 40% of companies rely on spreadsheets for their service parts pricing processes. Aberdeen research indicates that companies that are leveraging service parts pricing applications, market price databases, and other service parts solutions are seeing results on

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Maximizing Profitability with Optimized Service Parts Pricing

the top and bottom lines that dwarf those of companies using outdated productivity tools (Figure 9). Figure 9: Pricing Software Spurs Performance Gains

% change in service parts gross profit

11% 4%

% change in service parts revenues

Pricing software, database, other technology solution
Spreadsheets

11% 5%

0%

2%

4%

6%

8%

10%

12%

Source: Aberdeen Group, March 2005

Performance Management
To achieve the highest returns from service parts pricing optimization efforts, leading companies are measuring pricing effectiveness on an enterprise-wide basis, accounting for parts sold by multiple divisions into multiple markets. With technology-aided insight into part demand and price elasticity on a division-by-division basis, companies can adjust prices for the same part by division and maximize overall profitability. But fully 56% of companies participating in this study reported that they do not consistently measure service parts pricing effectiveness at all. For those that do, service parts gross profit, service parts revenues, and customer satisfaction are the top three key performance indicators (KPIs) (Figure 10).

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Maximizing Profitability with Optimized Service Parts Pricing

Figure 10: Service Parts Pricing Key Performance Indicators

Service parts gross profit Service parts revenues Customer Satisfaction Service parts inventory turns Service parts inventory carrying costs Part-specific market share 0% Best in Class Average 10% 15% 20% 30%

67% 40% 64% 47% 58% 35% 55% 28% 52% 27% 30%

40%

50%

60%

70%

% of respondents

Source: Aberdeen Group, March 2005

Pressures, Actions, Capabilities, and Enablers (PACE)

With innumerable demands on companies time, money, and resources, whats driving them to focus on service parts pricing? Among the key market pressures are elevated customer requirements for service, commoditization of products, and increased competition (Table 2). Aberdeen research indicates that companies that identify the most impactful pressures and take the most transformational and effective actions are most likely to achieve superior performance. The level of competitive performance that a company achieves is strongly determined by the PACE choices that they make and how well they execute. All service organizations should examine their prioritized PACE selections and compare them to those of best in class companies, to determine where adjustments might be made.

PACE Key For more detailed description see Appendix A

Aberdeen applies a methodology to benchmark research that evaluates the business pressures, actions, capabilities, and enablers (PACE) that indicate corporate behavior in specific business processes. These terms are defined as follows:

Pressures external forces that impact an organizations market position, competitiveness, or business operations Actions the strategic approaches that an organization takes in response to industry pressures Capabilities the business process competencies required to execute corporate strategy Enablers the key functionality of technology solutions required to support the organizations enabling business practices

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Maximizing Profitability with Optimized Service Parts Pricing

Table 2: Best-in-Class PACE for Service Parts Pricing Optimization Pressures

Dissatisfied or demanding customers

Actions
Adopt market- and customer-driven approach to service parts operation Position competitive prices as needed within competitive zone and then rebalance captive parts prices. Use research findings to set target prices for negotiation with suppliers. Optimize parts prices and harvest undervalued parts, redefining service part strategies over entire product lifecycle Reverse harvest parts with high warranty consumption and re-position their prices low in the competitive zone. Deploy service parts technology solution for forecasting, planning, and pricing

Capabilities
Collaborative winwin relationships with dealers and other channel partners Ability to monitor current market prices for competing and comparable parts.

Enablers
Competitive pricing information

Increasing pressure from competing parts suppliers and declining market share

Segmentation and market-adaptive pricing tools.

Increased pressure to raise profit contribution from parts operations

Ability to measure and apply price elasticities on a part-specific basis.

Optimization and market-adaptive pricing tools. Price data and factors visibility.

Better control over warranty expense when dealer warranty reimbursement is linked to parts prices Growing inventory levels and costs

Ability to maintain and access warranty consumption by part number.

Segmentation and market-adaptive pricing tools.

Standardized processes and operation throughout the network of decisions

Data recommendations to drive parts forecast and inventory management via pricing. Single-instance, multi-language, multi-currency pricing system

Inconsistent strategies and results in different markets/channels

Model and implement global strategies and process

Equipped and coordinated local or channel decisionmakers

Source: Aberdeen Group, March 2005

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Chapter Four: Recommendations for Action

Key Takeaways A critical element to pricing service parts effectively is understanding how your customers are purchasing and using them. It is highly likely that certain subsets of your installed base have widely differing requirements when it comes to purchase triggers and service levels Service managers should evaluate service parts pricing technology solutions that provide dynamic views into part-specific price elasticity and help to optimize parts prices for maximum overall profitability.

Companies should work to integrate service parts planning and pricing systems and procedures, as price adjustments will impact demand, which will in turn influence inventory stocking and distribution plans. Likewise the current status or strategy of the stock plan should influence pricing.

ompanies that are responding to toughening conditions in the finished goods marketplace by building growth and profitability strategies around their service parts operations stand to gain the following benefits: Increased profitability Increased revenues Contained service costs Improved competitive position Increased service parts market share Improved customer satisfaction and loyalty

Faced with the uniquely challenging service parts landscape, leading companies are leveraging pricing technology solutions that provide dynamic views into part-specific price elasticity and help to optimize parts prices for maximum overall profitability. As indicated by survey respondents, the capabilities of spreadsheets and ERP systems fall short in this area. Many best-in-class companies have leveraged service parts price optimization solutions to unlock significant profits and revenues hidden within their service parts. Regardless of industry, competitive maturity, channel sales strategy, or depth of technology experience, every company can take specific actions to improve its approach to service parts pricing and significantly impact its financial, operational, and competitive performance, including the following:

Tips for Laggards

1. Build case for service operations focus: At 63% of the companies surveyed by Aberdeen, executive management assigns secondary or no importance to the service chains potential impact on revenues and profitability. Service parts manag-

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Maximizing Profitability with Optimized Service Parts Pricing

ers should take the time to track the recent trajectory of original product-based profit margins and revenues, and by comparison, begin to piece together the story of how strategic service parts management can impact top- and bottom-line performance. 2. Understand your demand patterns and lifecycle stages: A critical element to pricing service parts effectively is understanding how your customers are purchasing and using them. It is highly likely that certain subsets of your installed base have widely differing requirements when it comes to purchase triggers and service levels. 3. Measure performance over time: The 56% of companies that are not measuring service parts pricing effectiveness at all are poorly positioned to manage corporate performance and competitive differentiation. Due to the constantly changing service parts market, timely pricing performance measurement is that much more critical. To start, companies should understand service parts revenue and gross profit trends.

Tips for Average Companies

1. Chart strategy for graduating from exclusively cost-plus pricing: A cursory market analysis will reveal that cost-plus pricing methodologies generate prices that are either too low or too high, leading to either lost profits or lost market share. Backed by executive buy-in, service managers should evaluate service parts pricing technology solutions that provide dynamic views into part-specific price elasticity and help to optimize parts prices for maximum overall profitability. 2. Understand and track the competition: Pricing service parts without adequate visibility into competitive and comparable part prices is flying blind. On a partspecific basis, companies should always have an up-to-date view into the competitive landscape, which should serve as a critical input into parts pricing decisions and lay the groundwork for more Tracking high potential parts -market adaptive pricing approaches. those collectively representing Knowing the competitive landscape 80% of the total revenue potenmeans knowing which parts are captive, tial from whole goods usually which are competitive, who the most provides enough insight into important competitors are, and current pricing trends and can impact street prices. Tracking high potential your top and bottom lines. parts -- those collectively representing 80% of the total revenue potential from whole goods usually provides enough insight into pricing trends and can impact your top and bottom lines. Focusing on fast-moving parts alone could be a mistake because those parts with low market shares could be missed. 3. Beware of make-do technology tactics: As indicated by survey respondents, the capabilities of spreadsheets, retail pricing systems, and most ERP systems fall short in meeting the unique requirements of service parts pricing. Many best-in-

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Maximizing Profitability with Optimized Service Parts Pricing

class companies have leveraged service parts price optimization solutions to unlock significant profits and revenues hidden within their service parts. 4. Implement consistent processes and strategies: A single platform is essential to equip and coordinate local market decision making with corporate strategies and processes. This can also help manage the cross-boarder issues that arise from changing exchange rates.

Tips for Best-in-Class Companies

1. Integrate pricing with planning: To strengthen existing customer relationships and establish profitable new ones, companies should continue to focus on overall customer experience as the defining performance metric. In this vein, companies should work to integrate their service parts planning and forecasting processes with their pricing procedures. Price adjustments will impact demand, which will in turn influence inventory stocking and distribution plans, so there must be seamless integration among the relevant business systems and processes. Likewise the current status or strategy of the stock plan should influence pricing. 2. Segment your service parts inventory: Leading companies are grouping their service parts into categories based upon shared part characteristics such as market potential, competitive intensity, price leadership, warranty mix, and other attributes. With well-defined, yet flexible, part categories, companies can then apply targeted pricing strategies to part families, to achieve various business goals, such as reduce warranty expenses, maximize gross profits, and improve competitive position. 3. Dont forget about market share: Less than one-third of leading companies consider part-specific market share to be a key metric for tracking service parts pricing effectiveness. While KPIs like service parts revenues and gross profit and target performance levels are critical components of overall performance management, companies should maintain an understanding of the leverage they enjoy in the market. This critical benchmarking information will serve as input for ongoing pricing decisions and allow companies to build more targeted pricing strategies to achieve overall profitability goals.

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Maximizing Profitability with Optimized Service Parts Pricing

Author Profile
Mark W. Vigoroso, Vice President, Post-Sales Service and Support Research Aberdeen Group (617) 854-5278 mark.vigoroso@aberdeen.com
Mark Vigoroso spearheads Aberdeens research of technology-driven business value in the service chain. Through primary market research, he analyzes how service executives are utilizing field service management, mobile service, service parts planning and distribution, service force optimization, machine-to-machine (M2M), and other technology solutions to automate and streamline post-sales service and support processes. Vigorosos current efforts include documenting best practices in post-sales service, quantifying best-in-class service chain performance management strategies, and benchmarking real-time optimization of workforces in the service chain. In addition to his extensive service chain research, he has published research in the areas of strategic sourcing, supplier performance measurement, enterprise spending analysis, total cost management, global trade management, and asset management. Vigoroso has spent years covering service chain, electronic procurement, supply chain, and logistics management trends as an analyst, journalist, editor, speaker, and columnist for various industry publications. Specializing in e-business applications and strategies, he was an editor at Purchasing Magazine and Manufacturing Marketplace. He has also been a columnist and feature writer for The E-Commerce Times, ZDNet TechUpdate, and Workz.com.

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Maximizing Profitability with Optimized Service Parts Pricing

Appendix A: Research Methodology

n March 2005, Aberdeen Group examined the service parts pricing procedures, experiences, and intentions of 144 enterprises in industrial manufacturing, automotive, high-tech, and other industries.

Responding logistics, supply chain, customer service, service parts, sales & marketing, and manufacturing executives completed an online survey that included questions designed to determine the following: The degree to which service parts pricing is impacting revenue and profitability at todays corporations The structure and effectiveness of existing service parts pricing procedures Current and planned use of technology solutions to enhance service parts pricing effectiveness The benefits, if any, that have been derived from service parts pricing solution deployments.

Aberdeen supplemented this online survey effort with interviews with select survey respondents, gathering additional information on service parts pricing strategies, experiences, and results. The study aimed to identify emerging best practices for service parts pricing and provide a framework by which readers could assess their own aftermarket pricing capabilities and opportunities for improved profitability. Responding enterprises included the following: Job function: The research sample included respondents with the following job functions: logistics/ supply chain (24%); customer service (23%); marketing (12%); service parts (11%); sales (10%); finance (7%); procurement (7%); pricing (4%); manufacturing (2%). Industry: The research sample included respondents from the following industries: industrial equipment manufacturing (20%); computer equipment and peripherals (11%); consumer-driven industries (10%); telecommunications equipment and services (10%); automotive (9%); high-technology/software (9%); construction (7%); transportation/distribution (6%); business services (6%); medical devices (4%); aerospace/defense (4%); public sector (3%); utilities and related industries (1%). Geography: The majority of study participants (57%) were from the United States. Survey respondents from Asia-Pacific represented 18%; from Europe, 16%; from Canada, 3%; from Africa, 2%; from Latin America, 2%; and from other regions, 3%. Company size: About 34% of respondents were from large enterprises (annual revenues above US$1 billion); 38% were from midsize enterprises (annual reveAll print and electronic rights are the property of AberdeenGroup 2004. AberdeenGroup 23

Maximizing Profitability with Optimized Service Parts Pricing

nues between $50 million and $1 billion); and 28% of respondents were from small businesses (annual revenues of $50 million or less). Table 3: PACE Framework PACE Key
Aberdeen applies a methodology to benchmark research that evaluates the business pressures, actions, capabilities, and enablers (PACE) that indicate corporate behavior in specific business processes. These terms are defined as follows:

Pressures external forces that impact an organizations market position, competitiveness, or business operations (e.g., economic, political and regulatory, technology, changing customer preferences, competitive) Actions the strategic approaches that an organization takes in response to industry pressures (e.g., align the corporate business model to leverage industry opportunities, such as product/service strategy, target markets, financial strategy, go-to-market, and sales strategy) Capabilities the business process competencies required to execute corporate strategy (e.g., skilled people, brand, market positioning, viable products/services, ecosystem partners, financing) Enablers the key functionality of technology solutions required to support the organizations enabling business practices (e.g., development platform, applications, network connectivity, user interface, training and support, partner interfaces, data cleansing, and management)

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Maximizing Profitability with Optimized Service Parts Pricing

Table 4: Relationship between PACE and Competitive Framework PACE and Competitive Framework How They Interact Aberdeen research indicates that companies that identify the most impactful pressures and take the most transformational and effective actions are most likely to achieve superior performance. The level of competitive performance that a company achieves is strongly determined by the PACE choices that they make and how well they execute. Table 5: Competitive Framework Competitive Framework Key
The Aberdeen Competitive Framework defines enterprises as falling into one of the three following levels of service parts pricing practices and performance: Best in class (20%) service parts pricing practices that are the best currently being employed and significantly superior to the industry norm, and result in the top industry performance. Industry average (50%) service parts pricing practices that represent the average or norm, and result in average industry performance. Laggards (30%) service parts pricing practices that are significantly behind the average of the industry, and result in below average performance

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Maximizing Profitability with Optimized Service Parts Pricing

Appendix B: Related Aberdeen Research & Tools

Related Aberdeen research that forms a companion or reference to this report include: Field Service Benchmark: A Mid-Market Perspective (March 2005) Optimizing Field Service to Achieve Profitability Goals (March 2005) Managing Service Chain Performance for Competitive Advantage (February 2005) Next Generation Technology Requirements for Enterprise Asset and Field Service Management (January 2005) Next Generation Post-Sales Service Benchmark Report: Maximizing Service Performance with Machine-to-Machine (M2M) Solutions (December 2004) Mobile Field Service Benchmark Report (September 2004) Field Service Optimization Benchmark Report (June 2004)

Information on these and any other Aberdeen publications can be found at www.aberdeen.com.

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Maximizing Profitability with Optimized Service Parts Pricing

About

AberdeenGroup
Our Mission
To be the trusted advisor and business value research destination of choice for the Global Business Executive.

Our Approach
Aberdeen delivers unbiased, primary research that helps enterprises derive tangible business value from technology-enabled solutions. Through continuous benchmarking and analysis of value chain practices, Aberdeen offers a unique mix of research, tools, and services to help Global Business Executives accomplish the following: IMPROVE the financial and competitive position of their business now PRIORITIZE operational improvement areas to drive immediate, tangible value to their business LEVERAGE information technology for tangible business value.

Aberdeen also offers selected solution providers fact-based tools and services to empower and equip them to accomplish the following: CREATE DEMAND, by reaching the right level of executives in companies where their solutions can deliver differentiated results ACCELERATE SALES, by accessing executive decision-makers who need a solution and arming the sales team with fact-based differentiation around business impact EXPAND CUSTOMERS, by fortifying their value proposition with independent fact-based research and demonstrating installed base proof points

Our History of Integrity

Aberdeen was founded in 1988 to conduct fact-based, unbiased research that delivers tangible value to executives trying to advance their businesses with technology-enabled solutions. Aberdeen's integrity has always been and always will be beyond reproach. We provide independent research and analysis of the dynamics underlying specific technologyenabled business strategies, market trends, and technology solutions. While some reports or portions of reports may be underwritten by corporate sponsors, Aberdeen's research findings are never influenced by any of these sponsors.

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Maximizing Profitability with Optimized Service Parts Pricing

AberdeenGroup, Inc. 260 Franklin Street Boston, Massachusetts 02110-3112 USA Telephone: 617 723 7890 Fax: 617 723 7897 www.aberdeen.com 2004 AberdeenGroup, Inc. All rights reserved December 2004

Founded in 1988, AberdeenGroup is the technologydriven research destination of choice for the global business executive. AberdeenGroup has over 100,000 research members in over 36 countries around the world that both participate in and direct the most comprehensive technology-driven value chain research in the market. Through its continued fact-based research, benchmarking, and actionable analysis, AberdeenGroup offers global business and technology executives a unique mix of actionable research, KPIs, tools, and services.

The information contained in this publication has been obtained from sources Aberdeen believes to be reliable, but is not guaranteed by Aberdeen. Aberdeen publications reflect the analysts judgment at the time and are subject to change without notice. The trademarks and registered trademarks of the corporations mentioned in this publication are the property of their respective holders.

THIS DOCUMENT IS FOR ELECTRONIC DELIVERY ONLY

The following acts are strictly prohibited: Reproduction for Sale Posting on a Web Site Transmittal via the Internet
Copyright 2005 Aberdeen Group, Inc. Boston, Massachusetts

Terms and Conditions

Upon receipt of this electronic report, it is understood that the user will and must fully comply with the terms of purchase as stipulated in the Purchase Agreement signed by the user or by an authorized representative of the users organization. This publication is protected by United States copyright laws and international treaties. Unless otherwise noted in the Purchase Agreement, the entire contents of this publication are copyrighted by Aberdeen Group, Inc., and may not be reproduced, stored in another retrieval system, posted on a Web site, or transmitted in any form or by any means without prior written consent of the publisher. Unauthorized reproduction or distribution of this publication, or any portion of it, may result in severe civil and criminal penalties, and will be prosecuted to the maximum extent necessary to protect the rights of the publisher. The trademarks and registered trademarks of the corporations mentioned in this publication are the property of their respective holders. All information contained in this report is current as of publication date. Information contained in this publication has been obtained from sources Aberdeen believes to be reliable, but is not warranted by the publisher. Opinions reflect judgment at the time of publication and are subject to change without notice.

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