How to Price Spare Parts as a B2B SMB (Part 1: The Basics)

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{92b8314a80b58944ba0df9bff999fd6692ae6ba618bc5950ca8fb5ab90484bed} of all businesses are large […]

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In the U.S., about 10{92b8314a80b58944ba0df9bff999fd6692ae6ba618bc5950ca8fb5ab90484bed} 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{92b8314a80b58944ba0df9bff999fd6692ae6ba618bc5950ca8fb5ab90484bed} 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{92b8314a80b58944ba0df9bff999fd6692ae6ba618bc5950ca8fb5ab90484bed} who set prices as one of their many responsibilities.

Accounting for Aftermarket Services Within Manufacturing Business Revenue

Service is a critical part of industrial business’ sales and profits, and spare parts sales are a significant component of service revenue. Studies have shown that on average, aftermarket services account for 24{92b8314a80b58944ba0df9bff999fd6692ae6ba618bc5950ca8fb5ab90484bed} of the total revenue of a manufacturing business and 40{92b8314a80b58944ba0df9bff999fd6692ae6ba618bc5950ca8fb5ab90484bed} to 80{92b8314a80b58944ba0df9bff999fd6692ae6ba618bc5950ca8fb5ab90484bed} of its total profits. This does not account for the repeat business enabled by a company’s service business by ensuring high customer satisfaction and loyalty.

This is the first part of a two-part article. In this article, we’ll discuss the methods and considerations used to arrive at a spare parts price list that will satisfy most people who look behind the pricing curtain. In tomorrow’s article, we’ll discuss real-world issues and considerations which make spare parts pricing more than just an academic exercise. The complete pricing process is also discussed in the second article.

Pricing for Growth

According to McKinsey, “an analysis across 30 industries showed that average earnings-before-interest-and-taxes (EBIT) margin for aftermarket services was 25{92b8314a80b58944ba0df9bff999fd6692ae6ba618bc5950ca8fb5ab90484bed}, compared to 10{92b8314a80b58944ba0df9bff999fd6692ae6ba618bc5950ca8fb5ab90484bed} for new equipment.” They also reported aftermarket lifetime value can vary from 30{92b8314a80b58944ba0df9bff999fd6692ae6ba618bc5950ca8fb5ab90484bed} of initial cost (for heavy trucks) to 75{92b8314a80b58944ba0df9bff999fd6692ae6ba618bc5950ca8fb5ab90484bed} for gas turbines.

They go on to say, “At most OEMs, parts sales typically provide gross margins of over 30{92b8314a80b58944ba0df9bff999fd6692ae6ba618bc5950ca8fb5ab90484bed}, compared with an average of 10{92b8314a80b58944ba0df9bff999fd6692ae6ba618bc5950ca8fb5ab90484bed} for maintenance services —and that means they often make the most substantial contribution to average annual services revenues.”

Finally, it is important to note that there are three ways to grow parts sales and profits:

  • Increase the volume of parts sold
  • Reduce the cost of parts sold
  • Increase the selling price of the parts that are sold

This article focuses on the last point — increasing the selling price of parts that are sold.

How Should I Determine Product Pricing?

In the B2B field service world, there are three product categories that get assigned a selling price:

  • Physical products
  • Software and firmware products
  • Service products
    • Intangible services – training, preventative maintenance, and product-related consulting projects
    • Firmware and software – upgrades, bug fixes, and remote troubleshooting
    • Physical services – spare parts and break/fix repairs

When pricing the list, except for the spare parts and break/fix repairs, the best approach is value pricing. This involves discovering the value the customer gains from using the product and pricing your product below the value level while making sure to cover all your costs. The process is not as easy as it may sound, but it is still straightforward.

However, in many cases, value pricing is overkill, and a simpler method is more than sufficient.

A reminder — spare parts prices are not plainly important in their own right. They also impact the invoices you send for non-contract service calls and the prices you charge for a remedial service contract that includes parts.

With this in mind, the investment of the time it takes to arrive at a fair, defensible spare parts price list is well worth the effort.

Spare Parts Categories

Industry typically segments spare parts into three categories. This helps you identify the correct pricing method to use and decide how much inventory you will be holding. These three categories include:

  • Proprietary, Custom, or Unique Parts: Custom motors, integrated circuits, electronic assemblies, waterjet nozzles, and operating or diagnostic software. Many of these items are considered intellectual property (IP) and are protected by a patent or a copywritten drawing. Legally, these parts must be purchased from the OEM or their designated agents.
  • Proprietary Wear Parts and Other Consumables: Custom knives, x-ray tubes, and specially formulated chemicals and standards. In the medical area, ECG electrodes may be privately labeled by the instrument manufacturer, yet the instrument is designed to work with many or all brands. These are frequently purchased from the OEM.
  • Commercial Off-the-shelf: Commodity parts that the OEM purchases from a manufacturer or distributor and are readily available to anyone who needs it. Examples include switches, motors, gears, O-rings, cutting tools, and chemicals like alcohol and other cleaning agents. End users typically purchase over 75{92b8314a80b58944ba0df9bff999fd6692ae6ba618bc5950ca8fb5ab90484bed} of these parts from someone other than the OEM.

If you have a background in inventory planning, you are probably familiar with the A-B-C method of managing inventory. Here is a brief summary:

  • The A parts typically make up 75-80{92b8314a80b58944ba0df9bff999fd6692ae6ba618bc5950ca8fb5ab90484bed} of the annual inventory turnover and include about 15-20{92b8314a80b58944ba0df9bff999fd6692ae6ba618bc5950ca8fb5ab90484bed} of all part numbers.
  • The B parts make up about 15{92b8314a80b58944ba0df9bff999fd6692ae6ba618bc5950ca8fb5ab90484bed} of the annual turnover and make up about 30-40{92b8314a80b58944ba0df9bff999fd6692ae6ba618bc5950ca8fb5ab90484bed} of all part numbers.
  • The C parts account for about 5-10{92b8314a80b58944ba0df9bff999fd6692ae6ba618bc5950ca8fb5ab90484bed} of the annual turnover and are made up of around 40-50{92b8314a80b58944ba0df9bff999fd6692ae6ba618bc5950ca8fb5ab90484bed} of the part numbers.

Notice that the A-B-C spare parts categories align with the A-B-C groups from the inventory model, although the percent and value may differ. And just like the stocking of A-B-C parts are different for each group, the same differences apply to the pricing method.

How Should I Price Spare Parts?

There are three primary ways to price spare parts:

  • Value Pricing: This is best used for your “A” parts and should relate to the total value price of the product. For example, if the “value price” of your product is $500,000 and an “A” part contributes 10{92b8314a80b58944ba0df9bff999fd6692ae6ba618bc5950ca8fb5ab90484bed} of the total value, the selling price of that part should be $50,000. These parts are really your secret sauce. They required a significant investment in R&D and may be covered by a patent. Do not feel guilty about charging a high price because that part is the reason someone purchased your product.
  • Standard Cost + an Additional Percent: For example, whether a part costs $10 or $1,000, you automatically add 10{92b8314a80b58944ba0df9bff999fd6692ae6ba618bc5950ca8fb5ab90484bed}.
  • Margin Pricing: For any segment of parts (A, B, or C), you have a margin target. To calculate the selling price:

Medium_Screen Shot 2021-12-13 at 11.00.59 AM.jpg - in 2 minutes

Also, any of these three prices can be modified by any or all of the following four considerations:

  • Alternate Source Pricing: Once you have a recommended selling price, you should check it against what your customer will pay for the same part if they do not buy it from you.
    For example, your company purchases the “C” parts at a negotiated volume price, which will be less than the end-user low volume price. You mark it up and arrive at what you consider to be a fair selling price. If the price your customer would pay if buying the part from someone else is close to your proposed selling price, then you can keep your price or match the lower price and encourage your customer to buy it from you as part of a larger order. Or, if you do not want to match the lower selling price, then your order desk can suggest that your customers buy from the lower-priced source. Either way, you are keeping your customer’s best interests in mind.
  • Competitive Pricing: It is not unusual that your customer also buys parts from your competitors since they may own equipment made by different manufacturers and they all use the same off-the-shelf parts. To not appear to be overcharging, you should try and check a few of your prices against your competitors’ price lists. Also, there is an important question that you should always be prepared to answer:

Are your competitors raising or lowering their parts prices?

  • Strategic Pricing: After talking with your parts order desk, along with your sales, marketing, and financial groups, you can always adjust your proposed selling price if there is a strong feeling that your customers would balk at your prices. After all, you don’t want to jeopardize a capital purchase opportunity to make your service margin look better. So, be prepared to answer this question:

Are your parts prices important to your customer’s purchase or re-purchase decisions?

  • Customer Feedback: Customers will provide great feedback concerning spare parts pricing.

During a recent consulting engagement, I was told by one of my client’s field service technicians (who also does telephone support and quotes service parts) that a customer told him that an off-the-shelf electric motor was offered by their company at $700 and could be purchased from a major distributor for $179. During the same engagement, an end-user told me the client priced a wear-part for $200, so he had it made at a local machine shop for $25-$27.

If you receive this type of feedback from customers, internal sales teams, or channel partners, you should reread considerations 1-3 outlined above.

Tomorrow we’ll discuss other real-world issues that routinely impact final pricing and describe the actual steps to follow to develop a complete spare parts price list.

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: Syda Productions / Shutterstock.com

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