By allocating resources to their pricing competencies and systems, forward-thinking suppliers will achieve above-average margins. *Victor Keddis writes for Australian Mining.
In my first article of this series I presented the emerging data for a downturn in the rampant resources boom.
I also graphed the gross margins and operating incomes for some of the key players within the earthmoving industry i.e. the equipment suppliers such as Caterpillar, Komatsu, CNH, Ingersoll-Rand and Volvo.
I showed how these margins trended before and during the current resources boom.
I summarised by saying that it has taken approximately four years, a resources boom, and significant manufacturing cost shifting and reduction to deliver healthy gross margins and operating incomes for these suppliers.
I then concluded that taking away (or at least mitigating) the effects of the rampant resources boom, recognising that the benefits of manufacturing cost reductions have been largely delivered then forward thinking companies would realise that now is the time to start developing and implementing strategies to insulate them from the inevitable margin erosion on the horizon.
In this follow-up article I look at what some of these strategies might be.
In particular I will focus on margin protection through price optimisation.
I will look at seven strategies that can insulate most firms in this sector from price erosion. These are —
1. Price Premium Drivers
Most firms with good capabilities in research and strategy can answer the fundamental question: ‘What are the drivers of customer satisfaction/loyalty in your industry?’
As far as suppliers to the earthmoving industry are concerned these will often revolve around factors such as equipment quality and up-time, lead times on parts/service, staff quality and competence, etc.
However, we have found very few firms that can answer perhaps the even more important questions such as: ‘What are the drivers that enable you to command a price premium?’, ‘What is the link between your offering, your ability to lift prices, customer loyalty and ultimately sales growth rates and return on assets?’
Answering these questions is not so hard with some innovative research. However, it will require a little more than a basic survey and some regression analysis. It should also be remembered that the drivers of price premium and price power are not the same as those for customer satisfaction and loyalty.
For CEOs and CFOs who often question and grapple with ROI on the various initiatives undertaken by their firm, and which are principally focused on customer satisfaction and potential share growth, the ability to identify initiatives that feed directly into price premium and price power represents an immediate and significant ROI opportunity.
2. Bid Price Optimisation (BPO)
The large majority of new sales opportunities within the earthmoving sector are won/lost through a sealed bid process (or slight variation) where several suppliers are asked to respond to an RFQ.
The problem here is that faced by all sales professionals: have we left too much money on the table or have we priced ourselves out of a deal we need to meet our sales and market share targets?
The answer to this nagging question is an accurate and quantitative model which considers the three main players i.e. the client, the competitors, and the bidder.
The model is then tasked to maximise the bidder’s profit against the requirements of the client and the performance of the competitors whilst ensuring a specified chance of winning the bid.
A well designed model of this type can significantly increase the ability of firms to achieve both sales and profit targets. It also adds structure, objectivity, and accuracy to the bid pricing process.
3. Service Offer Price Optimisation
Equipment service is invariably a significant contributor to overall profits and there are three disciplines that will ensure its long-term profitability —
i. Cost Knowledge — Too often the true fixed and marginal costs associated with a particular service offering are not known. Overall assumptions about costs are dangerous especially when there is significant variability in technician/engineer experience and equipment age, location, and application.
Without accurate cost data firms face the risk of under-pricing their service offerings especially when concessions to large users are being considered.
ii. Service Segmentation — Service organisations often find themselves offering a wide array of different service contracts, preventative maintenance agreements and time and material repairs. This combined with a lack of accurate cost data often leads service organisations to simply raise fees across the board to improve service profitability. This however often leads to customer dissatisfaction and opportunities for third-party providers.
The more profitable alternative is to carefully segment the customer base and design and price service offerings that are aligned with the market and the capacity of the service organisation.
iii. Value Breakpoints — Service standards, such as response times and repair times, will generally vary between suppliers within a given industry.
Service suppliers to the earthmoving sector that are looking for incremental profit through superior and differentiated service will need to understand where Value Breakpoints are likely to occur.
Value Breakpoints are improvements in service offerings that significantly increase customer value perceptions and loyalty. Consequently they offer considerable margin opportunities.
4. Consumables Bundling
Parts kits have been around for a very long time. However, it is questionable whether the incremental customer value inherent in the kits (i.e. service integrity, convenience, etc) has ever been recovered by the suppliers given the discounts offered; even considering any incremental sales of items that may not have been replaced without the presence of the kits (e.g. minor o-rings, seals etc).
Consumables bundling goes beyond parts kits and looks at opportunities across categories (e.g. filters and GET) to create new market segments, grow category market share, and ultimately sales and profits.
A word of caution though.
Simply combining a few parts and offering them at a discount is a sure-fire recipe for a price war. Profitable consumables bundling examines customer value, purchase behaviour, and competitor dynamics before setting a price on a consumables bundle.
5. Brand Investment
In all our research in the B2B sector we are repeatedly surprised by the importance of brand as a purchase driver.
We have seen brand percentage importance range from 9% to 18%.
At 18% it is almost comparable to the B2C sector.
Suppliers in the earthmoving sector can leverage their brand by understanding what elements of the brand have a significant impact on price premium and price power. It is these specific elements that should be emphasised within the brand development campaign.
A brand campaign that simply uses copy and images sourced through typical channels (i.e. parent company, ad agency, etc) runs the risk of completely missing the price power leverage and considerably weakening the ability to measure ROI on the campaign.
6. New Machine Pricing
A new machine model represents an enormous opportunity to deliver value to customers and to simultaneously retain some of the inherent value for the supplier as incremental profit.
The way to do this is to optimise the new machine price by examining the distribution of wtp’s (willingness to pay) in the market.
Simply pricing a new machine based on its specs and/or competitor pricing will forfeit for the supplier the opportunity to maximise profit for all machines in the range. In addition to this, if the price is not optimised and it is found to be either too high or too low it is very hard to change without a lot of customer angst.
7. Managing Price Competition
Finally suppliers in the earthmoving industry will need to consider how to deal with price competition.
Putting aside illegal measures such as collusion, there are number of fundamental disciplines that suppliers can employ to effectively manage price competition.
In our engagements we have often found that it is internal actions (i.e. poor development of competitive advantage and/or seeking sales in segments where a firm has little competitive advantage, inadequate value-selling skills and methodologies within the sales team, misalignment and/or inappropriate targets, etc) that will often precipitate a price war.
In addition to addressing these internal issues, suppliers within the earthmoving sector will need to have in-place well thought out plans and quantitative risk models to manage the inevitable price competition as the market softens.
In a recent article by the University of California (Berkeley) the authors noted that as industry clock-speed increases Dynamic Capabilities will determine the health and competitive advantage of most firms.
They defined Dynamic Capabilities as the “…ability to leverage and re-configure existing competencies and assets in ways that are valuable to the customer but difficult for competitors to imitate.”
They go on to say “Dynamic Capabilities help a firm to sense opportunities and then seize them by successfully reallocating resources, often by adjusting existing competencies or developing new ones.”
As the resources boom slowly unwinds there is an opportunity for firms within the earthmoving industry to insulate themselves from the inevitable margin erosion.
By allocating resources to their pricing competencies and systems, forward-thinking firms will achieve above-average margins. But the time to act is now.