Service pricing strategies for maintenance services

Transcription

1 Service pricing strategies for maintenance services Dr Shaun West Lecturer for Product and Service Innovation Lucerne University of Applied Science and Art Technology and Architecture, Technikumstrasse 21, 6048 Horw Dominik Kujawski Student of Business Engineering Lucerne University of Applied Science and Art Technology and Architecture, Technikumstrasse 21, 6048 Horw Dr Philipp Schmitt Consultant Roland Berger, Holbeinstrasse 22, 8008 Zürich Abstract The objective of this paper is to identify and describe the maintenance service pricing models used by firms servicing industrial equipment. Today, price pressure in this market has been seen to be increasing with changes in customer buying behaviors. This pricing pressure confirms the need to focus on customer value when pricing (Anderson et al., 2006). Value pricing has been seen to be selectively successful in the B2B environment. Through analysis of different buying behaviors in different industrial segments this paper highlights difficulties and provides guidance on how to overcome them. Keywords: Service pricing strategy, maintenance service pricing, value-based pricing. Introduction The shift for manufacturing businesses to offer services is having significant impact in many industries, influencing manufacturing firms in developed economies to servitize, moving to a position where they offer higher value added products and services (Neely, 2008). To survive in rapidly changing markets, manufacturing companies are forced to offer services and solutions while offering spare parts, repair and overhaul services (Neely, 2008). As far back as the 1980s, Vandermerwe and Rada (1988) confirmed the importance of servitization as an activity adding value to core corporate offerings. However, Barquet et al. (2013) emphasize the influence of servitization on companies business model in a wider sense, and through this on the revenue model, and suggest rethinking pricing strategies and tools employed. Gebauer et al. (2005) revealed that manufacturing companies make substantial investments in extending their service offerings, leading to higher costs but not generating the expected higher returns, meaning that pricing was a key aspect of maintaining margins. Neely (2013) highlighted the importance of servitization in industrial business 1

2 strategies to improve their sustainability. Mohammed (2012) argues that to improve profitability of service offerings setting the right price and capturing the customer value is a top priority. Revenue/pricing models are a key part of the business model and Rapaccini (2015) stated that service offerings from manufacturing companies are seldom priced in a way that the company intended, and in fact, manufacturers should price their most advanced service offerings according to value-, rather than to cost- or competitionbased strategies. The aim of this paper is to describe the complexity of service pricing strategies for manufacturing firms and helps to understand the influence of customer value on pricing dimensions. It does this by comparing the approaches of six firms delivering industrial services take to pricing, considering the objectives of pricing, the strategies and the tools used. Background Pricing is one of the most critical decisions that a company can undertake and no other tool in the marketing toolbox can increase sales or reduce demand more quickly than pricing strategy (Harmon et al, 2009). Hinterhuber (2003) had a similar view, stating that pricing has a huge impact on financial results, both in absolute and relative to other instruments of the marketing mix. Many product-oriented companies struggle to change their revenue models, often giving away services for free to support product sale (Kindström and Kowalkowski, 2009). This indicates the importance of developing a pricing capability that can determine the price for new services and includes possibilities to change the revenue for existing ones; but the challenges to this are the security of the current business model and the involvement of several departments, which leads to problems with cooperation and responsibilities (Witell and Löfgren, 2013). Value as a fundamental component of service pricing Ng (2009) highlights that it is an oversimplified view to state that a buyer s choice is dependent on price and if the price is lower than the amount the buyer is willing to pay, the buyer will buy. Docters et al. (2006) state that pricing services is often more difficult than products, and firms should think about ensuring customer satisfaction. Bonoma (2006) presents the complexity of the buying process by introducing the different buying roles encountered in the selling situation. Anderson et al. (2009) confirm that deciding upon a specific price is not simple, because there are many other considerations. They simplify the question to: what is the difference in worth of the two offerings to my firm, and how does it compare to the difference in their prices? (Anderson et al., 2009). This indicates that suppliers should design services that deliver value to the customer based on both the emotional and functional value propositions, as well as the outcome dimensions. This is in agreement with Gebauer et al. (2005) who recommend optimizing productrelated services based on what the customer values before offering them to the customer. Pricing objectives The objectives of pricing are to determine which pricing strategy will be the basis for profitable decisions as a result of company s overall strategy (Hinterhuber, 2003). The objectives of firms are both quantitative - related to the firm s profits, sales, market share and cost coverage - and qualitative - associated with customer relationship, competitors and distributors (Avlonitis and Indounas, 2005). Indounas and Avlonitis (2008) summarize pricing objectives in terms of the factors: stability in the market; customerrelated; service quality-related; financial; achieving satisfactory profits and sales; market 2

3 share and capacity-related pricing; competition-related pricing objectives; and maximization of profits and sales. As competetive pressures increasingly commoditize product markets, embedded services will become the main differentiation for value creation, but firms will need to clearly understand the strategic rules and integrate them into their operations and objectives (Auguste et al., 2006). Pricing strategies Pricing decisions according to Avlontis (2007) are influenced by both inward and outward characteristics and can be divided into service (e.g. cost) and organizational characteristics (e.g. marketing objectives). According to Lovelock (1996), cost, competition and customer-based characteristics are the most important factors to consider when developing pricing strategies. Ng (2008) defines the cost-plus approach as setting a price that is deemed sufficient to recover full costs and adds sufficient margin above that cost to provide the firm with some profit. Anderson et al. (2009) state that in the cost-plus approach, values that the market offering provides to the customer are not considered, so the supplier is risking either being uncompetitively high-priced or giving away value that it does not know it provides to the customer. Whereas the competition-based pricing approach is defined as setting the price level in relation to what the competitors prices are, and using it is in effect handing over control of a critical aspect of marketing strategy to competitors (Anderson et al., 2009). Another approach proposed by Johansson et al. (2009) is to use value-based pricing: a pricing method based on usage of service and/or product use and/or customer outcomes (Sawhney, 2006). Pricing tools and pricing methods Avlonitis and Indounas (2005) identified three categories for service pricing methods: cost based, competition based, and demand based; stating at the same time that the empirical research on pricing methods is extremely limited. They go on to state that there are six significant pricing methods, namely: negotiated pricing, pure bundling, trade discounts, efficiency pricing, cash discounts, and mixed bundling. The findings were confirmed by Shankar et al (2009) who state that firms must pay more attention to new hybrid offerings to attract new customers, and improve demand among existing ones by providing superior value. This will enable firms to boost their revenue and profit streams, and improve liquidity at low risk.! Methodology This paper is based on the cross-case analysis of six firms providing maintenance services to the owners and operators of capital equipment. The firms were selected because they provide different maintenance packages or have different revenue models and were active in different market segments. Due to the often sensitive nature of pricing discussions, interviews were used to provide an initial insight into pricing strategies of services, rather than using a wider, and complementary, survey. Data for this study were gathered from structured interviews with the target firms. The results of the six cases were compared with published information from a wider base, including economic and B2C environments. Due to the sensitive nature of the subject, personal contacts of the authors were used for this initial study, so the risk of the results 3

4 being biased therefore could not be removed. The interviewees were all long-standing senior managers within the firms, with authority to take part in the interviews. This was important in the design as the interviewees need to understand the end-to-end sales process. The data were analyzed in a table allowing, where possible, direct comparison between the different firms. Common language from the literature was used to assist the analysis, as normally every firm has its own internal language. Results The results of the interview are shown in Table 1, the company names were removed to ensure commercial data could not be shared. The firms selected for the interviews all provided services on industrial equipment of some form; not all of the firms were Original Equipment Manufacturers (OEMs). The firms selected cover a range of sizes and markets. The interviewees were sent a brief five days prior to the interview to allow them to prepare. At the interviews the standard agenda was used with each interview scheduled for minutes. Description Segment Table 1 Overview of the firms interviewed and interview analysis Firm 1 Firm 2 Firm 3 Firm 4 Firm 5 Firm 6 Provides Full service Power Service Supplier and Industrial hardware and provider for generation provider for service turbosoftware for propulsion equipment and rotating provider of machinery industrial systems services equipment textile systems equipment and refrigeration services Industrial refrigeration Marine Power Generation 4 Maintenance eservices Textiles O&G, industrial Power Category OEM Aftermarket OEM Aftermarket OEM OEM Size SME Large Large SME Large Large Selling channels Equipment indirect Agents Equipment indirect direct Equipment direct Agents Equipment direct In addition to the summary in Table 1, key lessons were captured from the interviews in the form of quotes to provide a richer understanding of the different firms approaches to pricing. Key quotes from the interviews:! pricing challenge we help with [customer] problems via hotline but we do not charge for that I expect volume advantage from bundling spares! value drivers response time is important for customers good relationship you can get it when you can offer reliability the customer values availability and quality of the service you need to put a price where the customer still buys it. You look on customer s ROI/cost of capital add a premium and get close to the point where customer says no.! pricing tools our formal calculation scheme was a little bit old/out of date value-based pricing is a type of pricing based on sensitivity of customers we apply different pricing mechanisms where we do not have competition or we have a pre-dominant position, this is value-pricing for us if customer decides to unbundle, customer tends to end up with problems

5 Table 2 provides details of the objective of pricing and the strategies applied to obtain the objectives and tools subsequently used to support the achievement of the objectives. Table 2 Objective of pricing, pricing strategies of the firms and pricing tools Firm 1 Firm 2 Firm 3 Firm 4 Firm 5 Firm 6 Objectives of pricing Stability in the market Maximization of profit and sales Achieving satisfactory profit and sales Market share and capacity-related pricing objectives Financial objectives Competition-related pricing Customer-related pricing Service quality-related pricing Pricing strategies Market-based pricing Customer value Cost plus Customer willingness to pay Emotional input Cost leadership Performance Pricing tools Market benchmarking Cost build up Bundling Trade discounts Willingness to pay Historic Price lists Capacity pricing Cost/revenue models Demand based pricing Efficiency pricing: Payback/ROI Performance modelling Value in use Sales managers Cash discounts Negotiated pricing Discussion This section takes the individual responses and leads to a discussion on the lessons learnt for pricing. The firms All of the firms were providing after market parts and services to end-users of equipment. In four cases the firms were OEMs selling equipment indirectly to the end-user (often via an installer), aftermarket services were, however, provided directly to the end users. In two cases the firms were only active in the aftermarket. All were active in different market segments. The firms therefore provide an insight into the wider industrial aftermarket rather than a single market segment. 5

6 Pricing objectives Pricing objectives were based around margin optimization (or maximization), stability in the market, and maximization of profit and sales in most cases. In other cases, the objectives were based on finance or overhead recovery (again finance related). This suggests a strong affinity to the cost plus basis of pricing. One firm had an objective to manage market share and capacity-related market objectives. This objective has more market/customer value focus than a margin focus. The combination of maximization of profit and sales, and overhead recovery presents a mature view of two combined drivers that pricing can achieve. Under-utilization of employees (overhead coverage) in certain periods can lead to serious margin erosion even with high prices, and to some degree reflects an understanding that value is a two-sided model. The objectives of the pricing strategies are generally supplier focused, rather than customer focused. This provides evidence that the current strategies are not in line with the value-based pricing recommendations of Anderson et al. (2006). None of the firms mention that optimal pricing (e.g. customer value based) should be a key part of maintaining a suitable relationship with a customer. Pricing strategies Three of the six firms were applying market-based pricing strategies, one in particular was using market-based pricing as it took a cost leadership strategy with a market price of X% below the OEM price. The use of market-based pricing was generally applied to ensure that the price offered was close to that of the competition, and therefore used as a control mechanism. Looking at value based strategies, three of the firms were using willingness to pay or pay for performance to provide alignment with customer value creation. It is interesting, as Firm 3, which was considered to have the most mature approach to pricing, applied performance based pricing rather than simply considering the costs and then working to optimize the margins. Two of the firms have a cost plus approach to pricing as a strategy. In most cases this only include the tangible scope whereas it can also include the cost of capital depending on the strategy of the firm and in which chase would be include in the cost build up tools. Too few of the firms focused on customer value when considering the pricing of services, as recommend by Anderson et al. (2006). The pricing strategies of firms 3, 4 and 5 had some form of consideration of customer value in their pricing strategies, although for all of the firms there was a cost plus basis to support their pricing objective to optimize/maximize margins. Pricing tools There was an expectation that the pricing tools used should support the objectives of pricing and the pricing strategies. All of the firms applied three pricing tools (market benchmarking, cost build up, and bundling) to support their pricing objectives. The use of market benchmarking covered basic day rates (firms 1 and 4), to more customer-based comparative benchmarks (firm 3). The benchmarking used most commonly was a direct comparison with the competition. Historically, pricing fits closely with the market 6

7 benchmarking; it is important to be coherent with pricing as this is an aspect of customer relationship management (Zhang et al., 2014). All firms applied a cost build-up of some form or other. This is coherent with the objective to optimize/maximize the margins and finance-driven objectives. Without accurately understanding the service costs, it is not possible to review margins nor control costs. Price lists and trade discounts as pricing tools were often used in conjunction to support the pricing strategies. Trade discounts often provide a 'feel good' factor (e.g., intangible benefit) for the buyer, although do not directly reflect customer value creation. Bundling was used as a pricing tool by all of the firms questioned, as it could be used to make comparisons harder. The use of bundling in a more advanced way was presented by firms in terms of scope/price negations, thereby providing a different approach to customer value discovery. Interestingly, this approach can lead to co-delivery of services which has additional advantages of improved customer experiences (Shankar et al., 2009). This can extend the model to do-it-for-me, do-it-with-me and the extreme of do-it-yourself. Customer willingness to pay was used as a tool in many cases. Feedback on this tool provided limited understanding of this concept; it was not always directly associated with customer value but was often effectively a market pricing approach. Customer valuebased pricing tools were identified in a number of instances; from the use of cost/revenue models, demand-based, efficiency pricing of payback/roi, cash discounts, negotiated pricing, and performance modelling, to value in use. This is a positive step as it shows that the firms are attempting to identify customer value in one form or other, however the maturity of some of the pricing tools should be further investigated. Interestingly, four firms were using pricing tools to support their capacity planning in an effort to improve under-absorption and hence improve margins. This tool shows that both customer and supplier can benefit from appropriate pricing. Performance modelling was used to support the development of performance commitments: effectively outcome-based pricing, however this typically represented a small (15% or lower) amount of the total price. Key findings The findings of the interviews confirmed those of Ng (2008) and Bertini (2012) in that the pricing of services is complex, with many influencing factors, rather than a simple calculation. In essence, service pricing should not simply be left to the sales function alone, although delegation is necessary. Pricing, therefore, is an interdisciplinary task within a firm involving sales, production, logistics, finance and risk management. Pricing dimensions must be understood within the firm and understood by those upon whom the pricing impacts, because of the risks that exist for a supplier when there is a gap between the costs and the revenues of a business model. Risks for the supplier are lowest when pricing is closely related to inputs (e.g. cost plus), whereas risks are higher as the supplier moves to price-per unit consumption or to contract outcomes/performance. Within a firm there should be an alignment between the pricing objectives, pricing strategies and tools. This was not always clear from the interviews. Tools were not necessarily always present to allow pricing decisions and such tools are needed to create a value based pricing model according to Anderson et al. (2009). 7

8 The basis of effective pricing from the analysis was: understanding the previous prices provided to the customer; knowing the market price ; having effective benchmarks to assist with pricing; understanding the customer s value creation process. This is in agreement with Lovelock (1996) and Hinterhuber (2004) who stated that the following three aspects were key considerations in the pricing decisions: customer value, competitive analysis, and the internal cost/volume/profit analysis The key observations from the analysis were:! most companies confirmed that different pricing models help with margin optimization although they often felt it was hard to move away from a cost-plus model;! the buyer is not the user, creating misalignment of purpose on the buying side;! the buyer may be more advanced in pricing model innovation than the seller;! cost-plus pricing plus some form of performance payment was popular;! firms had a desire to move to value-based pricing but were unsure of the implications;! demand and supply management through pricing was an important objective;! there was limited customer segmentation/discrimination available to assist with price optimization;! bundling and unbundling of the goods and services could have positive results with the customers when applied in a disciplined manner;! pricing also provides a focus on measuring customer value which ought to be helpful to develop specific pricing strategies;! revenue models in advanced services moved to align to some degree with the value creation models of the customers;! some firms moved selling their receivables to enhance their cash flows;! transparency and elimination of waste are important terms to show the hidden value/cost of a service. Maintenance service providers should bear in mind that service is based on the idea of value-in-use over time and not only value-in-exchange in a given transaction (Kimbell, 2014). Single,!inflexible offerings can limit companies to sharing limited value, whereas flexible offerings respond to customers' changing needs. Flexible offerings, unbundling or modularization (e.g., do-it-yourself, do-it-with-me or do-it-for-me, long-term, spot, performance based etc.) offer dimensions that support customer choice and provide additional pricing dimensions that can have positive impacts on both supplier margins and risks. Integrating the customer within the service delivery with the customer becoming an integral part of the service delivery (Frei, 2008) can additionally increase customer satisfaction. This approach fulfills the qualitative objectives of firms associated with customer relationship and increasing service quality (Indounas and Avlonitis, 2008). Conclusion Many companies have traditionally seen value in the marketplace as fixed and that they were the rightful owners of value, so therefore they were entitled to charge whatever the market would bear (Bertini and Gourville, 2012). Pricing was treated more as a calculation, often at its most level basic of cost-plus, rather than focusing on customer value creation. 8

9 Today, pricing in a maintenance service environment is particularly challenging due to the large number of dimensions that exist. Many of the firms studied are struggling to come to terms with the complexity and need guidance to support their pricing strategies. This study, using a cross-case analysis has taken the lessons from each and identified that the firms should start to consider the objectives of pricing in a more holistic way, as pricing has more impact than in margin maximization alone. The strategies to achieve the pricing objectives should be reviewed with a wider group than the sales function. Tools should be used that help firms to deliver their objectives, and these tools should help to clarify the pricing dimensions that are available as well as considering Anderson and Narus's (1998) value-base model composed of: supplier, customer, and competition. This paper contributes to the service pricing theory by confirming that understanding customer value, rather than simply relying on cost-plus or market-based approach, is a key to pricing industrial maintenance service. It reinforces the need to determine specific pricing dimensions in addition to having clear pricing objectives that are in line with the firm s strategy. A pricing strategy to support delivery of the objectives using coherent tools is a starting point to improve the pricing approaches for maintenance services. Recommendations More research should be undertaken into the dimensions influencing service pricing objectives, pricing strategies and tools for manufacturing companies, due to the limited number of cases. The aim should be to perform a greater number of interviews as well as additional surveys to investigate how customer value across different customer segments influences pricing dimensions. The aim should be to identify the best practice to assist manufacturing companies to determine the right steps to improve pricing strategies and improve co-creation of value with the customer. This should be accompanied with determining which pricing tools are most efficient and effective to better understand customer value creation, and might help with overcoming pricing challenges. This research could be coupled with determining a best practice roadmap to implement changes within the organization to improve pricing processes across different departments. Acknowledgements The authors would like to acknowledge the six firms who were interviewed as well as the Lucerne University of Applied Sciences and Arts for supporting this study. References Anderson, J. C., Narus, J. A., & Van Rossum, W. (2006), Customer value propositions in business markets., Harvard Business Review. doi.org/ / n945. Anderson, J., Narus, J., & Narayandas, D. (2009), Business Market Management: Understanding, Creating, and Delivering Value, 3rd edition, Pearson/Prentice Hall, Upper Saddle River, New Jersey. Auguste, B. G., Harmon, E. P., & Pandit, V. (2006), The Right Service Strategies for Product Companies., The McKinsey Quarterly 1: Avlonitis, G. J., & Indounas, K. A. (2007)," An empirical examination of the pricing policies and their antecedents in the services sector.", European Journal of Marketing, Vol. 41, No.7-8, pp Avlonitis, G. J., & Indounas, K. A. (2005),"Pricing objectives and pricing methods in the services sector", Journal of Services Marketing, Vol. 19, No.1, pp Bertini, M., & Gourville, J. T. (2012), Pricing to create shared value. Retrieved April 11, 2016, from Barquet, A. P. B., de Oliveira, M. G., Amigo C. R., Cunha., V. P., & Rozenfeld H. (2013), Employing the Business Model Concept to Support the Adoption of Product service Systems (PSS)., Industrial Marketing Management, Vol. 42, No.5, pp

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