February 5, 2018
The concept of true outcome-based pricing has been around for a while. Most pricing professionals have heard of the ‘Power by the Hour’ model invented by Rolls-Royce over 30 years ago which remains an established practice in the airline industry today. We are now on the verge of outcome-based pricing becoming mainstream. What will this mean for pricing practitioners? Will the distinct discipline of spare parts pricing exist in the future? Let’s take a closer look at outcome-based pricing in spare parts.
Outcome or Performance based pricing is primarily a shift of risk from the purchaser to the service provider. This means that service providers must have reliable data to predict failure rates, optimum servicing intervals and the consumption of consumables. Collecting, interpreting and using this data to predict likely outcomes has been expensive and time consuming. While cost effective for very large capital equipment such as jet engines, trucks or cars, it has been difficult to justify for the majority of industrial applications.
The rise of the ‘Internet of Things’ has been fuelled by reducing costs to manufacture smart products, combined with almost ubiquitous network availability. As costs have declined, there has been an increase in the number of traditional products which can become smart. Obvious examples include pressure sensors in tires, or gas cylinder caps which can measure contents. The shift to cloud computing also brings with it the ability to store the massive quantities of data generated, while reducing the costs involved and creating access to very low-cost processing power.
Put simply, outcome-based pricing has or will soon become cost effective for a very large number of applications.
Just because it’s possible?
Outcome-based pricing is fundamentally better for the buyer than alternative models. The primary benefit is reduced risk as it moves to the supplier and this is most evident in cost management processes. The peaks and troughs are reduced, and their costs are now fundamentally aligned with their own business, or production model. At the same time, they know that having agreed to a given outcome-based price, it is now in the suppliers’ best interest to deliver a high-quality service which is dependable and highly available. When presented with both options, buyers prefer outcome-based models even when it means they pay more. The first company that can offer this approach in each market has a big opportunity to disrupt their competitors. They will have taken a first step that will force everyone else to follow.
Is it a new name for subscription or rental?
Subscription-based services have been around in many markets and particularly in the software world for some time. They are a step in the direction of outcome-based pricing, but only a step. Fundamentally, a subscription is simply the amortisation of an upfront cost, which is great, but it’s a long way from monetising the outcome you are looking for and does little to shift the risk. Imagine buying a drill and a pack of drill bits for making holes. A rental or subscription model allows you to pay regularly rather than up front to have the drill. In an outcome-based model, you might be charged for the number of holes you make because they are what you really want.
Who will keep their job in pricing?
The natural inclination is to assume that whoever prices the capital equipment today would simply shift to outcome pricing, and that because this could include all the spares, the discipline of spare parts pricing could disappear. Spare parts pricing professionals shouldn’t let this happen. While outcome-based pricing can seem like an inevitable step, and perhaps a ‘simplification’, it has its own unique challenges around measurement, invoicing, and margin performance tracking. These new issues are the key to both success in an outcome-based world, and to making sure that the expertise of our spare parts professionals is not forgotten.
Here are 3 steps to ensure you continue to add value to your businesses and perhaps become the natural leaders for outcome-based pricing approaches.
- Own the Data: In the world of outcome-based pricing, data is king. Whoever owns the data drives the direction. Make sure to collect and keep every recordable data item. Consider the value of collecting data on aspects such as the environment where the product is being used. This information will be key to measuring and predicting profitability.
- Analyse the Data: Use the data to derive insights that will be needed for outcome models. The most obvious examples are mean time to failure on, or usage of parts. Less obvious but equally important is to look for the optimum balance on margin when you look at the product combined with the service costs of regular replacement.
- Promote Disruption: It isn’t everyone’s natural inclination, but being the advocate for change, knowing the value available, and pushing for a new way could make all the difference.
Is spare parts pricing dead?
The end of ‘spare parts’ pricing as we know it, or at least a huge reduction, might be around the corner, but it isn’t really an end. It’s simply that capital and parts pricing will need to merge. Spare parts pricers with the right skillset will own the new models.
More resources for spare parts pricing can be found here.