In order to remain competitive with spare parts price fluctuations, machine manufacturers need to align their parts pricing strategy with the market.
Overview of Parts Pricing Strategies
Competing in today's marketplace requires a parts pricing strategy that is in line with what the market will bear and consistent with a company’s strategy.
Competing in today's marketplace requires a parts pricing strategy that is in line with what the market will bear and that is consistent with your company’s strategy.
There are many different pricing strategies, each with its advantages and drawbacks. It's important to understand the various methods to choose the best one for your parts business. Here's an overview of the main pricing strategies and their pros and cons.
Primary Pricing Strategies
Cost-plus pricing, also known as markup pricing, is where a markup percentage is added to an item's cost to arrive at the selling price. Grocery stores use cost-plus pricing, which makes it easy to predict how much margin each item will net.
Cost-plus pricing doesn't require many supporting resources or additional market research. It provides full cost coverage and a consistent rate of return. It can be inefficient and doesn't consider a customer’s willingness to pay.
Value-based pricing sets the highest price possible based on the goods or services' worth to the customer or their perceived value. Businesses use this strategy to price their goods and services at an amount they think customers are willing to pay. Apple provides a classic example of this, which includes its unique design, and integration of phone, tablet, desktop, and laptop devices.
You can easily penetrate the market with value-based pricing and command higher price points. However, it is challenging to set a price based on perceived value alone. Truly providing customer value will foster a niche market. Without a differentiating value proposition, it will be a challenge to maintain market share when competition arrives.
Market-based pricing involves assessing the market to set prices. The cell phone market is an example of market-based pricing in action. While there's no shortage of suppliers, the dominant players closely monitor each other's pricing and functionality. New phones command similar pricing and capabilities as a result. The automotive industry also uses market-based pricing. Cars of a particular type come with similar-sized engines, interior cabins, and sticker prices.
Market-based pricing is a low-risk strategy that attracts sales. However, if competitors make a pricing error, it can be easy to replicate. A firm grasp of market-based pricing allows businesses to price at, above, or below those levels. This allows for responsive pricing, fuels demand, and increases sales and profits.
Secondary Pricing Strategies
While cost-plus, value-based, and market-based pricing are the most common, other approaches exist. Here's a brief overview of auxiliary pricing strategies and their impact.
Penetration pricing attracts sales and allows a business to establish its market share by setting prices lower than buyers would willingly accept. For instance, an online news website might offer one or more months free or at a reduced rate to promote its launch or attract annual subscribers.
This approach to pricing can cause customers to switch from competitors and create brand loyalty quickly. Penetration pricing may promote price wars, leading to margin pressure. It also requires incurring upfront costs that may not be recouped in the short term.
Dynamic pricing involves changes to prices in response to changes in demand. It is also referred to as surge pricing, demand pricing, or time-based pricing. Airlines engage in dynamic pricing using the demand for seats, the number of available seats in each class of service, and days until departure to price their remaining inventory and maximize revenues.
Higher revenue and profits result from dynamic pricing, yet only some products or services lend themselves to this pricing strategy. This approach is highly responsive to market conditions and allows businesses to capture incremental revenue. Frequent price changes can confuse and alienate customers and lead to the gaming of the system by buyers to minimize their purchase price.
Skim pricing, also known as price skimming, is the inverse of penetration pricing. Instead of setting low prices to attract customers and build market share, skim pricing sets high prices with a plan to reduce them as competitors materialize. Apple uses skim pricing. Their new products come with high prices, yet initial demand for new Apple products is consistently high, allowing the company to boost sales. Once competitors release their products, Apple reduces its pricing to maintain market share.
This approach allows Apple to capture the largest share of revenue possible with different product lifecycle stages. The high-spending top market will be the first to adopt the new product, which then sees price reductions to further cater to the entire customer base.
Establishing a high selling price creates the perception of high quality in the mind of buyers. It also allows businesses to recoup their costs quickly. This strategy works with an inelastic demand curve, meaning the buyer’s demand does not change as much as its change in price. This approach will not work if competitors offer similar products and buyers view them as comparable.
Cost-plus pricing, value-based pricing, market-based pricing, dynamic pricing, and skim pricing are all common strategies used in business. Which one you use depends on your understanding of the market, your products and services, and how much risk you're willing to take. Each has pros and cons you need to weigh before deciding.
Selecting the right parts pricing strategy can improve parts revenue, increase profit margins, and help a business to outperform its competitors.
Market-based pricing helps manufacturers transform their parts business. Our research shows that when manufacturers do not use market-based pricing, they forgo revenue for an average of 73% on their purchased parts sales.
Want to dive deeper? Keep exploring the top pricing strategies for OEMs here!