Dr. Peter Colman, Senior Director, and Xi Bing Ang, Manager at Simon-Kucher & Partners, the world’s leading pricing consultancy, share perspectives on how to define pricing strategies for servitizing businesses.
What are the key principles for manufacturers embracing servitization when formulating the pricing strategy for their new business model?
Inherent to the product-centric heritage of manufacturing companies are well-honed capabilities in value creation: developing highly engineered products, ensuring consistent quality, providing convenient logistics etc.
Equal amount of energy and analytical rigour, however, is often not afforded to value extraction: reaping deserved financial rewards through effective pricing.
According to Simon-Kucher’s Global Pricing Study, 55% of surveyed industrial goods and machinery companies felt they were unable to achieve the prices they deserved for value delivered.
There is much room for improvement on this most powerful profit driver to move from cost plus to more value-oriented pricing.
Well-designed pricing strategies become even more critical as manufacturers adopt servitization, which brings fundamental changes in how value is delivered to the customer.
We have distilled our pricing experience into three key principles:
Define strategic objectives and financial targets
The general benefits of servitization have been widely publicised – growing revenue, improving customer relationships, avoiding commoditization etc. That does not mean that all will be realised in each company.
There are usually trade-offs to be made between individual strategic objectives, e.g. revenue growth versus margin improvement or new customer acquisition versus retention.
Therefore the overarching goal and associated objectives need to be defined, with financial targets set and the entire management team aligned, before a robust pricing strategy can be crafted.
Analyse economic value created for the customer
In our experience too few manufacturers focus on the economic value that they create for their customers. Manufacturers need to analyse how much it is worth to customers to solve their problems.
Once this is understood, they need to decide what financial reward they deserve in return. One client in the power and automation sector aspired to capture at least 15% of any additional value created. This number directly informed both the pricing strategy and the value-selling messages used by their sales force.
Model the customer cost-to-serve and risk
When selling products the production cost is incurred once and can typically be quantified to a high degree of precision. Profitability can therefore be scrutinised and managed at the transaction level.
When selling advanced services, however, a variety of costs are incurred over the contract lifetime and by service infrastructure that is shared across the entire customer base.
Measuring true customer-level cost-to-serve is notoriously difficult. For a servitizing manufacturer this represents a fundamental shift from managing product-level gross margins to estimating cost-to-serve and risk factors.
These factors need to be incorporated into the pricing strategy to ensure profitable service delivery.
Thoughtfully embedding these principles is crucial towards delivering the financial promise of servitization. We will explore the practicalities of applying these principles in designing pricing models in a future article.
Peter and Xi Bing work within the Technology and Industrials Competence Centre at Simon-Kucher & Partners, a global consulting firm specialising in TopLine Power®, which encompasses strategy, marketing, pricing, and sales.
Founded in 1985, the company now has 860 professionals in 29 offices worldwide. Simon-Kucher & Partners is regarded as the world’s leading pricing advisor and a thought leader.