Tuesday, March 10, 2009

Recessionary Pricing - Do Do That Voodoo That You Do So Well! or, …Hey, Forget the Voodoo and Get Cracking With a Little More Psychology and Science?

Cole Porter had it right on this one. We started our revenue management “brain surgery” practice in 1993. We call it “brain surgery” because most OEMs walk around with a pricing headache, but fear going to the doctor to get it fixed. Or, worse yet, they think that in a world of headaches, they are pretty well off compared to everybody else. It is not uncommon for top OEM executives to have family members going to dealers for simple maintenance and coming back complaining about high parts costs. They prove it with anecdotal evidence that can find its way to the board room. High prices are characterized as a cancer. So, it is not uncommon for the “institution” to believe that parts prices are dangerously too high … without any understanding of the attached value chain. And it is all too common for the pricers to think they really do have everything under control; that those executives simply do not understand, … so they must carefully continue do what they already know they need to do (whatever that is, nobody knows). They do that “pricing voodoo.” In the struggle between misguided opinion and voodoo science nothing changes. NY Times Op Ed columnist Gail Collins might characterize this as a classic Mexican standoff in a time of colossal opportunity. (Maureen Dowd would simply attribute it to W. and Cheney.)

Two war stories: Years ago we did some breakthrough work in parts revenue management that was supervised by a very suspicious EVP of North American vehicle sales and marketing. He positively knew that service-parts were already overpriced and always mentioned his favorite local dealer – “the ringer” – as the paragon of virtue and benchmark of aftersales support. We talked to about a hundred dealers and included the ringer in the mix. We documented how each of these hundred or so dealers set their list prices. The ringer was the most aggressive dealer in the mix in terms of matrix pricing (i.e., matrix pricing is a dealer retail price setting method that sets prices at a multiple of dealer acquisition costs and almost always results in prices that are higher than OEM suggested list.) Jaws dropped and we proceeded to re-write a price book that rang the bell for over $100MM in margin improvement … without any (call it “zero”) flak. The next year, after the pricing adjustments had been implemented, dealer satisfaction with pricing improved. So did CSI. On another assignment, this one vehicle pricing, we interviewed a slew of dealer salespeople and, using fresh deal jackets, documented the “choreography” behind hundreds of very recent deals. One salesman was especially proud of selling a tricked-out full size pickup to a compact-car price shopper. We interviewed the new pick-up truck owner later that evening and found he was as pleased as punch with the deal he got. Lesson? Pricing is more about complex integrated processes than prices. Hence, the term “revenue management.”

In our preparation for this year’s conference on “recession-buster ideas” we’ve heard a lot about pricing as a tool for more rapid coping with the recession. We are not hearing of it as being used as a pick axe to break into the money vault. Rather, we are hearing about using pricing to solve the value-chain solvency riddle. How can you price in a way that helps customer satisfaction, is good for dealers, and is good for the distributor? Let’s make this perfectly clear. How do you price so that customers do not use it as an excuse for tarring dealers as the high-cost spread, while dealers make more money and the OEM makes more money?

Plot, Plop, Fizz - 3 Keys to Unlock Recessionary Relief

Impossibly quick and simple. All you need to do is (1) UnLearn a bunch of stuff that might be metastasized through your organization, (2) ask a lot of “Why Nots” that challenge a lot of baseline operating knowledge and policy, and (3) very quickly roll out sim-tech solutions to realign prices, starting with the no-brainers and moving to brainers.

UnLearning. The first trick is to UnLearn some everyday walking knowledge. One of our cardinal laws of consulting is to UnLearn. It is in our “Handbook for the Recently Hired” training manual. Let me explain. We all know that you drive on the right side of the road – we learn this through observation and drivers education. Driving on the right side of the road soon becomes an automatic response – we do not have to think about it. Now, go to Japan and you have to UnLearn a lot about driving. Nothing is automatic about driving on the left side of the road, and you have to think about each and every step to avoid catastrophe. It’s the same with revenue management. Rather than rely on automatic responses, let’s think about some things that float closest to the surface.
  • We know that dealer repair order “optics” is the culprit in causing dealers to be erroneously seen as “higher cost” than IRFs – and the problem is more with labor rates and shop supplies than with parts prices.
  • We know that smart dealers with the most aggressive matrix pricing strategies, coupled with superb service and customer handling, have higher customer satisfaction than rank-and-file dealers who simply use suggested list prices. Approximately 50% - 60% of dealers use matrix pricing.
  • We know that the OEMs have less than half their parts market share because a lot of maintenance and repair work is done by IRFs who buy their parts from non-dealer sources.
  • We know that most of these IRFs double-net the non-fastest-moving parts on their ROs and they are aware that they make more money with higher priced parts. We know that they know customers think they are cheaper than dealers and they do this with lower labor rates, not parts costs.
  • We know that IRFs buy most of their parts from WDs and jobbers because of convenience, fast delivery times, and counter-person relationships. Not pricing. We know that they really do not do much price shopping once they have selected their preferred suppliers.
  • We know that a typical jobber can carry about 20,000 parts that services all OEMs – including air fresheners, tools & supplies, agriculture, lawn & garden, light construction, and truck. We know that the breadth of parts in stock for any one particular OEM’s model is fairly narrow and focused on fast moving maintenance parts. We know that if the part is not in stock, it cannot be delivered in the timeframe that the IRF prefers.
  • We know that Wal-Mart carries some parts that are priced very low and are highly visible reference points – mostly batteries, filters, and fluids. We know that smart-ass journalists who pick on OEM parts prices are lazy and do much of their research at mass merchandisers.
  • We know that price is always part of a value proposition: price, product, place, promotion. We know that there is a difference between price and value. A price is a digit. Value expresses the relationship of what you get for what you pay.
  • We know that we are price leaders on some parts, and that the aftermarket will follow us (price decreases here only lead to lower profits for all).
  • We know suggested list pricing is still quite unsophisticated across OEMs and the aftermarket.
  • We know that the “baseline” premium that customers are willing to pay for OE “genuine” is about 10%-20% and has not changed over the decades.
  • We know that, outside CE/Ag and fleet -
    • few people are do-it-yourselfers and that this is not a make-or-break segment for the OEMs
    • LKQ/Keystone has a fairly limited short-list of competitive crash parts for each OEM, the extent of which is proportional to the model-specific fleet size, and,
    • Powertrain is a lost segment where dealer sales are more situational than cost competitive – what’s left is fairly price insensitive.

What do we have to unlearn? The car-guys have to unlearn common knowledge that most parts are “competitive.” Actually, in the grand scheme of things, few really are competitive because OEMs generally do not effectively compete outside the dealer channel just on price, absent certain segment-relevant service quality sales components. Everybody needs to UnLearn that we must have pricing parity with all of our “competitive” parts, because unless you have a great wholesale strategy working out there, most of these parts (and parts prices) are simply ignored by the non-dealer market. We have to UnLearn core pricing laws that encourage us to competitively price for markets we do not really operate in (e.g., car-guys DIY, mechanical wholesale, accessories, and Powertrain) and that are completely different than the one we dominate in (this is the equivalent of selling boats in the Sahara). We must UnLearn that doing a “competitive benchmarking assessment” is a big deal involving lots of time – it is scalable and can be done with a 3rd party or, when cash is tight, in-house. Most of it (the 80% that causes most of the pain) can be done inside a couple of hours inside your local Wal-Mart, hunting on the internet, and talking to friendly bump-shops.

Here’s an interesting way of looking at pricing. Let’s take an OEM who does $250MM in parts sales as an example. Let’s assume that 5% of the total sales value is in the “comfort zone” of competitive pricing – e.g., looking out at the incredibly foggy terrain of pricing, we think we are plus/minus $12.5MM of being where we should be. We could hire one person to spend all their time on the internet, talking to dealers and bump-shops, searching the web, and auditing the shelves of Wal-Mart. This would cost us $100K a year for a scrappy new hire. Based on C&C’s 15 years in the pricing” brain surgery OR”, that $100K investment is likely to get you to $262.5MM in sales with more comfort than you have at $250MM in sales. That’s a pretty good investment, even if you need 10 more people (or the equivalent $ with a third party) rather than just one scrappy BA. We need to UnLearn how we think about a “revenue management” organization, headcount, and operating costs.

Why Nots. We publish a price book and have a walk from dealer net to suggested list. We have discounts and incentives. We have programs. First off, we need to UnLearn that these are all independent events. They need to be connected. Actually, they can be integrated and connected to replace the voodoo with psychology and science. Why Not do this? Let me explain. OEMs like flat mark-ups from dealer net to suggested list – a 40% dealer margin is standard. So, the “suggested” dealer margin on an oil filter that competes with Wal-Mart is the same as an arcane electronic ignition part. Change this and risk the wrath of vitriolic calls from powerful (and influential) dealer council members. So, we might lose this “lever” and are forever sub-optimized. We have to unlearn this. Why not squeeze the suggested list on the few highly competitive parts and use a wholesale compensation program to economically drive wholesale penetration? Or, why not simply eliminate suggested list on these parts altogether? We need to UnLearn the fact that wholesale compensation programs can be gamed by dealers – innovative use of today’s technology can help prevent the most egregious offenses, and entrepreneurial third parties can audit compliance much the same way freight bills are audited.
  • Why not challenge the premise of achieving dollar-wise competitiveness in the most highly competitive crash parts pricing? Why not programmatically guarantee specific crash parts for the life of the ownership and even cover subsequent collisions? VIN matching and fine print can protect you from abuse.
  • Why not take the pressure off Powertrain pricing, because it is pretty much a lost cause for most OEMs. Instead, plan for the rather huge and sweeping changes that are about to come from Obama’s more aggressive green house gas emission standards – this will impact about half your volumes, across all sectors.
  • Instead of focusing resources on a hopeless battle with companies like Jasper, start developing brilliant core management and remanufacturing strategies for the new crop of Powertrain components.
  • Why not change some select parts prices and track them over time? Why not do consistent price experiments – starting today - to learn about the market?
  • Why not do sell-out lifecycle pricing more elegantly? Rather than trying to use complicated adjustments to retail prices over vehicle lifetime, use a program to give customers of older vehicles a discount.
  • Why not segment your customers clearly before you take action? You have retail end-customers, insurance, fleets, dealers, independent workshops. Don’t treat all of these the same.
  • Why not publish a suggested list price to the trade (different from the retail list price)?
  • Why not focus on the top 5 parts in each product line?
  • Why not play the same game as Aftermarket distributors? Actively use suggested list to steer your dealer margin and channel strategies: e.g. artificially provide high dealer margin on some commodities and work backwards with sell-out promotions to maintain cost-of-ownership and price perception. Discounts off list for wholesale customers will look better and dealers will have some flexibility to give discounts to price sensitive customers.
  • Why not have a simple discount matrix where the OEM can quickly adjust pricing and margin strategies according to market dynamics? This would not disorganize retail pricing and is everything but transparent for Aftermarket competitors.
  • Why not keep things simple AND effective? What about two margin levels by product line where this makes sense. A parts manager can cope with that complexity: “I know I do 40% margin on my oil filters, and I also know I get 50% on these 2 or 3 very fast moving filters.” (They already know by heart these key part numbers.)
  • Why not have a real peek at what we spend on promotional activities? We all know that year-over-year campaigns do not work that well. Dealers stop buying 2 months before and 2 months after the campaign. Why continue? We know that certain campaign types always trigger great results. Why not focus on these to generate profit and yield higher loyalty?
  • Why not make our pricing value proposition clearer? Dealers are often overwhelmed by the different components. They primarily look at basic pricing and don’t get the total picture: campaigns, bonus programs and other allowances. That’s pretty bad when it’s time to compare prices with Aftermarket. Simplification is key in pricing communication!
SimTech. This is short for simple technology. Once you make it through UnLearning stuff that is no longer true, understanding your revenue management levers, and employing some no-brainer creativity, you need to start ringing the bell. To start the process, you don’t need hyper-expensive software that is value-priced. In fact, you really do not want to start there. There is an old farm saying, you don’t learn to drive in a Rolls Royce – you start out on a tractor. Or, a 1973 Chrysler Cordoba with Corinthian Leather seats. Sanjay Seth will talk next week about accessible do-it-yourself pricing technology and segmentation.

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