Monday, November 25, 2013

DMP – Dynamic Menu Pricing For Dealer Service Operations; The Next Evolution In “Parts” Pricing

Preface: Everything in life is connected, and sometimes the connections are quite simple. “Dynamic Menu Pricing” is all about some simple connections that our industry hasn’t been able to achieve. Until now. Menu pricing is simple – it allows a dealer to offer a competitive price for oil and filter changes at, say, $39.95. Or, it allows a competitive price for brake and rotor replacement at, say, $295.95. For service customers, menu pricing is compelling because it gives them something they can understand and something they can trust. It’s the real price -- without the $100-an-hour labor charges that seem suspiciously high.

“DMP” is all about making everything a dealer sells just as simple. Price elasticity is simple in concept … but really hard to determine. Price elasticity is ultimately all about selling more volume or less volume by changing the price of what you sell. Like airline seats, hotel rooms, blue jeans at WalMart, and automotive parts and labor. The problem is that it has always been very difficult to calibrate the price elasticity of automotive parts. Or maybe not. If you plug in the simple menu pricing concept while calculating price elasticity, you enrich both concepts, and help dealers and OEMs make more money from more loyal customers. That is what DMP is really all about.

The current mix of parts pricing software technologies and operating philosophies is fairly primitive. It represents the best “Gen-1” thinking possible; but, it has not evolved sufficiently. Most employ pricing algorithms and segmentation logic that Carlisle developed 20 years ago. The “secret sauce” to the parts pricing we slaved over decades ago uses curve-pricing for “captive” parts, which account for about 20% of typical OEM parts revenue, and 80% of their
part numbers. The industry has harvested billions of dollars of added profits and improved satisfaction with this simple concept. But it was too simple and too good to be true. So, other stuff was stirred into the pot to cure client goose bumps – things like price benchmarking other OEM captive parts (this always made me queasy because captive parts ultimately have no benchmarks), and engineer-related benchmarking of parts (as if an end-customer can see any physical differences that can be translated into prices). My favorite is selling (or buying) a pricing software package based on Virgin-Atlantic-like airline seat price “elasticities”. This is simply too naive an idea to waste any more words on it.

Oh, what the hell; I can’t stop myself. Let me first explain price elasticity of demand. This concept governs sales volumes – if you lower your price, you sell more. If you raise your price, you sell less. The “elasticity” is all about the relationship between the price delta and the sales volume delta. The bar chart (End Customer Total …) shows clusters of hypothetical price discounts from a 10-step discounting process. This simulates many years of potential price elasticity market testing; prices were reduced step-by-step to see how the market sales volume reacted. At each step we reduced the prior step’s parts price by 5%, or the labor cost by 5%, or both parts and labor by 5%. The height of each bar reflects the cumulative customer repair order discount from the start of the process. At step 10, cumulative parts discounts alone represent a total customer “repair order” discount of 17%; for labor alone, the discount would be 20%; and for parts and labor together, it would be 37%. The most anemic way to calibrate “price elasticity” is to focus on parts pricing at the factory/OEM level. OEM discounts on part costs are diluted by the other piece to the RO: labor. You’d get a bigger bang for your buck by discounting labor rates as well… but only dealers can do this. A careful progression of discounts on both parts and labor will result in discounts with a much better chance of truly and operationally calibrating real price elasticities.

So what does this mean? It means that the next evolution of “parts pricing” needs to accommodate total service pricing (labor and parts) under free market conditions. It means that OEMs should work only with willing dealers – the fraction of dealers that volunteer to cooperate in making more money. Pricing strategies need not be “brittle”; they don’t require all enterprise partners to participate. Only a fraction of “can-do” dealers need to play ball; that will be enough to kick start the next evolution of “parts” pricing. Of course, OEMs can use Performance Terms & Conditions to grease the implementation skids here.

Dynamic Menu Pricing (DMP) embedded in pricing software leverages the power of undiscovered price elasticities in the global “parts” (and service) market. Used at its most basic level, DMP is a simple way to menu-price every single part and service component in your flat rate manual … and what falls outside the guide as well. DMP eliminates advertising static (possibly seen as uncompetitive) dealer labor rates, which have recently become the focal point for digital service customer cost comparisons. In some states with archaic laws that pre-date “menu pricing”, dealers will still have to post some form of labor rates, possibly a range, somewhere (perhaps in the new car showroom?) However, the posted ranges of labor prices in the hands of a good state lawyer will eliminate the ugly duckling effects we currently suffer from.

Service customers are very interested in costs, as seen in the top ten customer values; being informed of cost upfront is #2, a reasonable labor rate is #4, and a reasonable cost for parts is #9. Give customers what they want and value, and you will increase their vehicle and service repurchase likelihood.
If cost represents three of the top ten value drivers (and two of the top five), it might make sense to improve how a dealer bellies up to the cost bar. Carlisle has historically bifurcated its approach to helping OEMs retain more service customers at the highest possible operating profit. On the profit side, about 30% of the work we do is in global pricing, including software development. On the satisfaction side, about 25% of the work we do, and nearly 100% of our R&D, is in some of the softer aspects of customer retention. DMP brings both sides of our shop together.

Here’s how DMP works – there are three steps:
  1. Dealer Determined Labor Rate Matrix (LRM)– Can-do dealers need to think in terms of variable labor rate pricing. What’s there to think about? Easy. If you set a lower labor price on something, will you sell more of it? Or, if you set a higher labor price, will you sell less of it? This is independent of parts pricing. A good example is pads and rotor replacements, where the part costs are, say, $200, and your labor rate can vary from $50 an hour to $150 an hour. Let’s say that the job takes four hours of labor. The Dynamic Menu Price-spread from this would be from $400 ($200 + 4 times $50) to $800 ($200 + 4 times $150.) Obviously, the cheaper labor rate will sell more brake jobs … but, the big question is, “will I make more money?”

    Good question. To make more money the labor rate matrix must be set up to reflect maintenance and repair clusters, with labor discounts/surcharges that have similar market characteristics.
    1. Fast moving highly competitive procedures like LOF, tire replacement and rotation … stuff like this
    2. Initial service intervals – the first time they come back for a 20K or a 30K maintenance interval
    3. Second service interval visits
    4. Third and beyond service interval visits
    5. Brakes and rotors for vehicles under 30K miles
    6. Brakes and rotors for vehicles with 20K to 70K miles
    7. Brake and rotors for vehicles with more than 100K miles
    8. Light repair
    9. Heavy repair

    Note that managing the labor rate matrix is entirely up to the dealer. He/she can set up a generic LRM at 100%, which reflects straight labor rate across all job clusters. Furthermore, pricing program rules need to clearly accommodate warranty labor pricing. The simple fact is that we have an overabundance of great lawyers in this country. Use them to solve this riddle and enable OEMs and dealers to work together, rather than against each other.

    Using the LRM, coupled with dealer parts prices, to produce customer repair orders and quotes, enables the dealer to menu-price 100% of their service counter work. It replaces a two-step process that looks ugly to customers with a simple one-step process.

  2. Dealer/OEM Determine Menu Overrides – These are maybe a dozen or so highly competitive service operations that have market driven price points. Perhaps LOF for 4-cylinder gasoline vehicles, wiper replacements for certain models, or others. If the dealer doesn’t trust their OEM, they can determine these overrides on their own. Or, if they have a good relationship with their OEM and appropriate performance terms are in place, they can work with their OEM to set menu overrides. For example, an OEM’s performance terms and conditions might be sensitive to joint dealer/OEM menu overrides where compliance equals more terms cash

  3. OEM-Provided Total Price Elasticities – This is the game-changer. Look at the Dynamic Menu Pricing-Labor Rate Matrix chart. This is the concept at its most simple level. There are ten job clusters, and three columns of labor “discounts.” The dealer is in charge of the two left-most columns. “Start/Last” represents labor rate discounts that are currently in effect – it is a reference point. “Next” represents the labor rate discounts that the dealer wants to load at this time.

    The “OEM/Best” column is the game changer. It represents the result of crunching all DMP dealer data across all active dealers using the technology, and understanding the operative pricing elasticities of the total market. It also represents the optimal labor pricing discount that yields the maximum dealer fixed operations profit.

    Again, playing the pricing game at this level is entirely up to each dealer. They can simply enter “100%” in each of the two left-most cells, and take no discount. Of course, they will miss out on another level of performance terms that rewards participating dealers with more cash (more about this to follow).
Bottom line: Twenty years ago we discovered different ways to look at parts pricing and increase total value-chain partner margins. Our original algorithms have been codified into a broad array of software package alternatives … that have not evolved much in the last 20 years. This is not terribly surprising. DMP is the next evolution. This should not be a surprise to anybody.

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