If you are responsible for pricing in an OEM business, you have three major revenue streams: finished products, spare parts, and services and service contracts. In the life science business and a few others, most of your income and profit comes from selling a fourth category: consumables.
Let’s break down the four revenue streams:
1. Many small to medium-sized industrial OEMs pay the most attention to their finished products because they generate revenue and profit. They also probably use some form of cost-plus pricing unless they discover value pricing.
2. The next significant source of revenue for most OEMs is spare parts sales. In March 2022, I published an article titled How Should I Price Spare Parts? Here, I suggested breaking your parts into three categories:
- Proprietary, Custom, or Unique Parts
- Proprietary Wear Parts and Other Consumables
- Commercial Off-the-shelf
I then recommended unique markups for each part category.
3. Services will be the smallest revenue category, except for equipment rentals until customers demand more. Then, you must learn and apply value pricing.
Service Pricing
Service pricing depends on the value you create for the buyer. There are four high-level types of services:
1. Reactive services/run to failure: Spare parts, warranty (usually free), time and material, service contracts, and return to depot. These services produce the lowest margin and revenue per incident.
2. Preventive/time-based: PM checks, qualifications, remanufacturing, and diagnostics. Approximately the same margin as reactive services but at a higher revenue per incident.
3. Predictive/condition-based: Advanced artificial intelligence (AI) software to predict failure and remote monitoring with software analytics. A significant gain in margin and revenue because the AI software is perceived as valuable.
4. Proactive (high value-added)/outcome-based: XaaS, process optimization consulting, managed services, pay-per-use, and pay-for outcomes. Excellent margins and good revenue because the risk has been transferred from the buyer to the seller. Buyers are willing to pay for peace of mind and to change a CAPEX purchase to an OPEX arrangement.
Generally, the service’s value is inversely proportional to the risk of downtime. For example, reactive services begin when a problem is identified and the OEM’s service organization is notified. There are generally no promises of an on-site response time for either a person or a part. On the other hand, predictive services cause the OEM to be creative, so they can remove a part that is likely to fail soon and replace it with a part that is either new or equivalent to new at a mutually convenient time.
As you go up the list, the equipment downtime will likely decrease as the fee increases. According to a recent ABB survey, outages typically cost industrial businesses $125,000 per hour, and 69% of plants or sites experience unplanned outages at least once a month.
In 2023, I spent many days poring through public industrial, medical, and analytical instrument companies’ annual reports to determine each company’s service revenue as a percentage of total revenue. I found 69, mostly U.S. companies. The average service revenue as a percentage of total revenue was 35%, and the median was 29%.
This chart shows the top 25% of companies generating >50% of total revenue from their service operations:
Note: If you would like the complete chart, email the author at sam@middlesexconsulting.com
Final points:
- As an OEM, one of the best pieces of information your sales team should collect is “What does it cost your company per hour if the equipment we are talking about is down?”
- These days, more and more buyers are interested in using capital equipment through an outcome-based contract.
- Today, outcome-based contracts are most common in Europe and will become more common in the next year or two. If you are not ready, you should start now.
About Middlesex Consulting
Middlesex Consulting is an experienced team of professionals whose primary goal is to help capital equipment companies create more value for their clients and stakeholders. We continue to provide superior solutions to meet our clients’ needs by focusing on our strengths in Services, Manufacturing, Customer Experience, and Engineering. If you want to learn more about how we can help your organization create more value through customer-centric solutions, please get in touch with us or check out some of our free articles and white papers here.
Image credit: Sam Klaidman