The Price is Right - Not!

Last year, Forbes magazine profiled Vextec, a company that has developed a very accurate approach to predicting how materials behave under operational conditions. This company's product promises to revolutionize the economics of design, reducing barriers to entry in several capital intensive industries. What struck me most about the article was the price charged for the services. It seems that the company charges customers based on their own costs (plus a markup) rather than the value their product brings to the customer. I suspect that most manufacturers of engineered products follow a cost-plus approach to pricing. This might be partly due to competitive pressures and partly to the simplicity of the cost-plus approach. However companies that rely on the cost plus approach are limiting their growth and their profits to a fixed multiple of their assets. Such companies might be better served by using value-based pricing. For instance the subject of this article offers a service that allows manufacturers to circumvent several expensive iterations significantly reducing the cost of development. By using cost-plus pricing the company is limited to the amount of work it can handle by leveraging its existing man-power. Value-based pricing would allow Vextec to pick projects where its services bring the greatest value and therefore the highest return to the company.   Value-based pricing trains a company to better understand its customers. Such understanding inevitably results in products and services that offer customers what they value most. Following the value approach enables companies to charge a fair price (based on the value they offer) and  improve the efficiency of their own operations.              .

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We don't need any Marketing !!!

Last year I met a successful Infrastructure entrepreneur who consulted me on an alternate revenue model for infrastructure projects. This entrepreneur's company had won contracts for construction of portions of India's Golden Quadrilateral (GQ) highway network and were looking to change the model for revenue generation.  Currently, projects in this region are offered on what is known as Build, Operate and Transfer (BOT) basis. The winning bidder completes the project with their own funds, collects payments from users during the Operate phase, then transfers operational ownership to the government.

I energetically applied all my learning from Business school to the entrepreneur's question. But I felt that there was more to it and so I kept digging. Over the next few months I realized gaps in the entrepreneur's business model. The primary issue was a lack of the marketing effort by the company. This omission had not affected revenues in the early years when the economy was going strong at 6-7%. However as the economy deteriorated in the global downturn of 2009, revenues declined. The entrepreneur fixated on the unpredictability of revenues in the only manner he thought possible. I proposed a detailed list of specific actions that the company might take to stimulate demand for the corridor operated by the company. I also advised the company on a schedule that they could follow to ensure steady and increasing revenues from various projects including airports and other highways that were still under construction.  

Time bound revenue models require that a company stimulate demand during the period when they stand to benefit. This requires an investment in a formal marketing department and a focused plan of action. Companies that are blinded to this reality tend to look to fix external variables. My customer, wanted to fix the revenue model not realizing that changes were required to their own organization. This is a classic pattern with businesses that traditionally shy away from formal marketing or strategy. Early success, blinds these companies to the need for organic evolution. When they see a problem their first response is to try to change external factors. Even successful companies need to be continuously alert to the need to evolve in order to stay relevant to their industry.
  

New aircraft or aftermarket?

I was recently talking with someone who works for a manufacturer of aerospace waste water recycling systems. Out of curiosity, I researched the company and found that they offer a product that is lighter and more reliable than existing alternatives. The product is also modular and therefore easier to replace. My research on this company also indicated that they have just won contracts for supplier furnished equipment on various new business jet programs. To me this suggested a traditional mindset behind the company’s product strategy. It has long been a tradition in the aerospace industry for companies to invest heavily in development for new aircraft to monopolize the aftermarket. But the times, they are a changing, and companies can no longer count on holding on to monopolies for as long as they traditionally have.

There are trends underlying this shortened duration of aerospace monopolies. Perhaps the most important is the proliferation of PMA parts in the after-market. Besides making for an extremely competitive after-market, this signals a willingness on the part of companies to challenge monopolies. It also underlines customer's willingness to try cheaper alternatives. Airlines themselves face tremendous pressures to manage costs and are therefore more amenable to cheaper ways to operate. Another trend is the casting off of airline MRO’s as independent entities allowing them to aggressively pursue business beyond their captive airline customer. These MRO's already possess the technical capabilities required to perform repairs. When this capability is coupled with an investment in supply chain management and improved logistics, these MROs are able to offer better reliability along with technical competence matching the OEMs. Ironically, building volumes allows these MRO companies to negotiate better terms with the very OEM companies they supplant.  Together these trends make for an extremely competitive marketplace that challenges the traditional mindset.  

In the new market there are compelling reasons for companies with technically superior components to pursue the aftermarket.  For one companies whose products contribute to much bigger systems such as in an aircraft, tend to be treated as just another part of the bigger system. Typically the focus is on managing the overall cost of the system and each component manufacturer is competing with manufacturers of other components in the system for a better price. This limits opportunities to command a premium for what may be genuine improvements over existing alternatives. The aftermarket is an altogether different game in that each sub-system is evaluated in terms of its lifetime costs. This throws up opportunities to differentiate and to command better prices for features that will make a real difference to the customer. 

Coming back to the manufacturer of aerospace waste water recycling systems, I would question a strategy that exclusively focuses on new aircraft programs. I think this company, ought to pursue aftermarket work in parallel with new aircraft programs. Moreover, I think they should offer products with their best features in the after-market rather than on new aircraft programs.