Pricing Objectives

Dec 2, 2009

The automotive aftermarket has its price but how is its price determined? Unique to the aftermarket are a number of options from which to choose a pricing structure. Common to the mix of options is the fly-by-the-seat-of-the-pants method, whereby the business owner and/or manufacture remedy the matter by considering overall production costs, marketing and add in a few points for profit. It’s a rather non-academic method but still commonplace.

Understanding pricing objectives and how price affects and is affected by other elements of the marketing mix, internal goals and understanding the demographic of the market are critical to understanding profit and the subsequent pricing structure. A natural goal set for a manufacturer and/or WD is to become the dominant producer in their respective market. It might then develop a marketing objective of achieving maximum sales penetration for a region, followed by a related pricing objective of setting prices at levels that maximize sales.

Price affects and is affected by elements in the automotive aftermarket mix such as product decisions, promotional plans and distribution choices which all impact the price of the product. For example, products distributed through complex channels involving several intermediaries, such as levels within supply chain distribution, must be marked high enough to cover the markups needed to compensate wholesalers and retailers for services they provide.

Pricing objectives vary in our industry. This is frequently seen from manufacturer to manufacturer and their representatives offering the deal. The basis of understanding is having knowledge of the four major groups concerning pricing options: (1) profitability objectives, (2) volume objectives, (3) meeting competition objectives, and (4) prestige objectives.

Profitability Objectives

In marketing, you must set prices with profits in mind. Covering expenses and providing a financial cushion to cover the unforeseen needs and expenses is critical and often left out of the equation. Understanding economic theory and the basis of two major assumptions can ease the pain of faulty misunderstandings and/or taking no action at the forefront of your decision making while pricing your products.

The two assumptions are, first, that you will behave rationally and, second, that this rational behavior will result in an effort to maximize gains and minimize losses. Sounds simple, but how many actually place this concept into their daily business practices? Oftentimes, small to medium aftermarket businesses estimate profits by looking at or assuming their competitors sales; others use elaborate calculations based on predicted future sales.

It has been said that setting prices is an art, not a science. The talent lies in the business owner’s ability to strike a balance between desired profits and the customer’s perception of a product’s value. Consider the varied pricing of intake manifolds. There is across the board over a 60% variation between brand names. Assuming overall quality of each manufacturer, the price becomes relative to the cost of doing business. Thus, the ability to strike the deal is in your favor depending on the volume of sales anticipated. As you can see, the art of the deal is actually in the ability to negotiate.

Also, consider that intense price competition, sometimes conducted even when it means forgoing profits altogether, often results when rivals battle for leadership position. Therefore, a profit-maximizing price rises to the point at which further increases will cause disproportionate decreases in the number of units sold. An example is a 10% price increase that results in only an 8% cut in volume will add to the firm’s revenue. However, a 10% price hike that results in an 11% sales decline will reduce revenue.

Understanding your profitability objectives will enable you to better plan both short and long-term strategies in pricing as you garner profit.

Volume Objectives

Some aftermarket business experts argue that pricing behavior actually seeks to maximize sales within a given profit profile or constraint. In other words, they set a minimum acceptable profit level and then seek to maximize sales in the belief that the increased sales are more important in the long-run competitive picture than immediate high profits. As a result, companies should continue to expand sales as long as their total profits do not drop below the minimum return acceptable as their profit objective.

Sales maximization can also result from non-price factors such as service and quality. Volume objectives can also be expanded by achieving a specified market-share objective. Thus, the objective is to increase sales in order to maintain and excel in increased profits—assuming that increased production will increase sales through advancing marketing efforts while increased production reduces the overall unit price. Another strategy is achieving higher financial returns by becoming a major competitor in several smaller market segments than by remaining a relatively minor player in a larger market.

Meeting Competition Objectives

The third aspect of understating pricing is simply to meet the competitors’ prices. In many lines of the aftermarket, competitors set their own prices to match those that have an established name and are industry price leaders.

Price is a pivotal factor in the ongoing competition between manufacturers as well as WDs and jobbers. Pricing objectives tied directly to meeting prices charged by major competitors deemphasize the price element of the marketing mix. Pricing is thus a highly visible component within the aftermarket as the marketing mix and becomes an easy and effective tool for obtaining a differential advantage over competitors. It is, however, a tool that other firms can easily duplicate through price reductions of their own.

Because price changes directly affect overall profitability in an industry, many companies attempt to promote stable prices by meeting competitors’ prices and competing for market share by focusing on product strategies, promotional decisions and distribution which represent the non-price elements of the marketing mix.

Prestige Objectives

The final category of pricing objectives, unrelated to either profitability or sales volume, is prestige objectives. Prestige pricing establishes a relatively high price to develop and maintain an image of quality and exclusiveness that appeals to status-conscious parts buyers.

Price is a tool used to promote the product. Quality and timelessness are often conveyed as an image of need frequently displayed at the likes of classis auto auctions, as well as certain aftermarket notables such as the prestige manufacturer’s item list for brakes, tires, wheels, gauges, apparel and the list continues.

Establish Pricing Goals

The first element of the road to profits is having a good understanding of the marketplace and the aftermarket buyer. All pricing should begin with a thorough understanding of the person willing to hand over their hard earned money for your product. This is not an easy task and often you may be misled by what the competition is selling. After-all, who ever said they were dead-on anyway? Thus misleading display advertising, business cycles and an overall economy should be considered in developing your product pricing objectives.

All pricing objectives have trade-offs that owners and managers must weigh. A profit maximization objective may require a bigger initial investment than the company can commit or wants to commit. Reaching the desired market share often means sacrificing short-term profit because without careful management, long-term profit goals may not be met. Meeting the competition is the easiest pricing goal to implement. But, can managers really afford to ignore demand and costs, the life-cycle stage and other considerations? When creating pricing objectives, business owners and managers must consider these trade-offs in the light of the target customer, the environment and the company’s overall objectives.