Fly Above Cost Plus
Revenue Management Labs was engaged to help an Aircraft Tire Manufacturer improve margin and optimize the price of a new product offering. The client developed an innovative tire, which contained 20% less rubber than the incumbent market offerings. Unfortunately, industry pricing norms dictated that tire prices be closely aligned to rubber content (Figure 1). Adding to the complexity, the new tire had increased manufacturing costs. If the client followed established industry pricing practices, the tire would have a negative margin.
The RML Approach
Segment & Value Identification
Who is the target market and what do they care about?
Value Differentiation & Quantification
What makes our product different and why?
Financial Value Optimization
How do we maximize our profit over the long term?
Execute, Monitor, Report & Adjust
What is needed for sustainable market implementation?
The client needed to price the new offering to meet customer needs and achieve a 30% margin. To improve margin, we already saw the need to shift from cost-plus to value-based pricing. Historically, the client had two pricing formulas, each of which proved problematic for the innovation:
1. Margin-Based Pricing provides the needed 30% but creates a significantly higher price than the incumbent competition with only margin targets to justify.
2. Market-Based Pricing provides a more competitive price but results in negative margin due to the higher cost of manufacturing.
1. Segment & Value Identification
The first step involved identifying the target customer. This was done by analyzing the predominant aircrafts in service across the customer base. It became quickly apparent that the Embraer 190 aircraft, with over 523 planes in service across 24 airlines, represented the greatest opportunity (Figure 2, small number of customers with large numbers of planes).
To understand the financial value that the new tire could provide, the airline operating expenses were broken down (Figure 3):
The two main value drivers of the innovation impacted 40% of a typical airlines cost structure:
- Fuel: Lighter tires provide fuel savings
- Maintenance: Increased durability results in less maintenance and replacement
2. Value Differentiation & Quantification
The team evaluated the new tires’ effect on both durability (i.e. number of flights per tire) and weight. It was found that the new tire was twice as durable and could handle 300 more landings than the main market competitor. Figure 4 represents the financial value quantification of the tire durability.
3. Financial Value Optimization
When accounting for all the customer adjustment factors related to size, certainty and speed, a list price of $2471 was established
4. Execute, Monitor, Report, Adjust
Our team, in collaboration with the sales team, developed a selling story to overcome the customer skepticism regarding the validity of the savings identified. The financial value quantification highlighted to the customer the savings potential along with supporting data.
+ $80MM Revenue Growth
+ 18.4% Margin Increase
The client experienced an 18.4% increase in Margin compared to existing products and revenue growth of $80MM drastically outperforming expectations.