Risk as a competitive advantage in pricing

Risk as a competitive advantage in pricing
Manufacturing Pricing Excellence, Milan
22-23 May 2018
Dr Shaun West & Victoria Pyatova
Risk
…(exposure to) the possibility of loss, injury,
or other adverse or unwelcome circumstance;
a chance or situation involving such a
possibility. (OED, 2005)

Manufacturing Pricing Excellence, Milan | May 2018 | Shaun West
Introduction
Using risk as a competitive advantage in pricing
We are going to look at real
use cases from industry to
allow us to build a
competitive advantage from
Industrial feedback on risk
How we traditionally consider risk
Use cases showing risk and how it affects margin
Creating a competitive advantage with risk

Industrial firms with up to 25% service
Basic services with only a limited understanding of risks
Agreements
- Transactional sales and 3-5 years agreement (MRO)
- Basic metrics (eg, response time, delivery)
Execution and commercial risk
- Unable to separate execution and commercial risks
- Focus on internal operations rather than on services
Control and Mitigation
- no data, no formal process, rely on sales experience,
Internal risk management processes (eg, risk adverse
or risk blind)
Risk is not seen as a
competitive advantage

Industrial firms with more than 25% service
More advanced risk management in place with more complex service agreeements
Agreements
- Transactional sales and multi year agreements (MRO)
- Service agreements is performance commitments (eg,
availability, reliability, efficiency, output)
Execution and commercial risk
- Separate execution (eg, late delivery, supply chain
costs) and commercial risks (eg, LDs, delayed
payments)
Control and Mitigation
- Rely on contacts and internal processes to manage
risks
Risk is not seen as a
competitive advantage

Risk is not seen as a competitive advantage
Risks in the less mature firms were in effect ‘warranty’
Companies with up to 25% service Companies with more than 25% service
Control
Better processes+
contract clauses+
Insurance
Identify
Experience + Customer &
Market review
Control
Better processes+
contract clauses+
Insurance

Risk is just warranty, isn’t it?
Global Automotive
Warranty Survey Report
Commercial Services | Automotive
Survey Report
Partner organizations
www.bearingpoint.com/files/AutoWarrantyReport_final_web.pdf
Aerospace OEMs Automotive
Warranty is viewed as a business cost… how can we turn this into a competitive advantage?

Risk is just warranty, isn’t it?
It is much more
$530M is more than ‘just warranty’ for Rolls-Royce
www.mro-network.com/engines-engine-systems/problems-
persist-trent-1000-updates

Alright so we have to correct the failure in design
http://www.cityam.com/259007/rolls-royce-losses-hit-46bn-worse-than-thought
Item
Cost
New design workNew manufacturing processes
Replacement of obsolete parts
Installation of new parts
Additional insurance cost
Increased insurance deductible
Increase in warranty provisions

OK so we have to pay damages too
Liquidated damages are damages whose amount
the parties designate during the formation of a
contract for the injured party to collect as
compensation upon a specific breach
https://en.wikipedia.org/wiki/Liquidated_damages
www.architeam.net.au/2017/07/12/wcpgw-liquidated-damages/

We lose again
Reputational risk, often called reputation risk, is a
risk of loss resulting from damages to a firm's
reputation, in lost revenue; increased operating,
capital or regulatory costs.
https://en.wikipedia.org/wiki/Reputational_risk
EMPTY
PROMISE

Lessons learnt
We need a more active model for risk management if we want to create competitive advantage
Risk is not just ‘warranty provisions’
Consider risk over the whole
product lifecycle
How can we
convert risk to
a commercial
advantage?

Consider risk over the whole product lifecycle
Where are the risks? What are the risks? How can we quantify the risks?
Design Manufacture Use
- Operate and maintain
the asset
Supply chain execution risks
Commercial risks

Let’s use the case of aero engines
The Trent 100 / Dreamliner issue is live today – this is looking back so we can look forward
Design failure in new turbine causing premature failure
Most customers have TotalCare (Power-by-the-hour)
agreements, some customers buy transactionally
http://www.dw.com/en/engine-disintegrates-on-air-france-a380-
transatlantic-flight/a-40780925
As we assess the risks and the commercial
opportunities we will understand the risk
transfer and the cost of risk

New product development
How much should the price tag be for the ‘evergreen’ warranty?
Execution impact
New design, new manufacturing process, late
fulfillment of orders, impact on other programs
Commercial impact
TotalCare: availability damages, consequential material
damage, field service costs, loss of revenue
Transactional: replacement of parts under warranty,
rejection of turbine
Risks assessment
What is the history of design issues with new products
(time to correct, cost to correct)?
Modelling of contract commitments
www.atsb.gov.au/media/33974/tr200100445_001.pdf
Poor
Design

Manufacturing
How much should we charge for the spare turbine?
Execution impact
Additional time to complete engine build
Commercial impact
TotalCare: availability damages, loss of revenue or
none with a replacement turbine
Transactional: late delivery damages
Risks assessment
What is the history of on time delivery?
www.pinterest.com/pin/487866572108650609/
Late
delivery

Operations – engine efficiency
How to capture the full value from the increased productivity?
Execution impact
Engine has to be removed for inspection earlier than
planned
Commercial impact
TotalCare: availability damages, efficiency damages, no
revenue when engine is “off wing”
Transactional: all costs are for the customer
Risks assessment
How frequently do upgrades occur?
What is the upside?
Poor
rebuild

Maintain, repair and overhaul
Good contract management is needed to manage risks
Execution impact
Additional time to complete engine build
Commercial impact
TotalCare: availability damages, loss of revenue or
none with a replacement turbine
Transactional: additional revenue
(extra works, if tools were owner’s tools)
Risks assessment
History of on time delivery
www.mromanagement.com/feature/demand-for-airbus-a320-maintenance-at-record-levels
Special
tooling
missing

Asset management
How to capture the full value from the increased productivity?
Execution impact
Replacement of old design with new design
Commercial impact
TotalCare: initial cost for new spares (change in
cashflow), cost savings due to longer part life and
standardized fleet spares
Transactional: all costs are for the customer
Risks assessment
How frequently do obsolescence upgrades occur?
What is the upside?
Modelling of contract commitments (including upside)
i.pinimg.com/564x/75/b6/a1/75b6a124e3abc6abcd45846ba59b1253.jpg
Parts no
longer
available

First we need to work out the costs
With bigdata we should have the information to do this today… So why don’t we?
Issue description
Frequency of issue
Statistical description
Execution impact ($)
Risk policy
Balanced /
adverse
Execution impact
The supply chain
cost of risk
Commercial impact
LTSA - Wide ranging
according to contract
PO - Limited impact
(PO value)

Second work out the fee or premium
Willingness to pay
- How much would it cost them to carry the risk?
- What are their best next alternatives?
You are providing piece of mind: so price as a subscription or like an insurance premium
Fair price
- Remember it should be cheaper for them to buy
from you than cover the risk themselves
Minimum risk premium = (1+WACC) x (Execution cost at risk + commercial cost at risk)

Closing
Summary
How will you start tomorrow
to use risk as a competitive
advantage?
Most manufacturers give value (as risk) away to customers
Risk pricing is much broader than the cost or warranty
Understand the different between execution and commercial risk
Create a competitive advantage with risk by pricing value

Thanks for your time!
Shaun West
Lecturer
Victoria Pyatova
Researcher

Risk as a competitive advantage in pricing

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