Johnson Controls Pricing Spineometer: 5 of 5 Vertebrae

Johnson Controls, an engineered environmental solutions company, had a positive Q3 2024. Revenue rose 1.4% to 7.2 billion and earnings before interest and taxes rose 63% to $1.3 billion over the same period last year.

A review of Johnson Controls’ July 31 Q3 2024 earnings call and associated financial reports provided insight regarding the importance of pricing on performance.

Appropriately, pricing was not the main topic of the call. Many other issues were of higher importance for discussion. The clearest signal that pricing is managed and measured came from Marc Vandiepenbeeck, CFO of Johnson Controls. “Organic sales in our global products business grew 3% year over year, with price offsetting a modest volume decline.” The Volume-PriceMix appears to be actively measured at Johnson Controls.

Two key messages from the earnings call were related to business divestitures and CEO succession management.

Johnson Controls is divesting the Residential and Light Commercial HVAC (Heating, Ventilation, and Air Conditioning) business and its Air Distribution Technologies Business in advance to focus on engineered solutions in HVAC, Fire, Controls, Security, and Service. Engineered solutions for larger buildings have a recent history of delivering higher growth rates and more predictable revenue.

1. Commercial property owners are shifting their mindset from a “build it and let the next owner worry about the cost of maintenance” mindset to “manage it towards lower building lifetime cost with reduced emissions requirements (energy cost savings)” mindset. This increases the demand for ongoing maintenance services and digital services contracts, both of which replace the cycle of reactively fixing challenges when they occur by proactively taking action to prevent outages or challenges from occurring. It also has an impact on the business model, more of which will be discussed in the pricing requirements section.
2. Maintenance and digital services also produce a more predictable revenue stream. Experience at Johnson Controls shows that these services can deliver ten times the revenue over the initial engineering and implementation revenue over the customer lifetime.

Marc Vandiepenbeeck, CFO, also spoke about the impact of the business changes on operations, which have an impact on the pricing capability and footprint.

“There’s really two things that are happening. We centralize more the decision-making process as which vertical and which markets we really approach. And we really focus that commercial organization toward those parts of the market where we see a very much attractive margin as we can sell value. And we have customers that are interested in our product and see value over that cycle.

But also, parts of the market where you see a stronger service attach. And when you do that, you’re able to actually drive modest growth in the system business but a much larger growth in our Service business as that service attach yields better outcome overall. So that’s — that operating system has been really fully deployed in North America.”

Concurrent with these business model changes, Johnson Controls has initiated a CEO succession plan. George Oliver, Chair and CEO, will be moving to a chair role alone where he expressed a commitment to the ongoing success of Johnson Controls. Currently, they are in the search process for a CEO to replace him in that role.

Many other aspects of their business impact the pricing requirements at Johnson Controls.

• Data centers are a major customer segment of Johnson Controls. This segment is growing rapidly with the adoption of AI globally. High growth in turbulent markets implies an increased need for pricing capability.
• Johnson Controls has been growing with its customers globally. While its dominant operations are in North America, it also serves Europe, the Middle East, Africa, Latin America, and Asia Pacific.
• Macroeconomic impacts, such as a slowdown in China, have a noticeable impact on business performance. Here again, we see the need for applied macroeconomists and microeconomists on the pricing team to help Johnson Controls navigate economic turbulence globally.

Industry benchmarks suggest Johnson Controls should have 55 to 280 professionals dedicated to pricing.

1. The new business model is akin to a tying arrangement, also known as the Razor and Blade model. Upfront, Johnson Controls captures the value of the engineered building solution. Over the customer lifetime, Johnson Controls captures the dominant stream of revenue from ongoing maintenance and services.
2. Tying arrangement profitability is highly contingent on customer lifetime value, not simply the customer acquisition costs and initial sale. Many levers can be pulled to improve customer lifetime value, a key one of which is market segmentation selection. This aligns with the choice to divest from certain segments at Johnson Controls.
3. To my understanding, about 85% of the engineered solutions are attached to an ongoing service contract at Johnson Controls. This implies that Johnson Controls can offer an engineered solution at two different prices, a discounted one with an attached service contract and a normal one without. Managing this price differential along with the service contract lifetime requires deep pricing.
4. Customer contracts for longer time periods, say a year to ten years, imply a need to deploy index pricing to ensure prices are aligned with costs. While low inflation periods may not have had much of an impact on the need to adjust prices, with longer-term, and probably more profitable and predictable contracts, input cost inflation must predictably impact customer prices to ensure both parties can enjoy a long-term and mutually beneficial relationship.
5. The global nature of Johnson Controls implies a need for a globally dispersed pricing team. Commercial policy and competition differ greatly across the globe and so must Johnson Controls business and pricing practices, within corridors to prevent arbitration.
6. Johnson Controls has predictable needs to manage prices at the existing product level, across the new product development lifecycle, at the sales execution level, and at the sales incentive level. Much research and analytics can be predicted to be of value.

Research into the investment by Johnson Controls in pricing yielded encouraging results.

1. The number of professionals identified as focused on pricing was within expectations. They were globally distributed as one would expect located across North America, Europe, Asia Pacific, and Latin America.
2. Their titles ranged from analyst and manager to director and vice president. More than one vice president at Johnson Controls highlighted their pricing expertise.
3. Pricing professionals at Johnson Controls focused on product pricing, deal pricing, and even some expressed a love for economics.

Given the importance and capability of pricing at Johnson Controls as indicated in financial reports, management statements, and our pricing team research, and given their performance, we have come to the following conclusion as of August 2024.

Johnson Controls Pricing Spineometer: 5 out of 5 Vertebrae. Improvements are likely possible and opportunities for improvement exist, yet it is clear management takes pricing seriously and has made a strong investment in this area.

JCI (Johnson Controls International plc) was relatively unchanged at 69 the day prior to their earnings call to 66 one week later. FY 2023 revenue of $26.8 billion with a 6.4% operating margin and P/E ratio near 22.

For FY 2023, a 1% improvement in price would yield a 15.5% improvement in operating profits holding all else constant at Johnson Controls.