So, the commodity supercycle is here! The annual inflation rate in the US edged up to a 13-year high of 5.4% in September. At the same time oil prices are above $80, their highest since 2014. Not only has it arrived, all the signs point to it enduring for some time. Consumer product companies must quickly adapt to avoid significant impact on their P&L.
In our previous articles, we explored how to ensure the availability of critical raw materials and second how to mitigate the cost increases via supplier relationship and value engineering. This, the final piece in our short series, we will discuss two more levers that consumer product companies can use to improve their position:
- Production process performance
- Revenue management
Production process performance
To counterbalance the commodity price rise, companies should take an in-depth look at what is happening on the shop floor. To ease the inflation pressure, we suggest three actions for their production sites, enabling the security of supply and sustainability in the meanwhile.
- Increase flexibility and agility.
Wise equipment investment will give manufacturers the opportunity to benefit from the favorable price of substitute raw materials.
As an example, during the 2013-2014 raw milk price increase, leading European dairy companies who had the capability to simultaneously process cream, skimmed, and dehydrated milk gained a competitive advantage. Such process flexibility did not come easy, calling for multiple Bill of Materials (BOM) costing, strong master data management, and tight integration between operation and marketing departments to minimize complexity. At the same time, companies had to deliver a consistent product experience to consumers.
- Minimise (or eliminate) waste.
Enabled by shorter inventory control cadence and equipped with a focused continuous improvement mindset, production managers must address raw material wastage by setting and rigorously maintaining optimized process parameters, overcoming the historical-based material scrap factors. State-of-the-art dosing and mixing equipment, together with intelligent performance measurement, are the best allies to engage in the zero-waste battle.
- Enhance energy efficiency.
It is somewhat surprising that, after years spent promoting utility efficiency, only a few site engineers can provide an accurate map of their plant thermal and electrical consumption by point of use. By partnering with specialized utility auditors, leading CPs have progressively built their plants energy “digital twin,”- an intelligent network of sensors and flowmeters connected in real-time.
With such visibility, they can accurately prioritize investment (e.g., heat recovery, insulation, energy-efficient engines, etc.) to reduce the energy bill further.
The good news for the operation leaders is that they can start soon in having an energy reduction impact: in our experience, up to 15% energy consumption can be achieved by reviewing machine start and stop procedures and sequences, addressing leak detection, and measuring energy mass balance during site idle time.
If the inflationary pressure on raw materials can’t be curbed entirely, then one must consider passing on part of the cost increase to stabilize the profit margin.
Some key issues to consider are:
- Cost visibility is not always assured. To correctly pass on cost increases, one must be able to accurately estimate logistics, energy and raw materials cost increases.
- Your customers could be experiencing multiple headwinds including inflation themselves. There is the risk of increased customer payment delays or defaults, increasing DSO (Days Sales Outstanding) and negatively impacting working capital.
- Loss of revenue as customers go elsewhere in the face of attempted price rises.
- First, you should assess customer by customer the potential to pass-through costs
- Second, your company must have a single, company-wide strategic approach to customer negotiations, linked to budgets and planning. Price increases must be modelled including estimating potential volume loss / customer churn, and overall net revenue impact
- Third, all of your sales force will need to actively engage with key customers, supported and led from the top of the company.
Although the capacity to pass through cost increases will vary, all companies that cannot insulate themselves from commodity price increases should consider it.
Inflation War Room
Finally, to coordinate all of the activities and levers that we discussed in this short series of articles, we suggest setting up an “Inflation War Room”.
An Inflation War Room enables a business to focus on and effectively implement a strategic and coordinated response. This includes:
- Ensuring the availability of critical raw materials;
- Updating commercial agreements;
- Value engineering and new product development;
- Reviewing production process performance; and
- Revenue management
The myriad disruptions facing the supply chain and the potential impact on margin for consumer products businesses has propelled this issue into the boardroom. For some businesses this is much more than an operational and procurement and could be an existential crisis if it (a) endures and (b) there is a failure to implement a strong response.