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| 2 minutes read

Crunch time – mitigating margin impact while minimising lost sales

The impact and causes of the global supply chain crisis have been well covered by our colleagues elsewhere. While Covid has been seen as a catalyst for the chaos what it has really done is expose the vulnerabilities inherent in an efficiency-oriented supply chain model. Just-in-Time delivery has been a staple for some time in a number of industries but it is frail and the myriad covid shocks have exposed that.

Across the globe manufacturers are reporting shortages and there’s little sign of this abating any time soon. Reports of a difficult Christmas for retailers and consumers are a staple of the news channels. This presents the unwelcome dilemma of how to address the pricing challenges this situation creates. There is widespread raw material inflation, challenges all along the supply chain including bottlenecks, transit delays and security of supply, in addition to significant energy cost increases are severely affecting businesses right now. And, that’s before wage inflation pressures are taken into account. The inflationary impact in some businesses could be, according to our research, be as high as 30%.

In a market economy scarcity is addressed with price increases. This enables the demand to stabilise and match the supply available. But, after well over a year of harsh pandemic conditions, one Christmas already effectively ‘cancelled’ and growing financial concerns among certain consumer groups this is unpalatable if unavoidable. The challenge, as reported in the FT recently, will be balancing the need to mitigate margin impact without detrimentally affecting consumer loyalty and patience. Regardless of the underlying and practical drivers of price increases, consumers judge price rises harshly and more so in a crisis where this can be seen as profiteering.

Mitigating the impact on margin without affecting long-term consumer perceptions and spending is a challenge. It is arguably the biggest challenge facing businesses right now and when the most obvious answer is the least agreeable – pass it on to the consumer – this requires a rapid and holistic response to avoid potentially falling foul of liquidity or banking covenant issues.

At AlixPartners, we’ve been supporting clients across industries to identify and mitigate against inflationary risks and supply chain disruption. A key first step is to clearly establish the baseline – the existing level of commodity cover, relative exposure and potential EBITDA risk. This is not necessarily a straight-forward exercise, especially for highly decentralised, multinational businesses that operate across different currencies and labour markets and often results in an additional overlay of risk to EBITDA. The next step is to identify concrete Pricing or Cost improvements (Design to Value, Sourcing), especially in categories where the cost increases will be structural and not temporary.

Smart thinking is required and this is a complex exercise that requires significant attention not just from the internal experts, but also from senior management. Those that balance short term margin preservation while re-engineering their supply chain for longer term agility will be well positioned for the future. Those that do not may well be facing an existential challenge.

In 1986, Daniel Kahneman, Jack Knetsch and Richard Thaler published an explanation of why prices do not shift in a crisis: customers hate it when they do... [they] colleagues noted that when prices adjusted to balance supply and demand, economists viewed this process as “as natural as water finding its level — and as ethically neutral. The lay public does not share this indifference.”

Tags

disruption, consumer products, retail, supply chain

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