2022 has been a challenging year for procurement and supply chain teams across the globe. With inflation soaring in many regions, prices of key commodities, raw materials and finished goods have fluctuated wildly – making it extremely difficult to maintain a stable supply of them at the right price.
When costs rise as much as we’ve seen them do this year, that’s a major risk for organisations of all kinds. All it takes is one key category to hit a certain price threshold, and suddenly an entire organisation’s profitability and commercial model can be thrown into jeopardy.
Understandably, organisations are taking significant steps to help mitigate that risk. Here are three strategies that we’ve used recently to deliver high value for our CPG clients, helping them continue to source what they need at the right price, while the markets and categories around them shift.
Strategy 1: Build simplified pricing models instead of elaborate cost models
Procurement teams have spent years developing in-depth cost models for materials they buy. The granular data used to power those models helps teams understand what they should be paying for key materials including ingredients and commodities, and take steps to secure goods at – or at least, close to – that price level.
But, when prices and market conditions are changing rapidly, that granularity quickly becomes a drawback. With so much new data to constantly enter into the model to generate up-to-the-minute pricing and cost insights, gaining the necessary results that relevant teams need can quickly become a full-time job.
Lately, we’ve seen many organisations take steps to streamline their pricing models and create capabilities that are far easier to maintain. These simplified models cut the time it takes to generate actionable pricing insights, so teams can adapt to evolving conditions quickly.
The Smart Cube recently helped a multinational cosmetics manufacturer build a streamlined cost calculator to help its procurement team keep up with raw material price changes. The intuitive tool only requires the team to input three or four fields of data points such as feedstock price, labour cost and current consumer price index/inflation (based on readily available sources/indices) to start generating new and current raw material price insights.
As a result, teams can get fresh, actionable cost insights in less than five minutes, empowering them to focus more of their time on what they do best – negotiating, strategising, and sourcing what they need at the right at the right discount from the market price.
The calculator is an easy alternative to the elaborate cost models that are used in organisations to understand the optimal procurement price. These are often difficult to update every time during a supplier negotiation. The Smart Cube’s calculators include all components of the should cost models, but the end result is a simplified tool that can provide an accurate real-time market price in a very short time, and can be used by buyers at any point during a negotiation.
Strategy 2: Track how raw material price changes are co-related to changes in finished goods prices
When raw material prices increase, the profitability and viability of products and SKUs shift. In crowded and competitive markets like CPG and retail, it’s incredibly important to understand which solutions your competitors are choosing. That should start with a detailed analysis of their finished goods prices.
Recently, The Smart Cube helped one of the largest CPG companies in the world use third-party data sets to correlate the prices of its competitors’ finished goods for the hair care category, with rising raw material prices. The results show that despite significant rises in costs, most weren’t opting to put their prices up.
That in turn showed that if the company in question was to raise its prices, there’s a good chance its customers wouldn’t appreciate that – leading some to defect to lower-priced competitive products.
From there, the decision to mitigate inflationary risk is not only limited to the sourcing teams, but now involves the overall company’s strategists (including logistics, R&D, etc.) to control profit margins. In this scenario, the company in question dug deeper into its competitors’ actions, exploring what they’d done to mitigate the impact of rising raw material costs. That insight proved invaluable for informing the company’s own choices.
By understanding which cost absorption paths their competitors have chosen, teams can transform the risk of rising prices into a new opportunity to carve out competitive advantage and gain market share. If they choose the right pricing or packaging strategy relative to those chosen by competitors, they can not only mitigate higher raw material costs – they can turn them to their advantage.
To mitigate the impact of rising prices, businesses generally take several approaches, which may include the following strategies:
- Increase product prices and pass increased costs directly onto consumers
- Reduce pack sizes to deliver lower volumes of the same product at the same price
- Optimise packaging and distribution to cut the costs of getting the product to customers
- Evolve sourcing strategy to source the raw materials they need more cost effectively
- Product reformulation to understand if alternative ingredients can be used that are more cost effective
Strategy 3: Carefully explore backward integration
As Omer Abdullah and Subash Chandar explore in their book Risk and the Supply Chain, the economic disruption we’ve seen over the past few years isn’t set to stop any time soon. With the next major disruptive event potentially just around the corner, some organisations are exploring ways of reducing their exposure to commodity and category shifts, instead of continuously working to mitigate their impacts.
To achieve that, teams are evaluating potential backwards integration strategies, including setting up their own raw material plants and production facilities. If they’re well chosen and implemented, those strategies can deliver significant value for decades to come. But, there are a huge number of variables to consider before an organisation should jump into implementing a backwards integration plan.
With global market and category expertise, The Smart Cube is uniquely positioned to help organisations evaluate potential backwards integration strategies, and find the right path for them. In a recent project with a global CPG company for its personal care category, we started the process by helping them identify partnership opportunities.
Through a deep-dive supplier analysis, we helped the company establish a clear view of not just who is producing parent materials for their products, but which of them may be open to working in partnership to introduce a new product line or a product extension, where the investment for the product manufacturing may be jointly shared. A direct partnership with a raw material supplier is by far the easiest backwards integration strategy to implement, which makes it a great place to explore first.
In this example, no feasible partnership opportunities were identified. So, the team started to go deeper – exploring potential paths to creating a new production facility, and identifying all the skills, capabilities, and costs that would be required to make that happen.
Together, those insights related to understanding the pros and cons of a make vs. buy decision help build up a complete picture of just how possible it might be to create a new facility and begin producing your own raw materials. For this CPG company, the analysis found that there wasn’t a clearly feasible route to make that happen. The costs and complexity of setting up a new plant would outweigh the potential benefit of running it themselves, making it ultimately not worth pursuing.
That’s a disappointing outcome for the company. But being able to determine that without actually investing in a backwards integration strategy is invaluable. The deep feasibility analysis helped them avoid the potentially catastrophic outcome of investing millions into a strategy that doesn’t deliver value.
For others, the same analysis can surface incredibly valuable opportunities to become their own suppliers and reduce their exposure to supply disruption and cost volatility. It’s a high-potential strategy, but our advice is to proceed with caution, and conduct a deep feasibility assessment before you leap into any new opportunities.
Stay on top of rising inflation with The Smart Cube
Whichever strategy you choose to pursue, The Smart Cube’s deep market, category and commodity expertise can help you stay ahead of cost inflation and source the materials you need at the right price. Find out more on our website.