Strategies for managing commodity price volatility
We have observed companies:
- Negotiating with retailers: some firms have been successful in negotiating with retailers to share the impact of higher costs — but this can be a hard sell.
- Improving purchasing operations: for example, by increasing forecasting expertise, seeking alternate sources of commodities to ensure they get the best deal or leveraging scale. One North American food manufacturer is aiming to capture US$1b of procurement savings by halving the number of suppliers it uses and acting as a single global organization. Many consumer products companies are tightening up procurement.
- Changing products: options include reducing the weight of product packs while maintaining existing prices; substituting cheaper raw materials, such as edible oil instead of butter; reducing packaging; or innovating to add value to the product and justify the price rise. One industry analyst estimated recently that Danone could offset the impact of commodity rises simply by reducing packaging or making better deals with suppliers.
- Making structural changes: for example, changing the portfolio mix, or the overall operating model and supply chain, to become more efficient and offset commodity rises with cost savings. Sara Lee recently agreed to sell its more exposed, lower value-add North American bakery business to Mexican food giant Grupo Bimbo.
Volatility will remain the "new normal" and bring continued change.
Consumer products companies need a battery of skills to combat volatile commodity prices.
How much have costs increased?
Industries experience cost increases in different ways.
- Food and beverage commodity prices rose 25% in 2010, with strong swings from month to month in the last quarter.
- Certain commodities saw particularly steep rises, including sugar (up 91% from July to December) and palm oil (up 61% year on year).
- And it's not just agricultural commodities: packaging—especially plastics—is also up, driven by concerns about oil prices.
How is the industry tackling raw price volatility?
When the cost of supplies increase it exposes consumer products companies to a number of risks.
These include cutting into profits, impacting price strategy and presenting serious supply chain management issues.
One possible way to overcome the increased cost of materials is to increase consumer prices. Research company Sanford C. Bernstein believes food producers need to "raise prices by up to 1% to 2% for every 5% rise in commodity costs."
Some consumer products companies think that consumers won't want to pay more for the same product, so they try to increase the perceived value of their product when they increase prices.
The industry is using a range of other strategies aside from adjusting pricing. Hedging offers a way to avoid the issue temporarily, and many global consumer products companies hedge some proportion of their commodity needs.
Other approaches involve improving efficiency so that rising costs can more easily be absorbed, or perhaps changing the operating model so that the business needs less commodities.
Volatility is here to stay for several years yet, and has already had a serious effect on CP margins.
We can therefore expect to see consumer products companies continue to make fundamental changes to their business operations and structure to offset the problem; companies need to be as efficient as possible in all areas of the business so that they can absorb costs when they can't change prices.
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