CPG companies are witnessing the highest level of inflation in several decades due to the pandemic-induced supply-chain constraints as well as higher prices of energy, raw material, packaging, and freight. A leading US-based manufacturer of personal care products, for example, has witnessed the cost of raw materials like polymer resin increase by 30%. Similarly, the CEO of a leading food company remarked that they have seen an increase of half-a-billion dollars in input costs within a year. Initially, companies took a wait-and-watch approach hoping the supply chain kinks would even out and ease inflationary pressures. But, it seems, inflation is here to stay for some time.
The big question, therefore, confronting every CPG company is how to deal with it. Cost-cutting measures alone are not adequate to offset the increase in cost of goods (COGS). Price increases are also called for, and CPG leaders like P&G and Nestle have already announced price increases. However, increasing prices can be tricky. If it is not done in the right way, companies could lose revenue and market share. Some products can take price rises without significantly impacting sales, whereas other price-sensitive products cannot take a price rise without losing consumers. Revenue growth management techniques and tools can be used by CPG companies to navigate complex pricing decisions in a calibrated way and minimize the impact to the top line and bottom line.
Let us look at how three CPG companies are adopting different approaches to tackle inflation and the lessons and inferences we can draw from their strategies. The first CPG company is a leading food company and a category leader. Their products, targeted at the health-conscious consumers, are in the premium price range, and, therefore, the pricing is significantly higher than competition. They are doing very well in revenue growth but are facing a difficult choice due to inflationary pressures that have increased the cost of goods. They can either increase prices to protect the bottom line or absorb the costs and take a hit on the bottom line. As their prices were already high, the company feared losing market share if they increased the prices further and, hence, decided to absorb the higher COGS. So, while the company managed to protect its top line, its bottom line, however, took a beating and the company ended up in losses.
The second company is in the home and personal care segment. Their major raw materials are palm oil and crude oil, the prices of which had jumped over 100%. The CPG company passed on a part of the higher raw material costs to consumers by increasing the prices of products. On the other hand, the competition took a more measured approach by increasing prices in small increments and for selective stock keeping units (SKUs). As a result, the CPG company lost market share and struggled to recover it. This company did the exact opposite of the first one and, yet, ended up on the losing side. Is there a better way to respond? Could these two companies have done anything different to protect their top line and bottom line?
Yes, another approach is possible, like the one adopted by the third company, which took a more calibrated approach to price increases. Neither did it simply pass on the higher input costs, nor did it absorb the burden. Instead, it examined products based on price sensitivity. It left intact the prices of products more sensitive to price change and selectively increased the prices of those that are less sensitive. Typically, products with greater stickiness due to health or other specialized benefits are less price sensitive. As a result, the company was able to offset at least a part of the increase in COGS without losing sales or market share.
The company used another smart strategy. Instead of a product-based response, it took a portfolio-based approach by looking at the basket of products in the category and at their different pack sizes. With a portfolio-based approach, there was more room to play around with price increases and protect the overall category revenue.
CPG leaders straddle the category pyramid with products in the value, core, and premium segments. They also have a wide variety of pack sizes to cater to various occasions and consumer segments. Price optimization techniques across the portfolio of different products and pack sizes maximize the overall outcomes of revenue and profitability. The idea is to manage the entire category in a holistic fashion and not just a particular product.
Another approach is to do a deep dive into the margin waterfall chart and analyze how the increase in COGS can be countered by effective price mix and holistic margin management techniques. US-based global CPG player General Mills, through effective revenue growth management techniques, enhanced the price mix by 5%. By using holistic margin management, they removed non-value-added costs from a customer's perspective and reinvested the savings in value-creating opportunities. As an example, the company stopped using different lid colors for yoghurt varieties and stuck to just one, saving two million for the brand annually.