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Tuesday, April 16, 2024

Charting a winning course

McKinsey & Company’s Jessica Moulton and Ella Burroughes discuss the benefits of holistic margin management during times of uncertainty

Price increases in critical commodities may be easing for the moment, but many consumers remain wary amid macroeconomic uncertainty. For example, McKinsey’s latest research on European consumer sentiment finds that despite rising confidence, many consumers are continuing to reduce spending and trading down to stretch their incomes. Coming on the heels of COVID-19, supply constraints, and raw material cost increases, FMCG players are therefore still wrestling with how to stabilise margins and protect themselves against the next shock – while also appreciating retailers’ margin challenges and consumers’ heightened price sensitivity.

As one CEO noted during a recent McKinsey survey on leadership and inflation response, companies that ‘act early to lower costs and protect the balance sheet can become stronger with more agile pricing when the economy begins to improve.’ First movers are already demonstrating that with urgency and collective focus, changes that would have previously taken many years can be pushed through in months.

In this article, we summarise three critical capabilities that leading FMCGs are building to bring pricing activities closer to fluctuating costs, thereby making their businesses more resilient and competitive: deep analytics to improve dynamic pricing, a margin cockpit to enhance collaboration and transparency, and a volatility council to speed decision making.

How analytics is transforming pricing

What actions related to pricing can FMCG CEOs and their teams take in response to volatility? Most important is to support dynamic pricing, which knits together inputs such as availability, innovation, line pricing, elasticity and market activity. Data-driven algorithms can better inform precise price movement by SKU at varying levels of frequency, helping FMCG brands (in collaboration with retailers) grow share and maintain sustainable margins – and, most important, preserve price trust with the customer. Accordingly, a company with a strong understanding of both the consumer and its own supply base has a distinct advantage.

Everyone in the C-suite has a role to play, particularly in extracting maximum impact from advanced data and analytics. Organisations that are deploying more sophisticated product costing, pricing, promotions and spend analytics gain increased insights, which leads to better and faster joint decisions. With data that ties together more fluidly and comparably, executives can evaluate category or cross-division programs with greater confidence.

Collaboration enables holistic margin management

Experienced executives understand that effective pricing and margin decisions depend on understanding many factors at once: the mind of the consumer, the activities of competitors, what’s happening with input costs, and current risks within product supply and procurement. Accordingly, insights derived from analytics – and the strategies that result – are more valuable when shared across departments within the company. Rather than retaining existing silos, with the pricing team working as a closed unit, companies that are innovating now work to integrate procurement with pricing, adding expertise and on-the-ground experience of the pressures driving costs.

A better understanding within the pricing team of the issues currently facing key suppliers – for example, a particularly steep hike in fuel costs in one region – can enable a more accurate, responsive pricing strategy. Where supplier relationships have traditionally been held by procurement, the knowledge they generate can be made available to other teams, helping create a more integrated approach to pricing.

One model available is to set up a “dynamic margin cockpit” – a detailed dashboard that synthesises internal and market data for real-time insights on factors such as customer demand, inventory, market pricing, and supply disruptions. Lessons on how to do this well are available to FMCG companies that look outside their own sector to understand the potential. For example, an automotive company recently created a cockpit covering more than 1000 components, using automated data flows from a combination of third-party databases, internal sources, and news sites. Managers can now conduct sensitivity analyses of different sources of volatility, such as foreign-exchange risk and variations in individual site operations – all sources of potential pricing pressure, and potential opportunities to claw back increases that no longer reflect market reality.

A ‘volatility council’ to support faster decisions

That cross-departmental approach can also be rolled out in the form of a ‘volatility council’, with a mandate to take action to address margin fluctuation, help the business become nimble in response to customer feedback, monitor markets, and identify risks. Such groups also provide capacity for rapidly staffing projects or supporting supplier negotiations – indeed, some report daily to the CEO. Similarly, a procurement ‘resilience team’ can provide real-time insights on customer demand, inventory, market pricing, and supply chain disruptions. Working together, these two groups have the potential to secure growth and help modernise the wider organisation.

At a packaged-foods manufacturer, this type of coordinated, cross-functional approach helped overcome commodity volatility. First, leaders secured alternative sources of supply for constrained raw materials. Next, they leveraged financial instruments (e.g., options and hedges) to manage price risks for primary ingredients and energy costs. This flexibility allowed them to reinvest approximately four percent of the company’s cost base into higher value products. Additionally, this foresight allowed the company to accelerate new product launches, driving even growth and profitability.

A final opportunity is for greater collaboration in portfolio and product design, particularly to identify offerings requiring scarce materials with few suppliers. Leaders can reduce dependencies wherever possible and push for rapid qualification of alternative sources. One consumer-packaged-goods manufacturer, for example, used advanced analytics to assess design changes related to consumer tolerances. Sourcing and R&D teams could then find new specifications and formulations that had little impact on consumer acceptance, which in turn stabilised margins.

Volatility and uncertainty pose serious challenges for FMCG businesses. By instilling a comprehensive margin management approach to analytics and cross-departmental collaboration, CEOs can position their companies to innovate through this period and emerge stronger on the other side.

Jessica is a Senior Partner and leader of McKinsey’s Consumer Packaged Goods Practice in Europe. Ella is an Associate Partner.

Jessica is a Senior Partner and leader of McKinsey’s Consumer Packaged Goods Practice in Europe
Ella Burroughes is an Associate Partner at McKinsey’s

 

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