Claire Dannatt asks, how can consumer goods brands recover profit in 2024 while providing value to stretched retailers and consumers?
After a difficult period of heightened inflation, input cost deflation is now a real and welcome phenomenon for many brands. This is giving the FMCG sector a chance to breathe. But, no sooner have they caught their breath that a new challenge emerges to grapple with. Brands must now ask themselves how to balance the opportunity for margin recovery with demands from retailers and consumers to reduce costs and pass on savings.
Price pressures are easing in many commodities, signalling the advent of deflation. However, it is not completely good news just yet, as in some areas, inflation remains elevated. For instance, labour costs continue to climb, meaning that while food inflation will reduce from the dizzying highs of over 15% in many developed countries, economists still expect the measure to remain elevated, and we are likely remain in an inflationary environment in 2024, albeit with new characteristics.
Consumers adapt to the cost-of-living crisis
The pressure of inflation in the last two years has driven consumers to rapidly shift behaviours. Across Europe, consumers have been increasingly shopping in discount retailers. In the UK, the market share of discount retailers increased 1.1% between 2021 and 2022. Similarly, private labels now claim 38% of total FMCG sales across six European markets, compared with 36.5% in July 2022.
Pressures on disposable incomes have also magnified pre-existing category dynamics, such as increasingly gifting food and drink products as a lower cost option; or switching from red meat to white meat, driven by price considerations rather than health.
Retailers are recognising the belt tightening and reacting to these new consumer behaviours by increasingly focusing on giving value to shoppers, and thereby demanding price back from the brands which supply them. These conversations can prove difficult when trying to maintain effective and constructive relationships between grocers and consumer goods brands.
Transforming supplier relationships
As the inflationary curve began to form a steeper incline over the last two years, FMCG brands have been relying on increasing core prices to conserve margins. This has been met with mixed success, with the average consumer goods player seeing a 1.4 percentage point decline in gross margin from 2020 to 2022, according to OC&C analysis.
Simultaneously, retailers became more resistant to price hikes. From May 2023, leading grocers began announcing price reductions, with some even removing suppliers’ products to limit price inflation. For instance, Tesco pulled Whiskas pet food from its shelves over its cost. It has become apparent that new strategies need to be deployed to meet the requirements of suppliers, retailers and shoppers and to foster collaboration.
Getting the facts straight
The first step to manage this new environment is a careful audit. Supermarkets and FMCG brands must build a refreshed view of consumer habits, how elasticities have changed and the role specific brands and products play today.
As pricing has shifted rapidly over the past 18 months, old assumptions about goods categories may have become out of shape. Understanding the difference between actual price and consumer willingness to pay will help uncover pools of untapped pricing potential, and therefore opportunities to recover margins. Perceptions of “good value” will differ by consumers due to factors including income, purchase channel and availability of substitute.
A refreshed view of the operating environment for FMCG players is more important than ever, given that consumer preferences have shifted at an unprecedented rate, and category architectures and price-points have moved more in the past year than in the previous five.
The levers to recover margin
Understanding this new context will enable them to see new opportunities and deploy the best strategies to get there.
There are six pricing levers to drive value in the current environment:
1. Promotional Reset: Promotions allow brands to maintain higher shelf prices while providing value to consumers. For example, in a previous period of input cost deflation, Unilever in the US used promotions such as “Buy Two Get One Free”, 30% off discounts and their “free cone day” to drive brand trial and encourage consumer trade-ups.
2. Premiumisation: Premium players are able to pass costs through more efficiently given lower price sensitivity of its consumer base. Unilever in the US also pushed to premiumise its ice cream portfolio using M&A, by acquiring the high growth premium ice cream brand Talenti.
3. Clarity in brand roles: Considering where a brand or product sits within its category, and the role it plays for their priority consumer as well as the retailer is critical to unlocking value. Affordable premium brands offer easy trade-ups, whereas value brands must showcase strong value credentials.
4. Classic Price Pack Architecture: Orienting price pack architecture based on consumer willingness to pay will help unlock consumer demand. Rethinking ingredients, packaging formats and function can help with this.
5. Stock-keeping unit (SKU) rationalisation: Too many formulation variants and too many pack sizes create unnecessary complexity for consumer goods brands. Rationalisation allows businesses to focus on execution in key categories and markets.
6. Discounter/ Channel Strategy: New strategic channels enable access to new consumers and create a win-win situation for retailers and suppliers. It is essential for FMCG brands to understand where discounters under-trade in comparison to mainstream retailers, and the role of brands in driving consumer trial in more nascent categories. For instance, large format of ready to drink coffee helps build an emerging category in the US Dollar Store channel by providing better value to the consumer and limiting product comparison between channels.
These levers serve to drive consumer goods players’ absolute margin pool. Then, it is critical that a portion of this margin uplift is shared back with retailers. This will mean that the changes drive the retailers bottom and top line.
After the right mix of levers have been identified, brands must not forget to communicate their compelling sell-in story to retailers. Using up-to-date data that underlines the returns of the mix of levers deployed will improve credibility and trust, bolstering retailer-supplier relationships. Ultimately, the narrative for retailers needs to demonstrate not only the positive implications for the consumer, but also the overall category growth potential and cash prize on offer for the retailer.
Some FMCG brands must feel like they have jumped out of the frying pan and into the fire at the end of 2023. However, there are reasons to be cautiously optimistic about 2024. Globally, inflation is projected to trend down towards historical levels by 2025. And although growth is projected to remain sluggish in 2024, at around 1.4% in developed markets, the squeeze on consumers’ disposable incomes has weakened in comparison to 2022-23. The retailer interface also appears to be softening in many, but not all, cases, with evidence that retailers are taking a more collaborative approach with their suppliers. Many recognise that directly pushing through input cost deflation directly to end consumers is a pathway to profit pool erosion, particularly in lower volume growth developed markets.
Ultimately, with inflationary headwinds showing signs of diminishing there is hope if businesses can manage the new marketplace and consumer dynamics effectively over the coming year. By assessing consumer demand and pulling the right mix of levers, FMCG brands can look forward to a more stable and successful year in 2024.
Claire Dannatt is a Partner at OC&C Strategy Consultants.
She specialises in consumer goods, working with companies across a range of categories and markets. Her area of expertise lies in the development of multinational strategy and she has significant experience internationally, across Europe, the US and China.
