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Combating Commodity Price Increases



Rich Vitaro of AlixPartners offers three solutions.



By Rich Vitaro, AlixPartners LLP



Published April 26, 2011
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The world’s emergence from the so-called “Great Recession” and more recent events, like the turmoil in the Middle East and the disaster in Japan, have created a well-documented surge in commodity prices – one with significant implications for household and personal care products companies.
 
At AlixPartners, we track a group of more than 75 energy, food, chemicals and basic ingredients commodities on a monthly basis. During the past year, 80% of these commodities have increased in price and, on average, their prices have jumped by 21%. Meanwhile, forecasts from many independent sources are projecting even higher commodity prices by year-end – and these expectations have recently led to actions such as the following:

 
Procter & Gamble saying it has added $1 billion to its projected commodity-cost estimates for this year, doubling initial projections;
 
 
Unilever stating it expects higher commodity prices to negatively affect profit margins this year by 400 basis points; and,
 
 
Colgate saying it expects commodity prices to increase by 8% to10% this year.
 
 
Merely passing on these types of cost increases to today’s still recession-weary consumer will be challenging, to say the least.AlixPartners’ proprietary research shows that consumers continue to be very reticent to accept price increases. The AlixPartners Personal Care Products Industry Outlook, a study released in November 2010, projected little change in consumer demand or price sensitivity throughout 2011, with value remaining the dominant theme. In the September 2010 AlixPartners North American Household-Products Industry Review, consumers identified price as their top buying criteria, and 75% of consumers expressed a willingness to switch to private-label products if given just a 20% to 30% discount versus branded products.
 
 
While the economy has improved somewhat so far in 2011, the effect of recent price hikes in petroleum-based products, specialty chemicals and other commodities is working its way through the household and personal care products supply chain, and is reaching the consumer.Consumers are noticing these price increases and re-evaluating their buying behavior through substitute products, alternative buying channels (lower-price stores) and, in some instances, reduced consumption.And, of course, no one yet knows what final effect the Middle East and Japan situations might have on both commodity prices and the consumer psyche.
 
 
In this volatile environment, it’s important for household and personal care products companies to follow a set of best practices to manage through what appears to be a continuing period of significant commodity price escalations. These best practices include:
 
 
Utilize “scenario planning” analytics:Leading companies follow commodity prices closely, and dynamically model price changes using top-down scenario planning, along with product profitability and demand-elasticity models. They quickly understand the implications of commodity price increases and then make informed decisions on pricing, promotions and product design.
 
 
Minimize “event-to-shelf” cycle times: The most successful companies act quickly to mitigate commodity-price “events.” Even a few weeks delay in attacking increases can mean millions to tens of millions of dollars in lost profit margins for larger companies. Having a rapid go to market capability and a lean supply chain is critical to implementing changes from price increases to promotion rollouts to package size changes. This requires a combination of top down capabilities such as a culture focused on quick responsiveness plus a set of detailed, tactical capabilities from retailer/customer collaboration to S&OP effectiveness to fill rate attainment at the SKU level.
 
 
Deploy multiple tactics: Mitigating commodity price increases usually requires a deep toolkit of both strategic actions to drive competitive repositioning as well as tactical actions to drive financial improvement. Deploying both market-facing and cost efficiencies will generate a timelier and more effective solution to mitigate commodity cost increases. Many companies have deployed some of these tactics such as product size adjustments and packaging reformulations in the 2008 “shock” and have refreshed these actions beginning in early 2010. Moving forward, leading companies will deploy more targeted price increases based on micro markets and channels, tailor trade spend to optimize effectiveness and increase direct 1:1 promotions. On the cost front, the current “shock” provides another opportunity to re-evaluate product formulations at the molecular level, craft more innovative supplier agreements and optimize vertical integration across functions.
 
 
Today’s higher commodity costs and value-oriented consumers are key themes facing household and personal care companies for what looks like quite some time to come. While specific tactics will differ by company, addressing commodity price increases effectively requires quick action, dynamic planning and a combination of market-facing and internal cost-reduction actions. This is most effectively accomplished through a structured, programmatic approach that drives fast-paced change and balances customer, supply-chain and financial requirements.
 
 
About the Author
Rich Vitaro is a director in the Consumer Products Practice at AlixPartners LLP. Rich is an experienced advisor, known for solving clients’ most demanding issues and driving step-change improvements in performance. He holds an MBA, with Honors, from the University of Chicago, and a BS from the United States Naval Academy.AlixPartners LLP is a global business-advisory firm offering comprehensive services in four major areas: enterprise improvement, turnaround and restructuring, financial-advisory services and information-management services. The firm has more than 900 professionals and 15 offices around the world, and can be found on the Web at www.alixpartners.com.


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