By Ian Plumb, Associate Director, Endless LLP
Commodity prices. Over the past 18 months this phrase has sent shivers down the spines of even the most sedulous of management teams attempting to budget and set effective pricing strategies. Burgeoning demand, especially from the BRIC and other emerging economies, coupled with supply issues, such as political instability in some key exporting markets and limited capabilities to extract sufficient necessary resources, has led to all manner of indices rocketing upwards.
It is not surprising people are scratching their heads and sometimes getting a bloody nose whilst trying to duck, weave and even counter against the heavy punches of global supply and demand. But what measures can be taken to protect your company and survive the tussle? Here are a few SOLUTIONS.
Share the burden
Arguably one of the best ways to avoid a cost is to pass it onto someone else. The extent to which this can be done successfully will depend on the business’ sector and position. Retailers facing unprecedented pressure on the high street will undoubtedly want to pass on those costs to the supply chain. Equally, suppliers will be looking to customers to bear the brunt. Anyone wishing to subject the end consumer to cost increases will have a cautious eye on both current spending patterns and the actions of competitors.
In circumstances such as these the power of a brand or a product will be truly tested. Those businesses with negotiating strength boosted by a brand will be in a preferable position. Others may find that brand recognition alone is insufficient to persuade a powerful customer to accept a price increase.
Oust the competition
Opportunities can present themselves from a number of nusual sources. A business with strong profitability and a healthy cash balance may use rising raw materials to its advantage as a way of increasing price competition in their market. By absorbing the price rise, further pressure will be placed on competitors and the instigator of the price competition will hope to gain market share.
Look abroad
The flood of outsourcing to the Far East has maximised the opportunities from low cost economies. As China and others develop the low wage comparative advantage lessens. Whilst other emerging economies can re-establish the initial low wage advantage that China once offered, these options are limited as these countries develop. Flexibility to rapidly switch suppliers will soon become mandatory in order to remain competitive.
Use a substitute
Material substitutes can also be used to mitigate price increases. However, given the predictability of such an option the direct substitutes are likely to have also experienced price inflation. Tie-in rates Whilst currency hedging can be easily accessed via a high street bank, the world of commodity hedging appears more volatile and complex, as well as costly. Hedging may make sense for larger business, but it may not be cost-effective or appropriate for the majority of UK-based SMEs.
Innovate
If the product must not be tampered with, the option of an alternative range remains. This will require some careful product differentiation to ensure cannibalisation between the two ranges is avoided, however the preservation of customer loyalty and the option to access a new type of customer in the current climate should not be underestimated.
Operate in-house
As margins are squeezed as a result of rising raw material and energy prices, vertical integration could allow cost savings elsewhere through greater control of operations and a tighter rein on outgoings. Whilst companies providing outsourcing services can pass on their economies of scale, they tend to bulk buy quantities to meet the supply needs of a variety of outsourcees simultaneously. Efficient and effective management in-house may provide greater flexibility in response to changes in commodity prices and customer demands. The financial and non-financial benefits from bringing it in-house may outweigh the costs of reduced economies of scale otherwise enjoyed from outsourcing.
New formula
Premium content can be reduced if the customer is sufficiently forgiving. For example does the average sports fan have a keen interest in the nutritional content of his / her half time snack to the extent that a small percentage fall in a premium element would change a purchasing decision? Customer knowledge is paramount here as the more discerning consumers may not tolerate a reduction in quality content.
Small is beautiful
Quality may be untouchable, but size may not. The ‘pound shops’ ability to sell premium quality branded loaves of bread is at first impressive until the size is compared to the standard. Nevertheless, if this satisfies the customer’s demand then it is no less than skilful retailing.