Consumers are feeling the pinch as food and beverage manufacturers deal not only with the rising cost of ingredients, but also rising fuel costs that are driving up shipping prices. With growing populations and growing per capita consumption in countries such as China, demand for ingredients continues to increase. The fundamental laws of economics are at work, and with no relief in sight, food and beverage companies that do not take immediate action will continue to see eroding profits.
In one of Grant Thornton’s most recent surveys, eighty-five percent of food and beverage firms reported that commodity costs rose last year (31 percent reported costs increased by more than five percent). Nearly three-fourths of firms (72 percent) expect commodity costs to rise again in the next 12 months (15 percent expect costs to rise by more than five percent).
Few food and beverage companies are immune to rising costs brought on by the agricultural turmoil of droughts, fires, floods, freezes, and blights. Coupled with increased demand and the downstream impacts of crop-shifting to support the bio-fuel craze, the challenges to these enterprises seem insurmountable. Small and mid-size companies that increase selling prices to cover these costs risk losing market share to larger or vertically integrated competitors who may be in a position to manage them more effectively.
In fact, approximately 71 percent of firms increased prices in 2007 (14 percent increased prices by more than five percent). This year, 76 percent plan to increase selling prices (12 percent will increase by more than five percent). Firms with higher sales volumes and firms closest to marketleader status were less likely to plan large price increases in the coming year.
As consumers, we are well aware of other tactics companies have used recently to address these rising costs. Who has not noticed that the traditional “half gallon” of ice cream is no longer a half gallon or that the shrimp appetizer on the menu now includes only five shrimp instead of six? Should we applaud these companies for trying to keep their products more affordable or be insulted that they do not think we notice?
Rather than hiking prices, shrinking product portions, or suffering from declining profits, food and beverage companies should look closely at where and how they spend their money. For years we have read about companies pursuing Lean Manufacturing, Supply Chain, and Six Sigma initiatives to achieve production efficiencies and manage inventories. In many cases, these initiatives have been very successful. But the most obvious and simple means for achieving cost reduction objectives are often overlooked.
Where and how do we spend our money? It seems like a simple question. But when faced with answering it, most companies can only tell you that they spent “x” dollars with “x” company and no more — and sometimes even this is difficult. There usually is no visibility to what was purchased or whether it was purchased based on negotiated contracts (if contracts even exist). The exception might be their relationship with ingredient suppliers, where many companies are directly addressing the source of the pain and are already employing or considering detailed strategies to manage ingredient costs. But even then, they may not know be readily aware of all of their suppliers or how much they spend with them.
The result is that many overlook the vast savings opportunities associated with their indirect spend. But without the information on how they are spending these dollars and an effective process for using it, money is being left on the table.
By pursuing “smarter sourcing” of indirect goods and services, companies will not only realize significant one-time savings, they will enjoy them year after year. Some of the categories where companies are seeing savings of up to 25 to 3 percent include freight, operating supplies, maintenance and repair, utilities and office supplies. The opportunities will vary by company and the specific production and packaging processes of various food and beverage “sub-segments.”
Some of the symptoms that could indicate opportunities are as follows:
- Indirect costs as a percent of revenue are rising or are higher than those of competitors.
- Decentralized sourcing/procurement functions and informal processes.
- There is no purchasing department and/or no focus on indirect spend.
- There is little control over what suppliers can be used for indirect goods and services.
- Lack of contracts in place with key suppliers.
- The bidding process informal and manual – often focuses only on existing or known suppliers.
- There is little or no visibility into spend with suppliers.
- The company has recently been through mergers, acquisitions, or other changes that may change its leverage with suppliers.
Many financial and operational executives dismiss the opportunity, choosing to believe that the savings associated with indirect costs are insignificant or that “they are being handled.” They fail to acknowledge or understand that using a more formal, structured sourcing approach can have a substantial impact on the bottom line.
A key first step in this approach is to assess a company’s spending across various categories to determine where the savings opportunities exist. This assessment should include grouping the spend for indirect goods and services into various categories and determining the total annual spend for the top 15 to 20 categories, including breakdowns of the higher cost/volume items/services in each category. It should also include a listing of the suppliers used for each category and the amount of annual spend with those suppliers across various categories.
The second step is to develop an understanding of the qualitative factors surrounding these categories. Among the questions that should be explored are:
- How are they sourced and purchased? Are contracts in place?
- What specifications are important internally and which are important to customers?
- Are there alternative items/services that could meet the same need?
- What are the factors driving internal demand?
With this qualitative and quantitative information in hand, the categories that may present the best opportunity for savings should be prioritized. This requires instituting a process to achieve the identified savings.
The third step is to explore the market conditions associated with the selected categories. Are supply and demand trending higher or lower? What is the universe of potential suppliers including global suppliers and other suppliers that the company may not have used in the past? What is the reputation for these suppliers?
Armed with both internal and external information, the company should develop RFP’s that educate the suppliers on the opportunity that exists to serve their company. Let them know the volumes they can expect from the company and obtain an understanding of how well they can address the service levels and price commitments that you expect.
Once all of the information has been evaluated and you have met with the selected “short-list” suppliers, make your decision confidently based on the facts that you have gathered. We have found that this process results in significant savings, and best of all, the savings are usually accomplished without having to change suppliers. However, if you do change suppliers, work closely with them and stay in communication to ensure a smooth transition.
Finally, it is critical that processes are structured to ensure employees responsible for indirect purchases are buying against the established contracts. This is important to make sure that any volume commitments with suppliers are met to lock-in the negotiated prices. Establishing a simple training program and ongoing monitoring of the spend will help ensure compliance.
Steve Lyman is a partner in Grant Thornton’s Advisory Services practice and the leader of the Atlanta office’s Consumer & Industrial Products practice, Steve has 15 years of experience serving both Fortune 500 and middle market customers. He can be reached at [email protected].