When it comes to product development, nostalgia sells. Consider Nike’s new self-lacing shoes, circa Back to the Future, or Coca-Cola’s glass bottles.
Likewise, “what’s old is new again” also applies to the idea of product innovation as a means to boosting product margins. I’m happy to say that after taking a hiatus, product innovation may once again lead the way.
It’s important to understand why investing in innovation became a lower priority in recent years.
The old model for many Food and Fast Moving Consumer Goods companies (FMCG) companies was to invest in innovation to get “new and improved” products to the market that could support higher prices and larger margins. Manufacturers had the power to get retail distribution, and the media was dominated by a small number of national networks, enabling a low cost means to generate both awareness and trial.
The focus for margin improvement then changed to reducing the total cost of delivered goods through supply chain productivity programs, while reducing overhead across the board. Product innovation became a lower priority as technical resources were increasingly redirected to cost savings efforts. Most companies set yearly targets of 3-5 percent for the reduction in the total cost of delivered goods and redirected technical staff in both their product supply and R&D organizations to deliver on that goal.
To drive more costs out of the non-supply chain portion of the business, the industry then embarked on major mergers and acquisitions, spin-offs and staff reductions.
Today, these companies are increasingly under quarterly pressure by the equity markets to show top-line, profitable growth. They are having a lot of difficulty doing so. After years of reliably finding new ideas to deliver the 3-5 percent savings that management has come to expect, the “low hanging fruit” has largely been picked off the trees.
Now that most of the costs have been wrung out of the supply chain, it’s clear that FMCG companies need a new way of thinking.
I spent 31 years in R&D at Procter & Gamble and today lead ideation sessions on margin management (among other topics) for large and mid-sized consumer goods companies. What I’ve learned is that supply chain cost savings alone cannot be the answer. As practiced today, it is a game of vanishing returns.
The better approach is to take a holistic view of margin management, with innovation once again playing a pivotal role. Here are the five steps to a winning approach:
1. Make margin management an enterprise-wide, multifunctional effort. It should be led by the sector P&L owner and tracked quantitatively with transparent, relevant measures. Progress should be reviewed at each sector leadership team meeting, and benchmarked against specific goals/timing built into the functional leaders' compensation package. This is in contrast with a "cost savings" approach where the technical functions (R&D and Product Supply) have the responsibility to deliver lower product costs.
2. Balance top-line revenue growth with bottom line growth in operating income. A coordinated effort must be in place to grow volume and reduce costs. The "dial" should not be turned to an extreme where all the savings are used in marketing and temporary price reductions to grow volume while eroding margin; nor can all the savings be taken to the bottom line to increase profit while share declines.
3. Make innovation a core component of margin management. The way to maintain this share/profit balance is by linking tools to grow the top-line (e.g. pricing, product mix, new product line extensions/adjacencies) that can support higher pricing and margins together with cost savings. That requires coordinated multifunctional input and commitment to the sector project portfolio. It also requires careful attention to the allocation of scarce technical resources between innovation and productivity. Often product line extensions and adjacencies are fertile ground for innovation. For example, a leader in fabric care was able to tap into the experiential element of the brand to increase sales by introducing a new line of fabric softener fragrances based on experiences. In the oral care business, a company was able to envision a completely new product, teeth whitening strips, by understanding the consumer desire for both cosmetic and health benefits for teeth, at a more reasonable price than what’s available from the dentist.
4. Make margin management part of the culture. Not only must the responsibility for this program be adopted as a core, sector wide strategy with execution a priority for all functions, but other paradigms must be challenged. For example, a core principle of many cost savings projects is that the consumer must not be able to tell that the product has been changed in a meaningful way. In the past, very sensitive consumer tools (e.g. paired comparison blind use tests) have been employed to qualify the lower cost version of the product for market. It’s important to rethink these tests, as real world consumers don’t evaluate products blind, but in the context of the brand, the price, the claims and past experiences.
5. Infuse external thinking and fresh perspectives. With any difficult problem, it helps to get outside perspectives — someone from different functions, companies, and even industries to bring breakthrough ideas. In today’s free-agent workforce, where many very experienced experts work on their own or through outside companies, it’s easier than ever to access external thinking.
Marc Dahlgren, Ph.D. spent 31 years in R&D at Procter & Gamble and is now a leading YourEncore expert in technical problem solving, product development and margin management.