Food Forum: Looking for the silver lining

By  David Donnan

Commodity volatility can create business opportunities for grocers.

Effectively managing escalating commodity volatility is rapidly becoming an increasingly mission-critical agenda item for executives in the food and beverage industries. Because of their position at the end of the supply chain, retailers are in a particularly vulnerable position. Recent unprecedented volatility in agricultural markets has driven commodity costs to historic highs creating significant problems and more than a few commercial opportunities.

While this extraordinary environment, characterized by ever-increasing volatility and inflation, places food and beverage merchants at the receiving end of cost increases passed on by suppliers and manufacturers, it  does offer an opportunity to pursue game-changing strategies and leapfrog competitors by adopting creative approaches to controlling or passing on the burden of raw material cost inflation. Below are some best practices.

Leveraging changes in competitive position
Increasingly volatile commodity markets are changing the relative position of private label products. Some industry insiders believe this could reverse a decades-long trend of retailers growing less and less dependent on brand manufacturers.

Food and beverage manufacturers often have sophisticated commodity management strategies and infrastructures in place. These allow them to be closer to the market and anticipate changes faster than private label manufacturers who are apt to be more exposed to market fluctuations. Retailers, who should already be in the process of examining their brand/private label mix, and negotiating with an eye toward identifying the manufacturer who has achieved the greatest internal efficiencies.

Adapting the product portfolio
Food and beverage retailers can react to increasing commodity prices by either taking the hit or passing on cost increases to the consumer. Neither of these scenarios is promising, and can either lead to margin reduction, or cause consumers to buy less of the product or drive them towards discount stores. That said, there are alternative pricing and packaging strategies which should be considered.

One tactic is to adapt the packaging sizes to accommodate better price-points. Some consumer packaged goods companies opt to maintain item cost while reducing the amount of product in the package, and retailers can take advantage of options which blunt the impact of commodity inflation.

Diversifying product portfolios while keeping the implicit commodity exposure in mind is another approach for retailers to consider.

Increased commodity volatility can drive consumers to explore alternative products. Strong increases in cocoa prices, for example, may shift consumer demand from chocolate goods to other confectionery items.

Rethinking product pricing
The current retail “fixed-price-for-a-year” approach is counter-productive and an additional source of volatility.

The use of “natural hedges” through more frequent price changes to end-consumer (think your local gas station) will become common in several food categories.  Grocery retailers will act more like restaurants, with constantly changing price points reflecting changes in commodity pricing. Winning manufacturers and retailers are finding ways to collaborate with each other in designing optimal mixes of natural and financial hedges to split the benefits and risks.

Frequent price changes are already the norm for high-commodity content items such as ground coffee. The sophistication of pricing mechanisms applied through the entire value chain can be greatly enhanced, leading to more stable margins even in categories like coffee that are subject to high commodity price fluctuations.

Adapting the organizational structure
Many companies have a risk management strategy in place, which is either proactive (taking an active view anticipating future market changes) or reactive (to market fluctuations). From an organizational point of view, the critical issue here is how well the strategy is executed.

Hedging risks takes talent, a clear governance structure to make decisions quickly and a rigorous system of checks and balances. How much coordination is happening between the company’s global businesses? Is each business unit taking a view on the market, or is information and market intelligence shared between units? How well integrated are the procurement, finance and risk management organizations?

Scenario planning will become increasingly essential to develop contingency plans for resource and price volatility.

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