Consumer Packaged Goods Companies and Managing the Margin Squeeze: The last five years have easily been the most dynamic period in well over fifty years across most financial, commodity, and industry sectors. Price extremes and increased volatility coincided with a global slow down, a financial market crash and subsequent recovery to record stock market highs, and dramatic shifts in the supply & demand characteristics within the commodity sectors. A rising international middle class helped pushed key food, energy, and base material prices anywhere from two to five times the levels observed just ten years ago. And despite the presence of noticeable inflation over the time period, consumer prices have not kept pace anywhere near that level.
There have been pronounced winners and losers across the value chain as a result of these business environment changes. For example, energy and chemical companies in the U.S. with access to now relatively cheaper raw materials are more competitive than ever in the global marketplace. They have seen significant gains in profitability in recent years. However, this phenomenon changes as you move further upstream in the value chain. Consumer packaged goods companies (CPG) in particular found themselves caught between higher input prices, higher commodity volatility, but yet reduced pricing power. Consumers are spending more of their disposable income on energy and food purchases and are more cautious than ever with their remaining disposable income. Large consumer-facing retail organizations flexed their muscles and more frequently require their suppliers to offer longer-term fixed price contracts to counter the price volatility on their end. This leaves CPG companies facing the high possibility of margin squeeze with any upward shift in input pricing against fixed sales prices. Volatility is also a problem when pricing power is small as it strains budgeting, forecasting, and long-term planning.
CPG companies are utilizing several strategies to adapt to this margin squeeze. Changing product and packaging material composition, shifting towards fixed priced purchase contracts, supply chain realignment, and the expansion of commodity risk management programs are a few strategies being employed. Margin stability and volatility reduction are common goals of a commodity risk management program. A successful commodity risk management program does not only support the purchasing function, but goes deeper in identifying net economic exposures across the complete supply chain. To accomplish this, companies must understand and incorporate purchasing and sales contracts into their exposure management program and have high transparency into physical, financial, and contractual commodity exposures. Placing hedges in response to incomplete exposure information can serve to increase exposure instead of decrease it. For a CPG company this can happen when losses on hedges against raw material purchases coincide with reduced selling prices requested in response to reduced input prices.
capSpire is helping CPG companies implement successful commodity risk management programs by providing technical and best practice risk management solutions to its clients. Our firm helped one of the larger CPG companies in America take their risk management program to the next level in integrating purchasing, forecasting, and physical/financial risk management systems.
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