Surviving in a High-Inflationary Market: Escape the Cost-cutting Paradigm

February 01, 2019

Surviving in a high inflationary market: Escape the cost-cutting paradigm

The consumer packaged goods (CPG) industry in Turkey is facing some major challenges. While last year saw a currency crisis and the highest Turkish inflation in 15 years, at 11.6% the country’s most recently announced double digit unemployment rate continues to increase, and any disposable income is thinly spread.

The last two years have been quite stormy for CPG companies in Turkey. Not only must businesses contend with increased ingredient and packaging costs, worsening exchange rates, higher borrowing rates, and greater price transparency. The recent economic activity is also having a massive impact on consumer purchasing behavior.

Turkish consumers are definitely conscious of the recent economic developments. At 58.2, the consumer confidence index has remained at record lows since November 2008. Moreover, in a bid to curb inflation in Turkey, last year the government started to conduct inspections to monitor price increases. Businesses have been warned against unjustifiably raising prices, and consumers have been called on to report unusual price hikes in shops. Prime news channels even include price changes in the rundown of the country’s important events.

With rising prices and economic trends so closely followed, price management is riskier than ever. It might seem like the safest thing for businesses to do is bury their heads in the sand. However, it is possible to thrive in these stormy waters. What’s needed is a more sophisticated approach to pricing decisions.

Escape the cost-cutting paradigm

In the consumer goods sector, the typical responses to crisis scenarios are harmful for profits. Internal communication is oriented to defend volume and market share at all costs. Focus turns toward more economical segments. And in general consumers drift toward channels where there is more wiggle room with prices, such as the discounter and wholesale channel. To remain competitive, businesses pursue aggressive discount and promotions strategies on their goods and services, and leader brands become dispositioned. The result? Ultimately, these knee-jerk reactions sacrifice profits and trigger price wars.

Cost-cutting initiatives are the obvious solution when faced with diminishing revenues. It is safer to avoid negative reactions from customers and recuperate profits via boosted productivity instead of price increases. However, cost control can also jeopardize revenues, especially when pricing, marketing, and sales are hit first. Attack costs in the wrong places, and run the risk of cutting your way into your own growth!

To succeed in a crisis, companies should step into a new paradigm: revenue growth. Ask any CEO or an investor which lever is the single strongest driver of corporate profit or shareholder value. The answer is revenue growth! In the long term, revenue growth generates 76% of total shareholder return for blue chip companies. It also has a strong impact in the short term for a growing company. It helps to fund expansion, transforms R&D, generates more growth, attracts new talent, and creates career growth opportunities for all employees. Investments in professional price management might seem like the last thing on CPG companies’ minds right now. However, our experience with high inflationary markets shows that this is exactly how to thrive in stormy waters.

Key lessons learned from high inflationary markets:

Set prices according to consumer thresholds

Quickly adapting to high inflation effects requires a robust pack-price architecture based on price gaps and price corridors. Conduct a detailed customer analysis and market research to ensure you are providing the right offering for each relevant customer segment and their purchasing power. Are you addressing the different willingness or abilities to pay? You may need to redesign pack sizes to make them more attractive or affordable. Identifying poorly covered occasions and needs will help you determine the right combination of brand, pack, format, size, and price. It may also reveal new market opportunities and serve as a basis for more systematic decision-making in the future.

Define a process for implementing price increases

Trying to increase prices while under the microscope is a risky business. For price increases to gain acceptance, implementation and timing needs to be aligned across channels. To avoid channel and transshipment conflicts, the whole value chain of each channel needs to be factored in, as well as the split of the total margin. E.g. the retailer’s versus the manufacturer’s margin. Another way to ensure successful price increases is to use pricing simulators. These tools can be based on indexation and linked with substitutive products. Price recommendations are updated based on competitor moves and according to the effects of inflation.

Switch to a profitable revenue mindset

Rising inflation, increased costs, and a bad image due to significant and simultaneous price increases can have a severely damaging impact on profitability. Consumer goods companies need to move away from volume targets and adapt a profitable revenue mindset. This requires a targeted pricing strategy whereby the revenue plan informs the budget, not the other way around. By embedding a profitable revenue mindset in all commercial routines, the CPG industry can continue to thrive, even in stormy waters.