Contract Manufacturers: 5 Steps to Regain Profitability

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Over the past several years, businesses in nearly all industries have grappled with many coexisting phenomena, such as macroeconomic uncertainties, persistent inflation, and a changing labor market. Although inflation appears to be trending downward and the labor market has started to cool, the challenges of the last couple years have exposed commercial weaknesses that can erode margins and inhibit future growth.

Businesses across the board have seen a meaningful increase in costs, but for contract manufacturers (CMs) in particular, this poses a unique set of difficulties. While CMs have been successful at passing on the rising material costs to their existing customers, they often find it challenging to pass on rising non-material costs such as labor, freight, consumables, and other operating expenses. As a result, CMs’ profit margins have been squeezed, requiring strategic measures to combat these challenges. Additionally, CMs often find the need to align commercial practices with operations to ensure processes (e.g., quoting, contracting, price-adjustments) and systems (e.g., KPIs, governance, incentives) are coordinated to prevent margin leakage.

Our industry experts have developed an approach that CMs can take to regain their profitability and achieve growth for the long-term. This proven 5-step strategy, shown below, is based on our extensive experience with CM clients and has proved successful in delivering higher profitability while maintaining positive customer relationships.

Step 1: Identify the opportunity: Our first step is conducting a comprehensive assessment of the CM's portfolio to identify accounts where the company is incurring the highest losses. Not all products or accounts are equally profitable, and we often find significant variations in profitability across the customer base. By analyzing customer-level P&Ls and understanding these discrepancies, we can pinpoint accounts where there is a need for immediate intervention.

Step 2: Set the target: Having identified the opportunities, we work closely with the CM’s leadership and frontline managers to determine a pragmatic gross margin improvement target. This is based on a careful evaluation of customers on two crucial factors: "Ease of Increase" and "Need of Increase." By strategically selecting customers, we focus our efforts on a target audience of potential customers who offer the most substantial potential for margin improvement.

Step 3: Develop playbooks and tools: After establishing our improvement target, we work with customer facing team members (e.g., sales teams, account managers, customer satisfaction representatives, etc.) to create a negotiation playbook – a living document that captures a holistic view of the customer and helps plan and prepare for a future price negotiation. We equip customer facing teams with tools such as "balance of power", “battle cards” and "concession planning" to prepare for successful negotiations along the customer journey.

Step 4: Enable the sales teams: Effective negotiation is key to transitioning cost increases to customers. Hence, our fourth step involves enabling the customer facing teams through tailored training and mock negotiations. Our training sessions focus on nuances of negotiation in CM and are enriched with targeted breakout exercises aligned to the specific accounts that the customer facing teams manage.

Step 5: Monitor results: To ensure the success and sustainability of these efforts, we also develop a robust roadmap to measure and monitor results of the increasing profitability initiatives. By continuously tracking the progress and making data-driven adjustments, we can help CMs stay on course, achieve their margin targets, adapt to any unforeseen challenges, and protect their bottom line.

Navigating the complex landscape of current macro-economic uncertainty is a significant challenge for CMs. However, Simon-Kucher’s proven strategies and expertise has helped several CMs restore their profitability and unlock their full growth potential. Our 5-step approach, from identifying opportunity to monitoring results, backed by data-driven insights and extensive expertise, can help CMs not only weather the current storm but also emerge stronger and more resilient in the face of future economic uncertainties. When your CM organization is ready to reach its full potential and create a customized profitability plan, contact our Simon-Kucher experts.

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