Rethinking profitability in times of high inflation

Inflation is a real challenge that businesses must deal with periodically in their lifecycle. In times of inflationary shocks, firms often opt for quick fixes like increasing prices or laying off people, which yield adverse effects in the longer term, to reduce costs and maintain profit margins. The team at Strategic Gears, however, has experience in an alternative mechanism to cope with inflation and reach profitability: eliminating ingredients or process elements that are not valued by the end customer.

Doing so, however, is not an easy feat. Identifying non-value-added activities or ingredients can be a complex exercise that requires rethinking the production process and formula with a fresh & customer-centric eye. And when such ingredients and process elements are eliminated, higher gross margins can be unlocked for businesses.[1]

Here is the experience of a local conglomerate.

While this conglomerate was a leader in some of the industries it operates in, its gross margins had significantly eroded across the business due to inflationary headwinds. To cope with this and safeguard profits, the conglomerate’s management was seriously proposing to reduce manpower.

The treatment that was taken instead, however, comprised a waste reduction analysis to identify the elements that do not add value to the end customer. This involved a micro-level evaluation of the conglomerate’s production chain to question every step of the process and assess its value to the end customer. The evaluation covered each department—including purchasing, manufacturing, and logistics, among others—and critically assessed the role each played in ensuring that a quality product is delivered. By the end of it, the conglomerate received a compiled list of expendable process elements that did not add value to the customer nor the product.

By rethinking profitability and resisting the instinct to cut staff expenses, the conglomerate’s gross margins eventually improved by 250 basis points and saved around 10s of millions of Saudi Riyals when a similar approach was executed across its different businesses.

Another example comes from a leading Fortune 500 FMCG company in the Middle East and North Africa region.

Here again, the firm saw inflation slash gross margins across its products. Pricing research showed that most of the products had high price elasticity, meaning a significant share of revenues would decline if prices were raised. So to safeguard profits, the company’s leadership considered cutting investments in marketing and reducing staff expenses.

An alternative approach was prescribed. In an effort to understand what consumers value in a product, the treatment began with investigating factors that could impact consumer preference using statistical analysis.[2] Workshops were then held with the R&D and purchasing and finance departments to identify processes that could be removed, or streamlined, without compromising product quality. This exercise also helped introduce new sourcing methods for high-value-adding product elements and tested prototype creations with consumers.

The impact in the end was resounding. The company improved its gross margins by over 1,500 basis points (without price increase), its market share by 200 basis points, and its net promoter score by around 10 basis points.[3]

In short, dealing with inflation requires firms to be adaptive and bold. Short-term fixes like increasing prices, cutting marketing expenses, and laying off staff are drastic measures that crowd-out growth, and hence should be resisted. Profitability can be maintained or increased in times of inflation only when leaders think with a broader time horizon and remember to:

o?? Define who the end customer is

o?? Understand the customer’s needs and preferences

o?? Remove process steps or product elements that do not add value to the customer, while retaining those that do.

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[1] Gross Margin (GM%) reflects the share of money left from sales after covering input costs for production, like materials and labor.

[2] The regression included variables like the product’s design, ease of use, durability, etc.

[3] The Net Promoter Score (NPS) is a metric that reflects customer loyalty and satisfaction.