As a food industry business owner, CEO or CFO, what likely keeps you awake at night, especially in the second half of the (fiscal) year, is the profitability level of your company (or more specifically, EBITDA). How are you going to increase your profitability.
As you know, the second half of the fiscal year is the make-it-or-break-it point of whether or not you meet the year’s financial targets or fall dreadfully short.
One of the most persistent challenges food manufacturing companies face is the ever-increasing pressure on profitability. And in today’s world, that’s the reality industry wide, no matter what type of company you lead.
It’s a real catch-22… because if you run a stock listed company you are forced to deliver shareholder value, which either comes from a big leap in the stock value itself, or in dividends paid. Both are heavily influenced by profitability.
The same holds true for food manufacturing companies owned by private equity firms. If that’s you, you’re well aware the profitability targets are often even more stringent than for stock-listed companies, because private equity firms typically focus on achieving big financial success within a very short window of time. Usually within 3 to 5 years.
Over the years I’ve heard plenty of stories of investors going to great lengths to get what they need, often showing ruthless behaviour directly towards the CEO and CFO, which ends up making profitability a true “personal quest”.
If you’re thinking, gosh, I am lucky to oversee a privately-owned company and I’m not touched by all of this. Well – it’s not always roses for privately-owned companies either.
In fact, there are a large amount of sizable privately-owned food industry companies being financed by bank loans or private investors who still demand to see a return on their investment, which means there is an ongoing need to show consistent and preferably increasing level of profitability.
How do food manufacturing companies try to increase profitability?
Let’s jump in by taking a look at the four most common approaches food manufacturing companies take to try and increase profitability that never seem to work very well…
And one that does.
Four (Not so Great) Ways to Increase Profitability
Not so Great Way #1: Hoping to Increase profitability by growing top line sales.
The logic here is simple, by selling more products and keeping the fixed costs at the same level, profitability will increase as well.
However, this typically only works incrementally, because growth beyond the free capacity in the company usually means additional investments and a related increase in fixed costs.
On purpose, the word “hoping” is used in relation to this mechanism as all too often companies end up selling more products against increasingly lower prices, resulting in a relatively lower contribution margin and hence a lower profitability.
Other than increasing the sales volume, the company might be in a position to leverage one or more unique aspects of its product line by simply increasing the price a time or two to become more profitable. But this is certainly not a long-term path to success.
In the end customers will drop off or a competitor will likely begin selling similar products at a much lower price. Moreover, to a large extent there is a strong pressure from retail on food manufacturing companies to drive prices down – constantly.
Not so Great Way #2: Reduce costs of materials and wages
The approach most companies take is to reduce costs to increase profitability. While reducing costs is a very sensible approach to take, many companies execute these cost reductions in a way that is harmful for the business.
For example, buying cheaper raw materials or cheaper packaging materials is a quick route to higher profitability, or so it seems, because all too often the universal relation between quality and costs comes in to play here.
Cheaper materials can and will lead to more failure costs while processing these materials.
Another approach is to “do more with less people”. The logic here seems sound and it might even result in a short-term increase in profitability for the company, however in the medium to long-term you will likely find good people will leave the organization, while many others get over stressed or fall ill.
Once you factor in the costs involved in a higher staff turnover rate and the costs of having to pay for staff that falls ill, you’ll likely find this approach comes up short of long-term expectations.
When it comes to reducing costs of materials and wages, the total cost of ownership needs to be taken into consideration, factoring the potential increase in failure cost and the cost of unhappy customers.
Not so Great Way #3: The Salami Method
Simply put, it’s about cutting budgets evenly across all departments and all projects to deliver an increase in profitability.
However, these types of cuts usually only result in a marginal improvement, because you are not cutting the costs of the biggest driving factors: namely raw materials and wages.
Of course, you could include wages, but that will for sure drive the good people out of your company, diminishing overall productivity and future leadership development efforts.
Not only that, many managers might suspect a salami approach and will already factor this into the budgets they set for the year, which means the salami effect might in the end achieve nothing at all!
The salami can be defined as saving costs without any insight in the cost drivers and certainly not taking into account the effects of the cost saving. It’s like driving a car at 100 miles per hour with your eyes closed.
Not so Great Way #4: The Slash and Burn Method
Finally, like a razor-sharp chef’s knife through a side off beef, as a last resort there is the ruthless “slash and burn” method to cost cutting.
This involves things like stopping projects and investments, sending home all temporary staff and terminating contracts with external consultants and interim managers.
Typically, this type of cost cutting is either executed unplanned during the second half of the (fiscal) year, or in a semi-planned fashion where managers must factor in a B-level (and sometimes even a C-level) budget.
This type of cost-cutting can really hamper your business as it might affect a lot of crucial processes like sales, production and it certainly affects the longer-term stability and growth capability of the organization.
While this method may deliver good short-term results, it will have a negative future impact.
So, all that leads us to ask a couple important questions…
Why do so many Companies end up in these Types of Situations… and is there a better Solution?
In order to understand the underlying reasons, we need to start by taking a closer look at the way in which companies are governed internally.
Most companies will have a strategy that is based on either market insights (a so-called “pull” strategy) or based on their product portfolio (a “push” strategy), or ultimately a combination of both.
The strategy will define what projects are started, what investments are made, what KPI targets will be and to a large extent how budgets are set.
Throughout the year, the projects will be executed and KPI’s will be monitored on a monthly basis as well as the financial results.
But the question arises whether the on-time and in-full delivery of project milestones and a proper performance in relation to the KPI’s (“all is in the green”) actually will result in the targeted profitability levels.
Unfortunately most often this is not the case…
…and one will start making so-called “bridges” to see where money was lost and reclaimed in the hope to still manage everything within budget and closer to the profitability target.
While facing this situation some companies will start cutting costs in a ruthless manner as described above, while others might take a more “strategic” approach and invest heavily in programs like Lean Six Sigma or World Class Operations Management, sold to them by large, one-size-fits-all consulting firms.
While there is certainly a long-term argument for applying those “strategic” programs, in the short term this very often does not lead to the desired financial outcome.
More often than not, these approaches move companies with speed into a situation where they do more with less people and put very high pressure on their work force. It is like trying to force your way out of trouble by using a big gun…
If your company is experiencing any of these profitability challenges right now, you’re not alone. Before we reveal a solution, let’s dive in a little deeper…
You might be familiar with the story of the monkeys and the bananas by G. Hamel and C.K. Prahalad, which actually is about corporate memory.
Four monkeys were in a room that had a tall ladder in the center and suspended from the top was a bunch of bananas. The monkeys were hungry, and one started climbing the ladder… but just as he reached out to grab a banana, he was doused with ice cold water.
Squealing, he scampered down the ladder giving up on his attempt to feed himself. Each monkey made the same attempt with the same drenching with cold water. After several attempts they all gave up.
Then researchers removed one monkey and replaced it with a new monkey. As the newcomer began to climb the ladder …the other three grabbed him and pulled him back to the ground. Each time he tried; he was pulled back.
The researchers replaced the original monkeys one by one and each time a new monkey was brought in he was dragged down by the others before he could reach the bananas. In time the room was filled with monkeys who had never received a cold shower…but none of them would climb the ladder…
…And none of them knew why!
This story perfectly reflects the current situation in a lot of food companies…
The good news is, it doesn’t have to be that way… because the answers are sitting right under their nose.
The truth is, most shop floor workers and middle managers do know what is going wrong day by day.
They do know where the company is losing money, minute after minute.
…But since senior managers are not interested in their input, they have stopped giving it. In fact, they might even have stopped caring for these losses all in all, leaving them hidden from your sight.
That’s the negative influence corporate memory has on organizations… and yet, in it also lies the solution…
The solution you’re looking for ultimately lies in uncovering the “hidden” losses, by taking an unconventional inside-out approach…
Let us explain.
Inside-Out Strategic Insight
By uncovering these “hidden” losses and starting to factor these in what can be called an “inside-out strategy”, companies it becomes crystal clear where profitability is being wasted.
Moreover, when these failure costs are made explicit, it is not only possible but much easier and far more cost effective to define improvement actions, projects and investments to address them.
Once your company starts to uncover its failure costs in more detail and begins to put in investments to solve the underlying issues, a simple cost-benefit analysis for each investment can be made, enabling your company to seek out those investments that not only have the biggest return in the short term, but also put you on a path to long-term sustainability. (Read that sentence again).
This is a very powerful (and proven) way to increase profitability levels inside-out, from within your company.
The two most important differences to taking an inside-out approach versus the four traditional cost cutting approaches we covered are:
1.The inside-out approach does not hamper the organization in the short term. In fact, the biggest benefit is, it acts as a fly wheel function towards a more sustainable future, because…
2.When more resources get freed up, profitability increases, and your company can take on bigger and bigger improvements that will have bigger and bigger results long-term.
In 2018, we held a survey at 153 food manufacturing companies around the globe. On average these companies “admitted” to losing 5% of their turnover in terms of failure costs.
From working with our clients over the last year to create strategic insights into their hidden losses, we discovered it more often in the range of 10% to 20% on average for most.
Interested in gaining a strategic insight into the potential hidden losses of your company?
Of course, all action starts with proper, strategic insight. But in the end performing the actions and motivating an entire workforce to behave in a different manner are the things that need to happen subsequently. With great knowledge comes great responsibility… hence we invite you to use this strategic insight in your company’s hidden failure costs to increase the profitability in a strong and sustainable way. If you feel this approach would be of benefit to your company, contact us.
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