Most FMCG companies exist to create shareholder value through seeking to maximise profit. Simple enough, but how to maximise profit?
There are only three levers that drive the bottom line: volume, costs and most importantly, though frequently overlooked, price. We hear a lot about the first two, particularly costs, in terms of reductions and efficiencies, but pricing discussions, when they happen, tend to be focused on promotions. Price, both on and off deal, is though the biggest driver of profit as it affects all of the volume sold, with any additional price taken going straight to the bottom line. Isn’t it time that the power of Price was exploited to its’ full potential in the pursuit of maximising profit?
Profit = (Price – Cost) x Volume
Price will always be at the top of the profit equation as long as an item is sold above the cost it took to produce. Obviously price and volume are inextricably linked, and together they drive revenue, but as your colleagues in the Finance department will tell you, revenue is not the same as profit. Similarly a percentage decline in volume will have less effect on profit than an equal drop in price. It may not be the sexiest, most glamourous commercial consideration, but getting the pricing right can have a fundamental impact on the profitability of a company.
So how should price be optimised? Answering these three questions would be a good start:
1. Where’s the focus?
Fundamentally a company can grow profit either by increasing market share or by increasing margin: both of which are difficult to do simultaneously at the best of times, let alone in the current market. There is a fine balance between volume and profit growth, with a trade-off between the two: growing share through price cutting will only decrease margins, potentially leading to a “price war” and category devaluation, benefiting only the consumer. For an established brand therefore the focus should be on maintaining and driving margin.
2. What’s it worth?
Deciding how you price your product is more complicated than it may first appear. There are a huge number of factors to be considered, not least what consumers are willing to pay? Are you a leader or a secondary brand in your category? What is your main competitors’, and therefore the consumers’ benchmark, price? Does your price cover your costs? What happens when your costs go up? Understanding and answering these questions, particularly for NPD, are critical to pricing correctly.
3. Does your bucket leak?
Addressing the first two steps will only get you so far however and businesses need to focus on ensuring that profit captured through price is not lost. Tipping revenue into the bucket at the top, then controlling discounts, understanding how to manage and optimise your trade promotions to maximise ROI, are all fundamental to preventing profit leaking out the bottom.
In today’s retail environment and indeed for the foreseeable future, pricing products correctly, both on and off promotion, is more crucial than ever for FMCG companies. Price is too often overlooked as a profit lever, either in account plans or when the focus is on short term promotional activity or long term trade agreements. With limited opportunities however to maximise profit through increasing volume or decreasing costs, capturing and then holding on to price and margin is key to long term sustainable growth and delivering shareholder value.