A scenario of rising costs requires faster decisions in order not to be left out of the market

08/09/2022

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Largest consumer industrial companies in the world are making an effort to try and show a reaction to the current difficult situation — Foto: Daniel Wainstein /Valor

“Two and half years ago, you had to switch off the autopilot and go into what I call hand steering … You really have to try to stay as nimble as you can because you don’t know which shoe might drop next. So it’s these unknown unknowns that keep me most worried,” Nestlé CEO Mark Schneider said when asked by an analyst a few days ago what ails him before bedtime in an environment of widespread inflation. “Obviously, taking pricing is never a simple discussion. So we have, in some cases, some pretty robust discussion,” Danone CEO Antoine de Saint-Affrique told investors a day before Mr. Schneider’s speech. “Right mix of driving the pricing in a very sophisticated way and in a way that also makes sure that we don’t price ourselves out of the market.”

What was seen in the last few days, for hours on end, in conference calls of the largest consumer industrial companies in the world was an effort to try and show a reaction to the current difficult situation. CEOs needed to position themselves, in part, because analysts put pricing policy and cost management at the center of the discussion.

The pandemic crisis and the war in Eastern Europe exposed the need for companies to face something that current management teams had not faced before: an inflationary escalation in consumer markets that are very different, in terms of cost structures, habits, tolerance to adjustments, and a stagflation backdrop already bordering on the risk of recession. “Inflation was not a complicating factor at the onset of either of those crises. It is today,” with tensions “converging in the near term across the second half of 2022 and into 2023,” Austin Kimson, a vice president at consultancy Bain & Company, wrote in an article last week.

Most groups, which reported results for the second quarter and the first half of the year in July, announced price increases in recent months of up to 20%, in the world and in Latin America, to offset the rising costs of the production chain – sales volume has fallen.

Brazil was affected by the adjustment policies and was mentioned in conference calls by executives from four of the eight companies that reported results. In this group are Unilever, P&G, Kimberly-Clark, Nestlé, Danone, Coca-Cola, Whirlpool, and Electrolux.

Worldwide, five of the eight companies raised prices and sold smaller quantities between April and June, which tends to reduce operational leverage and efficiency – only Coca, Nestlé, and Danone adjusted prices without losing volume. In June, Economy Minister Paulo Guedes asked commerce and industry companies to give “a brake on price increases” and suggested that companies update prices only in 2023. At the time, in private conversations, industry and retail executives rejected such hypotheses as companies need to recover net sales and profit margins.

Analysts, when commenting on the dose of adjustments, say that companies are within an “acceptable” volume loss calculation. And they acknowledge that inflation is higher than they anticipated. Commercial actions have been revisited in a shorter period of time, including route changes. There is a visible effort by industrial companies to hold on to the “value” of their brands to prop up their strategies.

Marcos Gouvêa, CEO of the consultancy Gouvêa Ecosystem, says “Brazilian companies navigate well through this scenario because it is an environment they know, but it is not the rule.” He recalled that “CEOs around the world are having to evaluate more, test more, and quickly review what doesn’t work in an environment where consumers from different parts of the world are very skeptical and looking for the essential for the lowest possible price. And with many more brand options.”

Costs are expected to remain under pressure, and such a situation is likely to be passed on to prices for the rest of the year around the world. Brazil, which accounts for up to half of sales of the large groups, is unlikely to be excluded from this.

Unilever CEO Alan Jope, for instance, told investors in late July that the company has passed on, so far, 70% of the cost increases felt in Latin America after the pandemic.

There was a 21.7% increase in prices in Latin American countries and volume fell 4%, while sales grew 17%. It was the largest adjustment for a quarter since 2017 in the region. From January to March, prices had already risen 16.4% and volume shrank 5.7%. Mr. Jope says that the loss in volume is in line with expectations and that it was necessary to make these adjustments in the region “to retain our ability to invest behind our brands” – which can also be interpreted as a way to avoid a greater hit in profitability, which fell in the quarter in Latin America.

The decision to adjust prices, in a scenario with recession risk, was also cited by the management team of Coca-Cola in a conference call with analysts in late July. CEO James Quincey said that the company has been trying not to lose the timing of the price increases. In Brazil, data from IPCA/IBGE show that soft drinks and waters rose almost 11% in the 12 months through June. In April alone, they rose 2%.

“We are hedged on commodities,” he said. “We are seeing broader-based inflation than just commodities up and down. And so as those come through, we pass them through. And so we’ve passed a good bit through so far this year. We anticipate more cost increases will come through on a broad-based set of inputs. And we will continue locally in each country because it’s very different,” the CEO said.

It is a fine-tuning, where the biggest risk is to make a mistake and end up losing market share. The biggest difficulty today is to decide when and how much to increase prices because there is the risk of passing on too quickly and losing share, said Richard Pelz, a partner at Bain in Germany, in a presentation last week on the industry’s challenges.

In Latin countries, from April to June, there was an increase of 12% in the prices of Coca-Cola’s portfolio and in the value of the mix sold (with the effect of hyperinflation in Argentina), and the volume grew by 9%. From January to March, they had already passed on 19%.

Mr. Quincey said that in Latin countries he decided to “leverage compelling occasion-based marketing campaigns” after the company lost market share at the beginning of the year. After the actions, “the share losses improved.”

In the search for quick effect solutions, the strategy of investing more in marketing has been repeated by other companies, such as P&G, the owner of brands like Ariel and Pantene. Its management team recently told analysts of significant headwinds throughout the year, but also cited the “irresistible superiority” of its products to show “value” to buyers. P&G raised prices worldwide by 8% from April to June and lost 1% in sales volume.

“Exploring the brand is a way to get around mistrust, to create a connection with consumers. But it is hard to know if this will be welcome in such a pragmatic market with more mature private labels,” Mr. Gouvêa says. One question mark now is how to protect brand value and stand out compared with lower-priced brands, Mr. Pelz, with Bain, said.

On this matter, Nestlé’s CEO made a caveat in his conversation with analysts. He said that “private label supply chains are feeling the pinch too when it comes to their cost inflation and also some of them are still experiencing some bounce-back problems from the times of Covid.” In Mr. Schneider’s view, everything “is moving so fast” on things including pricing, habits, followed by the problems of inflation and the supply chain crisis – that is, many variables together at the same time. “Usually a large company’s systems are not really set up for [that].”

“I mean, we were geared up like everyone else in the business for smoother evolving situations,” he said, pointing out that further adjustments are expected to be made in the second half of the year.

Within this need to know the right time to move, Kimberly-Clark, owner of the Neve and Intimus brands, has made course adjustments. The company’s management team told investors days ago it seeks to work the issue in a measured way, but said there were some “price lagging in developing and emerging countries from competitors,” and, with this, the market share “softened a bit.” This was done with the intention of prioritizing the recovery of profit margins.

“We recognize that we’ve advanced pricing maybe further and faster than some of the competition,” said CEO Mike Hsu. “We’re going to have to continue to monitor that situation closely.” In emerging and developing countries, prices rose 12% from April to June (up from 9% overall), while volumes fell 6%.

Danone’s CEO told analysts that in countries like Russia and Brazil there is “huge” volume and price elasticity. In such cases, increases can lead a brand to lose sales easily. “In places like the U.S. or France, you see limited to no elasticity … So, it is, to be honest, a bit of an unknown quantity given the broad spectrum of reaction,” Mr. Saint-Affrique said. Danone says it is preparing “for the worst” by looking at the strength of its brand, portfolio, and consumer sensitivity. That is “to make sure we have a portfolio ready in case things are getting tougher.”

Danone, Nestlé, P&G, Unilever, and Coca-Cola declined to comment. Kimberly-Clark says it does not comment on breakdown data and that the second-quarter results reflect “the efforts of its teams in a challenging and dynamic environment.”

*By Adriana Mattos — São Paulo

Source: Valor International

https://valorinternational.globo.com/