Margin management can offset sustained inflationary pressures

Published October 2021

While many pundits predicted that recent inflationary pressures would prove transitory, they continue to exist. Since April 2021, producer prices in the United States have been showing at least a 5% year-over-year increase every month, and through September 2021 have increased 8.6% year over year, the largest increase on record since annual changes in PPI were first calculated in 2010¹. For consumer companies, container shortages, supply chain disruptions, recent energy crises, and acute labor shortages (with increasing minimum wages) are exacerbating this trend, potentially contributing to profit loss and margin erosion.

In many instances, these companies’ first line of defense is targeted pricing actions. We discussed the merit of and considerations for such actions in a recent article on pricing strategies during inflation. While we believe that, in many instances, there is a runway of opportunity for effective pricing actions, organizations will also need to pull a number of other levers to effectively manage margin erosion in the medium and long term.

Through decades of experience helping clients grow margins in uncertain times, we have developed a comprehensive approach to margin management, including commercial actions (such as pricing) and internal cost reduction efforts. This approach includes a range of tactical actions, structural changes, and strategic choices (e.g., M&A) to achieve sustainable margin improvement. Consumer companies will need to consider a range of levers to avoid margin erosion in the midst of sustained cost pressures.

A portfolio approach

While the macroeconomic forces challenging profitability may be common (inflation, supply chain disruption, labor shortages), there is not a one-size-fits-all response that fits all organizations. Rather, the suite of responses employed should be tailored to the unique financial and strategic objectives and competitive situation of each company.

When constructing a margin improvement plan in response to external pressure, it is critical to consider how quickly a company needs margin relief and how much relief is needed. For example, pausing planned projects may provide rapid initial improvement to financials, but it will likely be relatively small compared with deploying automation to address rising production costs. Pausing planned projects delays an expense (and any future ROI), while automation permanently reduces the cost structure.

Selecting the right levers

Once company leaders decide to protect against margin erosion, the next steps are to quantify, prioritize, and plan to capture potential opportunities. Determining the right mix of levers calls for clear objectives (timing and quantities) and robust analytics to unpack revenue, spend, and organizational trends. Analyses should look at people, financial, and operational data to develop opportunity hypotheses and preliminary targets. For example, benchmarking across business units could reveal a critical divestment opportunity that may enable the company to improve margins despite inflation.

Next, the company should rapidly quantify opportunities and develop business cases to help compile a list of potential margin improvement initiatives. While doing so, it is important to consider possible implications for the company’s future-state operating model, such as how automation may affect business processes and employee capabilities.

Finally, the company should prioritize and schedule its list of opportunities based on a cost/benefit analysis, as well as other factors such as dependency with other initiatives or time to benefit. At this stage, key stakeholders, including senior executives, should be aligned to the prioritized initiatives and implementation road map.

This foundational work positions a company to move swiftly and confidently to the value capture phase, where they can execute quick wins and develop detailed work and change management plans for longer-term, more complex initiatives.

Example: Prioritizing margin levers for a consumer company
A current client using this framework identified six near-term and two long-term opportunities to improve margins. Near-term levers included reducing back-office spend in professional services and facility services and driving adoption of intelligent automation. The long-term levers will focus on service delivery model redesign by shifting enabling functions to a centralized operating model. In total, these opportunities are projected to improve margins by ~$60M and will free up cash to reinvest in growth initiatives.

Source: Summary of MarginPLUS™ analysis for Deloitte consumer goods client

Act now to prevent margin erosion

Today’s economic climate and inflationary pressures present challenges not seen since 2008 and are sustaining that level of price increase for the first time in 30 years². According to a recent Harvard Business Review analysis of 5,700 global companies, those that eliminated expenses during the Great Recession of 2008 achieved higher total shareholder returns of 27% (median)³. Adjusting pricing strategies is an important first step, but companies should look holistically across a range of levers to guard against margin erosion and secure organizational longevity.

Deloitte’s MarginPLUS™ tools and accelerators can help companies quickly identify the right opportunities to respond to inflationary pressures. These tools analyze complex transactional data using machine learning and natural language processing, identify labor-saving opportunities using human resources information system (HRIS) data, assess service delivery models for efficiency gains, and more. Accelerating analysis time while maintaining high quality is critical for companies looking to stay ahead and holistically manage margins during these inflationary times.

Endnotes

• ¹ US Bureau of Labor Statistics, Producer Price Index (PPI).
• ² Federal Reserve Bank of St. Louis FRED economic data, “Consumer Price Index for All Urban Consumers: All Items in U.S. City Average.” Inflation in 2008 peaked in July, followed by three quarters of price deceleration; the CPI has been accelerating in 2021 since February.
• ³ Jason Heinrich, Simon Henderson, Tom Holland, and Megan Portanova, “6 Strategies to Help Your Company Weather Inflation,” Harvard Business Review, September 28, 2021.