Many retailers today face two major problems: supplier cost increases and overall supply shortages that are driving inflation rates higher than have been seen in at least 40 years. As a result, retailers are experiencing a daunting dilemma: to choose between absorbing cost increases or to pass those costs on to consumers — neither of which is ideal.
Driven by capacity constraints, product shortages are also being rivaled by labor shortages, supply chain issues, international strife, a still-lingering global pandemic, war in Ukraine and other factors. Retailers are at the mercy of suppliers to fill the shelves as they experience a significant risk to the bottom line and potential lost sales. How can retailers tackle these challenges?
It begins at the enterprise level by making the commitment to tackle these cost increases from suppliers and make some significant changes to the way merchants approach supplier negotiations and how they make their assortment decisions. Retailers should also invest in their digital capabilities to better prepare for these supply disruptions in the future.
Business-as-Usual Won’t Work
The first step is to recognize that a business-as-usual approach will not help address these challenges quickly, since suppliers have been increasing costs at rates industry has not seen before and doing so more frequently. What’s really needed is for retailers to set up a ‘war room.’ This is an approach to coordinate an accelerated and organized response that works across the entire supplier base and all categories.
In simple terms, a war room represents a focused effort for the entire organization to bring all stakeholders — merchandising, finance, store operations and marketing, among others — together, raising the visibility of the most critical issues to the executive team so that the company can develop a coordinated response.
Next, retailers need to standardize the intake process. That means requiring suppliers to submit cost increase proposals in a standardized intake form that forces them to provide more details around the cost increases. This intake process helps retailers primarily in two ways: 1. It forces suppliers to justify the cost increases driven by factors like commodity prices, labor rates, freight etc.; and 2. It provides more details around the cost increases that can be compared across suppliers to identify opportunities.
Product Cost Breakdown is the Best Lever for Negotiations
Retailers also should adopt a CPG industry approach, where they understand the cost structure and the cost drivers for every product on the shelf. For example, a baby bottles merchant should understand the cost of plastic, silicone and other materials that go into making the product. Further, they should understand the input costs such as labor, manufacturing, manufacturer overhead, packaging, tariff in cases of imported products and distributor margin if not sourced directly from the manufacturer.
While these inputs may not be readily available for all products, private label products would give an estimate on the majority of the cost drivers. All these input costs could be assembled to put together detailed cost models for the products. If retail leaders combine these cost models with commodity trends, they can quickly identify whether the cost increase is justified. Instead of simply accepting increases, merchants can use these insights in their conversations with suppliers and together identify opportunities that are mutually beneficial.
Adjust the Product Assortment and Supply Base
There are a several short-term tactics merchants can deploy on their assortment and supply base to get some quick wins. One of the major tactics is to rebalance the product portfolio by modifying the private label vs. national brand SKUs to minimize the impact at a category level. As soon as one major wholesale retailer learned about the product shortages from their private label supplier, they immediately increased their purchase orders from a national brand to rebalance, minimizing the impact at category level. Other retailers are reducing the number of SKU variations to simplify the assortment.
Additionally, retailers should re-evaluate their promotion strategy. For example, a major retailer that specialized in baby products historically kept a product on promotion to match with its competition so that it didn’t lose sales from price-sensitive consumers. The retailer, however, never took note that the competition had increased its price while the retailer continued to maintain the promotion. While the sales increased, profits declined, driving down the overall category’s profitability.
Retailers must sharpen their competitive pricing intelligence, including assessing how key competitors are responding and how this could influence retailers’ leeway to pricing adjustments. One retailer established a team to conduct periodic web scraping on competitor product, to glean insights on competitors’ assortment mix and pricing. This information was used in the line review process to tailor the assortment. All these signals should be used in the demand planning stage to improve forecasting accuracy.
Also, it’s always a good time to conduct market costing exercises or launch an RFP. One retailer conducted market costing during the peak of the pandemic. Through the process, the retailer identified a few new domestic suppliers that also offered cost savings. These new suppliers helped fill in the product shortages and helped diversify the supply base, de-risking the supply chain.
It’s also important how retailers approach these new suppliers during current supply-constrained conditions. Retailers should position these conversations with new suppliers as an opportunity for new suppliers to test and build long term partnerships.
Invest in Your Capabilities
Businesses in all industry sectors cannot control major disruptions like a pandemic, natural disasters or war. Retailers, however, can prepare for these supply disruptions and minimize their exposure if they have the right set of tools.
The foundation of this toolkit begins by developing a digital blueprint of the end-to-end supply chain that helps anticipate and respond quickly to major events. This digital blueprint will provide visibility into all aspects of supply chain, including where the product is originated, how it is routed, how much of it is sourced from where, etc. Further, machine learning and AI models can be added on top of this blueprint to monitor environmental, economic and geopolitical factors. These models both help anticipate the failure points and access the risk exposure.
Armed with this information, retailers can conduct various scenario analyses with different allocation strategies across different geographies, products, etc., based on the events or weak points. This analysis will help retailers anticipate and prepare for these disruptions before the damage happens.
Tilak Sagireddy is a Retail Advisor at AlixPartners with deep expertise in supply chain and assortment strategy. He led high-profile retail turnarounds leveraging AI and machine learning tools both in the U.S. and internationally. He also helped retailers with inflation mitigation strategies.