Manage complexity before it ruins the business
Elsevier Food International Vol.8, No.4, November 2005 Alexander Belderok
Today's consumers are more demanding than ever: they want more choice, convenience and value. They are catered to by all kinds of products, ranging from ingredients to complete meal solutions. Consumer demand for food is, however, limited by the size of the stomach and compared to other goods, spending on food has been falling for years and continues to drop.
Competition in terms of 'share of stomach' is intensifying and manufacturers have to deal with increasingly powerful retailers due to concentration tendencies. This puts even more pressure on producers’ margins, as consolidating retailers seek to leverage their buying clout at the expense of their manufacturers’ counterparts. Furthermore, consolidating retailers use their growing economies of scale to the benefit of their private labels, which mean an additional competitive threat to branded goods suppliers.
Food companies’ innovative zeal leads to a sheer endless flow of packaging variants, promotional specials and new product introductions. At the same time, shortening product life cycles erodes margins and shortens the windows for capitalising on innovations.
Breaking the deadlock
To meet all these challenges, food manufacturers increasingly seek to leverage their clout upstream the value chain. The manufacturers’ suppliers are increasingly sought after for their innovation and process capabilities rather than just their products, components, and ingredients. And guess what, food companies start to customise their products to both demanding retail requirements and consumer preferences, which leads to even further fragmentation and complexity.
Food manufacturers simply do not know how the cost-value ratio is affected by increasing complexity. The more product developers look for innovation or new varieties, the less consumers assess the added value due to an overflow of choice and information. Good complexity leads to real innovation, however, the problem is that bad complexity prevails. Limited or even no perceived added value and more added costs (e.g. development, production, supply chain) jeopardise profitability and ruin the business. A typical flavour house that caters to food manufacturers for instance, has thousands of strawberry variations in its portfolio. Imagine the production and supply chain ‘nightmare’. Food manufacturers under competitive strain that are seeking to leverage their clout upstream are not willing to pay for the increased costs, unless true differentiation assessed by consumers as added value is provided.
Complexity management is needed to break the deadlock. Complexity management is all about balancing the added costs versus the added value, leading to efficiently developing innovative products.
Complexity management is not easy, but companies are willing to take on the challenge. An AT Kearney complexity survey indicated that a staggering 92 per cent of CPG companies identify effective complexity management as crucial for improved performance. However, most companies are struggling. Evaluating the trade-off between the cost and value of complexity is not easy, for a number of reasons:
• Typically, retailer or consumer requirements are not fully understood, and therefore there is little transparency on the value angle of complexity.
• Complexity cuts across functional, business and geographic barriers and is hence intrinsically difficult to manage. A single department can create complexity, but it requires a cross-functional approach to eliminate it. The interaction between sales, product development and operations defines the 'handle' a company has on complexity.
• Because of its cross-functional nature, managing complexity requires senior level business leadership, which is often focused on other matters. Moreover, complexity is not a ‘sexy’ topic.
• The information necessary to evaluate trade-offs is often insufficient and rarely connected across the different functions. For example, the understanding where an added flavour component adds costs and where it adds value is limited.
• Learning to effectively manage complexity trade-offs can be a slow process. Most companies are under pressure to deliver tangible quick wins, which is why traditional complexity management efforts often focus on reducing the cost of complexity (e.g. through SKU rationalisation) rather than its strategic value.
Complexity across the value chain
For food companies, complexity of components (e.g. packaging items) and ingredients is as – if not more so – important as complexity of the whole product as such. There are, however, examples of food manufacturers who successfully address complexity across the full value chain together with their suppliers. A soup manufacturer rationalised the number of dehydrated vegetables in its dry soups by over 30 per cent by cooperating with selected suppliers. The taste impact in the final product was evaluated, harmonisation opportunities where identified and the result tested in the final product. In some cases, migration to higher value ingredients was possible due to volume discounts in the procurement process.
Generally, complexity means fragmented buying by food manufacturers, which gives their suppliers an opportunity to uphold complex pricing structures and, consequently, maintain margins at healthy levels. Although it might help to maintain margins, it prevents suppliers from leveraging their strengths to fully deliver ingredients and/or components to their clients and thus create a competitive advantage.
Suppliers can help rationalise complexity on the ingredient/component supply in return for larger volumes. It is vital that they discuss with their clients – food manufacturers – relevant marketing aspects like the positioning of the product, the expected product life cycle and the assessment of consumer perception of the product. Tailoring the choice of components and ingredients to this, leads to a reduction of complexity levels.
A good example is a 'modular' approach for the suppliers’ flavour portfolio. By bundling flavour ingredients in so-called 'building blocks', cost can be reduced up to 30 per cent, as such a modular system has 50 to 60 per cent fewer items to purchase from the suppliers, whilst maintaining or even improving the differentiation in the consumer market.
On the value side, this modular approach provides a better handle on consumer preference (as it is easier to ‘target’ consumer groups) and it dramatically increases the speed of new product development. The product developers themselves are able to 'play around' with the building blocks and do not have to wait for answers to the briefs they sent to their ingredients suppliers, the flavour houses.
Conclusion
It is clear that complexity is best managed in a broader context; taking both the value and the cost side into account. Complexity management consists of five elements (see Figure 2). Element 1 consists of gaining critical insights into the relative value of complexity by investigating the elasticity of the different complexity drivers.
By matching these complexity value insights with a cost transparency model (Element 2), a company knows which trade-offs to make. It shows not only where profits are made but also where there is room to change the price and improve the value perception (Element 4).
This has to be supported by tools for effective managing trade-offs, where complexity-hating parts of the organisation are connected to complexity-loving parts. For instance, a snacks manufacturer can separate its scalable activities (e.g. peeling, cutting, precooking of potatoes) which hate complexity, from its differentiating activities (e.g. specific seasoning to comply with local taste preferences) which love complexity.
All this has to be anchored within the organisation through the proper governance structures to ensure it is managed on an ongoing base (Elements 3 and 5). Moreover, the culture and incentive systems need to be addressed. Managers need to be willing to adapt to an incentive system that rewards fostering transparency, identifying shared goals and managing complexity across departments and corporations.
Alexander Belderok is principal at AT Kearney in Amsterdam.
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