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The heroic FMCG battle against soaring prices

Customers, particularly from the lower income groups who have been affected by the pandemic and the subsequent lockdowns, are increasingly buying smaller packets or cheaper brands of products. (Photo: Reuters)Premium
Customers, particularly from the lower income groups who have been affected by the pandemic and the subsequent lockdowns, are increasingly buying smaller packets or cheaper brands of products. (Photo: Reuters)

  • Rattled by higher input costs, businesses are testing multiple strategies to offset the impact on their margins
  • Companies are also negotiating with suppliers for a better deal. But smaller manufacturers have less leverage. All businesses appear to be focussed on cost savings initiatives

MUMBAI : Blame it on the pandemic. Taslima Kazi, 42, has been struggling to make ends meet. Basic essentials have become expensive even as her income more than halved over the last two years. Earlier, she used to work as a domestic help in six houses. Today, she works in just three. The three other households where she worked emptied out two years ago. The occupants went back to their home towns, taking advantage of work-from-home policies announced by their companies.

For Kazi, who lives with her husband—a construction worker who was rendered jobless by the lockdown—and their three children in the remote Mumbai suburb of Virar, the lower income meant she had to cut on essentials, forget the branded consumer products she was used to buying.

Pradeep Sheth, 55, runs a small kirana store in the Virar neighbourhood where Kazi lives. Sheth, who caters to lower-income group labourers and domestic helps, is one of those affected by the lull in the economy. Sheth says that his customers increasingly opt for smaller packets or cheaper brands of products when it comes to buying cooking oil, detergents, soaps and skincare. Low-cost products mean lesser margins for Sheth. But he has no other option.

Passing on
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Passing on

Kazi and her grocer Sheth are not the only ones impacted by the pandemic. Equally affected are companies whose products they once used to swear by but are now forced to let go off.

Higher input costs have hit the bottom-line of leading fast-moving consumer goods (FMCG) players in one of the world’s biggest markets—India. For instance, prices of palm oil (used in edible oil blending, soaps, cosmetics) has gone up nearly 32% to around 79 per kg in December 2021 versus the year-ago period; prices of high-density polyethylene (used for the packaging of hair oil and hair care products) is up 35% in the same period. Palm oil can make up between 11% and 18% of an FMCG company’s cost of goods sold.

During the second quarter of 2021-22, the increase in raw material prices dragged down operating margins by 50-500 basis points for most companies versus the same quarter two years ago. According to an Edelweiss report, on a two-year basis, gross margins of Dabur declined 200 basis points, while that of Hindustan Unilever’s (HUL) fell 300 basis points, Godrej Consumer’s (GCPL) plunged 677 basis points, and Marico suffered a gross margin contraction of 720 basis points. Colgate was the only company to see its gross margin expand as the inflation in its raw material costs were comparatively less.

So, what exactly have FMCG companies done to mitigate the impact of high input costs on their margins?

Passing on the price

Well, for starters, the FMCG behemoths have passed on the cost to customers through calibrated hikes spread over, well, virtually every month.

Consumers may continue to see the hole in their pocket widening, as prices of FMCG products will continue to rise with no signs of raw material costs softening. The latest hike was in this month, and the trend is likely to continue at least for another quarter. FMCG companies said they may increase product prices by 4% to 10% over the next three months.

Persisting supply-chain and logistics issues across the world, post the pandemic, is one reason for higher raw material costs. In fact, prices of a few items have even clocked a 40-year high. Besides, a nascent revival in the demand for consumer goods have emboldened companies to undertake aggressive price hikes.

An Edelweiss Securities note, dated 8 December, is revealing. Executive director at the firm Abneesh Roy wrote: “Companies have been aggressive about cost pass-through: paint companies with a 18% price hike, Pidilite with an 11% hike, and HUL with a 7% hike and biscuit companies with a planned 10% by Q4FY22 (7.5% by Q3FY22) hike, all of which are much sharper than earlier years". Even staples companies have effected a 7–10% price hike in a few segments, the note added.

“We have taken up prices by around 3-4%, besides undertaking several cost-saving initiatives to mitigate a part of this impact. In certain categories like healthcare and food, we have completely mitigated the impact of inflation by way of price increases. We are watching the situation now and if the inflation continues unabated, we may look at another round of price increases in the fourth quarter of this year," chief executive of Dabur Mohit Malhotra said.

Marico has partially passed on input cost rise to consumers because in certain categories raw material costs have gone up by as high as 50%. The company, however, reckons it is not possible to pass the entire quantum of input costs to consumers. “We have witnessed unprecedented inflationary trends especially in edible and crude oil prices, and have not passed on the entire cost-push to our consumers," Pawan Agrawal, chief financial officer, Marico said.

FMCG players know that passing on higher costs to customers is not a sustainable solution in the long run and are hence renegotiating with suppliers to offset the input costs.

Tightening the belt

Besides price hikes, Marico is “aggressively driving cost efficiencies" through institutionalized cost management programs. The company, in fact, has created a separate vertical focusing on cost optimization. “This has helped in creating a cushion for the organization with respect to inflationary pressures," Agrawal said.

Sunil Kataria, CEO for India and SAARC, GCPL, told Mint that his company has taken several costing measures through Project Pi (Profit Improvement). Under this, the company negotiates with suppliers for a better deal, attempts to offset the inflationary impact through strategic price hikes, besides focussing on cost savings initiatives across operations.

“We have been taking cost-cutting measures through Project Pi which is our regular multi-functional cost optimization project, to enhance efficiencies and generate cost synergies," Kataria said. “Inflation is at a record high and it has been impacting margins. We have taken calibrated price increases across categories and stock keeping units to strike a balance between volume growth and margin management. Naturally, it’s not possible to pass on the full inflation impact to consumers and hence, we have done this judiciously," he added. GCPL’s average price increase across categories is around 9-10%, over the last one year, the executive said.

For the other home-grown FMCG behemoth Dabur, ‘Project Samriddhi’ is the way forward. CEO Mohit Malhotra said that the project was launched with an eye on cost optimization and value enhancement across various levers of the business. “Everything is being seen with a sharp lens to benchmark ourselves with the best-in-class, besides renegotiating various cost elements. This is based on zero-based budgeting (developing a new budget from scratch) and we are exploring all avenues to manage costs in the new-normal scenario to transform Dabur into a more resilient company," he added.

While the process is on full-steam, the lead players were reluctant to share details due to competitive reasons.

According to Rajat Wahi, partner, Deloitte India, all big FMCG companies had the privilege to negotiate with the suppliers, and companies that had long-term contracts have benefited. “However, the pandemic is on for more than two years now and most contracts must have got renewed at least once in between. Overall, inflation is so high that suppliers can provide cushion to big players only to a certain extent. The smaller manufacturers are suffering the most as they get a raw deal from big suppliers," Wahi said.

Market leader HUL said the company is running a cost-efficient business model. “We mitigate cost inflation first by driving our savings agenda harder, looking at all cost lines with a laser-sharp focus, and removing any non-value-adding cost," an HUL spokesperson told Mint in response to an email.

The company has effected “a judicious price increase" over the last one year due to high input costs.

“Considering the inherent strength of our brands and our execution prowess, we continue to take judicious and calibrated pricing actions as needed using the principles of ‘net revenue management’, our science of pricing. We have been able to provide the right price-value equation to the consumer, thus helping protect our business model in a highly inflationary scenario," the spokesperson said.

What to expect

If input costs don’t fall, companies will continue raising prices as they struggle to manage margins. For customers like Kazi, there seems to be no relief in sight, for now. Kazi’s only hope is that her income grows in the months ahead.

Meanwhile, FMCG players have a delicate balancing act to do—keep volumes growing at higher-than-normal retail prices. According to Wahi of Deloitte, price increases have not helped much in offsetting the impact of high input costs. Supply-chain issues and other raw material costs are still on the rise. The existing price hikes will help to offset only 75% of the input cost inflation. The companies are afraid rising retail prices will scare away customers like Kazi who are just about returning to the market.

Arvind Singhal, chairman of Technopak, concurred that margins will be under pressure for FMCG companies in the coming quarter as well. He said it is difficult to increase prices in certain price-sensitive categories where companies are forced to absorb the costs instead of passing them on to consumers.

However, steady demand for staples (essentials) and recovery in sales of discretionary, out-of-home consumption products, coupled with calibrated price hikes aided consumer companies to post low to high double-digit revenue growth in the second quarter. Urban demand outpaced rural demand with some softening in rural consumption seen at the far end of the quarter. But with raw material inflation continuing, earnings estimates of FMCG companies for 2021-22 and 2022-23 have been toned down by analysts. The new variant of coronavirus, Omicron, is a concern, too.

All’s not lost yet. There is a silver lining in declining oil prices, and for the industry in general, supply-side issues are slowly easing out.

In the past few weeks, crude WTI (West Texas Intermediate) has come down from $85 per barrel to $72 per barrel. OPEC (Organization of the Petroleum Exporting Countries) has decided to hike production in January, which again bodes well on the price front. Palm oil price, too, has been stable over the past few weeks and slightly down from its peak. Also, with a recent cut in taxes by both the central and state governments, logistics costs for consumer companies will start easing. When deflation sets in, consumer companies will enjoy a few quarters of higher margins due to their high pricing power.

Singhal of Technopak, however, has a word of caution. “Fuel prices are volatile and unpredictable, it is too early to say things are coming back on track," he said, adding “We will have to wait and watch for a few more months before one can confidently say supply chain and shipping costs issues are resolved, and reduction in commodity prices has kicked in. While things have improved from pre-covid levels, we are still a distance away before everything gets normalised."

Malhotra of Dabur agreed to Singhal’s caveat, “With crude prices softening, there may be some moderation in inflation. That said, it is too early to give any guidance on the same," he said.

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