Retailers, consumer packaged goods manufacturers, and their suppliers are arguably having the toughest year in decades as they struggle to understand changing consumer behavior amid difficult macroeconomic context and rising inflation.

This struggle in the first half of 2022 has challenged profitability, ballooned undesired inventories, eroded pricing power, and left companies guessing what the right product mix. Longing for a lower inventory-to-sales ratio and higher profit margins, growth is illusive. In the retail sector, evidence of this challenge is highly visible.

The solution to this situation is twofold: First, sensing the optimal mix while leveraging processes like collaborative planning, forecasting and replenishment. And second, shaping demand by leveraging new technologies and algorithms with optimal pricing.

The Art & Science of Optimal Product Mix

Getting product mix right is both an art and a (data) science. The art element is an understanding of the drivers of consumer behavior. The science is the diverse data from online and offline sources including but not limited to discretionary and non-discretionary purchases, footfalls and clicks, reviews and ratings, and macro- and micro-economic indicators. This combination of art and science allows us to understand responses to demand variation and gives us the knowledge to develop a financially viable and consumer demand driven product mix.

Understand Demand Drivers

With so many macro- and micro-trends compounding on consumer behavior, getting educated on consumer behavior is extremely important. While it’s an art to understand the consumer, that understanding can become more illuminated with data. This art currently lies in the consumer insights function of the organization which is often invisible to the operations function.

Organizations can gain visibility into this end consumer behavior with a digitally enabled omnichannel ordering and fulfilment ecosystem. There are a multitude of variable factors that go into influencing the product mix that consumers desire and it is up to us to determine the demand drivers across channels, product attributes and consumer demographics. It is essential for the insights team to understand the variability of these strongly correlated influencing attributes to arrive at an optimal product mix that responds to consumer needs in the current economic climate.

Making Sure “The Price Is Right”

Pricing is a powerful tool for organizations to execute on their strengths in normal times and is critical during times of inflation. Optimal pricing requires a comprehensive understanding of the marketing/merchandising and business operations, clarity in contract management, and an understanding of the competitive landscape to setup and execute negotiation strategies.

1) Understand Cost-to-Serve

Senior Management must initiate and implement a coordinated organization-wide effort to understand the cost-to-serve and related attribute correlations for their business. Depending on organizational structure, different costing methods, and different levels of knowledge, it can be difficult for different functions to measure costs and align on optimal pricing. Bear in mind this alignment requires collaboration between Finance, Marketing/Sales, Manufacturing, Procurement, Distribution, and Logistics teams. A cross-functional team of cost-experts operating within S&OP or IBP  must educate each other internally on different costs and evaluate pricing models for different offerings.

2) Offer New Products at Different Price Points

Organizations must look for opportunities to create offerings at different price points with the agility to configure products according to demand. This ability to offer different price points requires physical agility in the supply chain network as well. This may require using different modes of global and regional transportation, different warehousing solutions (centralized or distributed), different manufacturing solutions (in-house, outsourcing, multi-sourcing). Having multiple options at different nodes in the supply chain network makes more products available to customers at different price points.

3) Develop Customer Value Profiles

Organizations must create customer value profiles and capture pricing and service sensitivity of customers when deciding on pricing changes. Depending on their financial situation and purchasing power, customers and consumers will absorb varying degrees of price variations and service quality. It is vital to classify customers and consumers according to the prices and service quality (as measured by KPIS) that they will tolerate.

4) Develop Negotiation Strategies

Organizations must adopt top-down negotiation strategies for customers and suppliers. Pricing, being a strategic lever, needs clear rules of negotiation approved by leadership. Organizations can benefit from developing a RACI (Responsible, Accountable, Consulted, Informed) matrix that defines roles and ways of working that support decision making for new pricing models and responses to changes in the market.

In Summary

Competing in this emerging century of disruption, uncertainty, and volatility is not for the timid. As companies continue their evolution from linear “chain” thinking to ecosystem supply “network” thinking, they will have to assess, adapt, and mature their business models and organizational structures.

This adaptation is critical to maintain a competitive product mix and pricing response to ever increasing global change. Implementing an Integrated Business Planning process, enabling the organization with advanced analytics and technologies, and leveraging collaboration across the ecosystem will drive actionable outcomes for  growth.

After many years of absence, cost and price inflation is returning as a risk factor for business performance. This has major implications for Demand Planners and supply chain professionals.

Central banks are re-assessing their monetary policies and programs to be ready to mitigate inflationary pressures in the economy. Financial markets are girding their loins for uncertainty in the bond and equity markets. Businesses are experiencing strong upward price pressures on energy, transportation, labor, supply, and materials costs.

Profit margins and ROI’s are at risk as businesses begin their financial mitigation efforts in this new and uncertain environment of post-Covid operations.

US inflation is  2-3 times the average annual rate experienced over the past 15 years

Currently, overall inflation in the U.S. is about 2-3 times the average annual inflation rate experienced over the past 15 years. Inflation for some key commodity categories like oil is much higher than that.

Supply chain management is experiencing rising costs due to commodity and factor prices along with delays and disruptions in shipping and transportation that are extending lead times and increasing inventory during this post-Covid adjustment period. Service and product pricing will need to be adjusted to reflect this to protect product margins and ROI.

Product costs are also rising due to materials and labor expenses, and other expenses which are essential to production. These too will contribute to adjustments in pricing to preserve margins. Higher inventories will result in higher interest, handling and warehousing costs, and other costs associated with holding stock. This will partially consume the free cash flow that would have been available in the pre-Covid world. And of course, there are also higher costs associated with Covid protocols essential to protecting employees, clients, and customers.

How Inflation Impacts Consumer Demand

Everyone working in supply chain has these same issues to deal with. There are inflationary pressures being experienced across and up-and-down the supply chain network. How is all this cost and pricing pressure going to affect the demand for products?

Enter the world in which Demand Planners are trying to understand the demand for products and services as household incomes change and as consumer behavior changes. Changing prices will affect demand patterns. The accuracy of demand forecasts directly affects the accuracy and mitigation activities of Supply Planners.

Inflation alters consumer behavior in ways that tend to increase demand volatility

Inflation also alters prices and consumer behavior in ways that tend to increase demand volatility and decrease demand forecast accuracy. So, the inflationary threats at hand are of critical concern to those who are doing the demand forecasting and demand planning as well as those who are using them in the supply planning and supply chain management.

Inflation Requires More Advanced Analytics

In times of low inflation and steady financial market conditions, it is easier for demand forecasters to accurately forecast demand with the many time series models available, which yields acceptable results with relatively simple methodologies. In current times, it is important to better understand consumer behavior and its reaction to changing household financial circumstances and economic conditions. This necessitates more complex analytics and more complex forecasting models such as regression.

Inflation necessitates more complex forecasting models such as regression

Now is the time for Demand Planners to focus more time and attention on gathering data and market intelligence from prior periods to better evaluate the factors that are currently driving demand. This can then be used with regression analysis and regression models to better explain the behavior of customers and consumers as their circumstances change. It provides an opportunity to simulate future outcomes and future scenarios of behavior instead of assuming relative stability of conditions as time series methods do.

This aids in gaining greater insight into likely product demand when prices and consumer income (in real terms) are changing. This can increase the reliability of projections used in supply management in periods of inflation.

Pricing Strategies Are Important In Inflationary Times

Since relative price is a key factor in purchase behavior, it will be important for Demand Planners to undertake analytics that test the price elasticity of demand and the associated pricing strategies to get the best financial results for the company.

It will be important for Demand Planners to undertake analytics that test the price elasticity of demand

Price strategies and market responsiveness to competitor actions are essential when competitors and inflation are simultaneously affecting the relative price of the company’s products. Marketing plans must be carefully considered when there are both company-controlled and market-controlled variables affecting demand.

Now is the time to increase collaboration across functions, increase use of qualitative methods to understand consumer behavior, and specifically focus attention on the multiple dimensions of inflationary effects that may influence product demand.

In Summary

Inflation is a condition which has been tempered for many years and is now a complicating consideration again. There is the question of whether it is a transitory condition due to the post-Covid transition, or if it may have a more long-term nature like it used to have in years gone by. Either way, its a reality that cannot be ignored by Demand Planners or supply chain professionals. Quality demand forecasts adapted to changing consumer behavior and thoughtful supply chain management will be essential to realizing the financial goals of your company and serving the needs of its customers.