Transformation through simplification
Simple - or simplified - food and beverage businesses can be:
● Easier to operate
● More efficient
● More profitable
But is simplification always possible? And how do you go about simplifying a complex business? In this article, we will provide answers to these questions.
Consider these two food manufacturers. Both operate in similar categories and have roughly the same revenue, but markedly different profitability.
Complex Foods produces $110m of revenue from 256 SKUs and nine production processes. While Simple Sugars produces almost the same revenue from much less SKUs and only two production processes.
Yet, Complex Carbohydrates has an EBIT of $ 1.3 million while Simple Sugars has an EBIT margin of $ 6.3 million. An almost five-fold difference.
If we asked which one you’d prefer to run, the answer would be obvious: Simple Sugars. Fewer products, pack formats and customers would make it easier to operate - and its far more profitable.
But, if this is the case, why are so many companies more like 'Complex Carbohydrates' than 'Simple Sugars'?
Why are more complex businesses usually less profitable?
And how can you transform a 'Complex Carbohydrates' company into a 'Simple Sugars'?
Lets start with the first question first.
Why are so many food companies so complex?
Companies usually start out narrow and focused. They have one great idea, maybe a few product variants and a single production line. They sell this into a handful of customers. And life is easy (well not really, but relatively speaking)
Over time though, they feel the need to keep growing. Why? To achieve greater scale and larger profits. This makes sense. Greater volumes mean greater buying power so lower input costs. Longer production runs mean increased production efficiency. And bigger orders mean full trucks so lower transport costs. Right?
But this only works if you are selling more of the same products through the same sales channels. What we often see is companies struggling to grow their core offering after a period of time. Often because they haven’t invested enough in marketing and brand building, so they are struggling to reach more end consumers (Hello Mark Ritson!)
And when this happens, they try to grow by expanding and diversifying. They develop new products, they create new brands, they enter new categories, they expand geographically and into new sales channels.
And the result of this is increased complexity. More products means more R&D, more production lines to run and maintain, more ingredients and packaging to source. More brands means more marketing campaigns. More customers means more sales reps and more administration. And more geographies means more distribution centres and delivery vans. The business becomes very complex very quickly.
Why does more complexity equal less profitability?
When we think about the above, it is obvious that more of everything means more cost. Which isn’t a problem as long as revenue growth is strong. If the company was generating $10m in revenue per product previously, and each new product continued to generate $10m, then the additional income can fund the additional resources and activities required. And the same with customers – if each new customer is worth the same as the last all is well.
However, this is typically not the case. The next new range or product isn’t as successful as the original. New brands don’t work as well because they aren’t given the time and investment they need. Sales teams chase more and more marginal customers.
So average revenue per SKU/brand/customer all begin declining. And what’s worse, the growth that is achieved can often cannibalise existing volumes. So, you get increased complexity for little revenue growth. And you haven’t achieved any scale benefits because you’re not increasing utilisation of your existing assets, processes or overheads.
You end up with slowly growing revenues, rapidly growing costs and losing profitability.
Case Study: The Profit-Sapping Effect of Complex Business Operations
Take the example of one of our recent clients.
This client started out with a single-site operation. From here, they produced three products in two different pack formats which were sold to a single customer. They maintained this model for over five years. Over time, they added several new variants and handful of new customers. But they kept a laser focus on doing what they did well. The business generated decent revenues. It was efficient and had low overheads. What's more, it was very profitable.
But at about the 5-year mark, growth slowed, and the business began looking for new sources of growth.
Over the next few years, the business added thirty new products and two new pack formats. It added a second production site to increase its geographic reach. And it began selling direct to food service and independent supermarkets, adding 120 new customers in the process.
While revenues almost doubled during this time…
Costs more than doubled.
And profits fell from a healthy ~11% margin to negative 2% and falling.
By the 10-year mark, most of the original management team had left the business, taking the institutional knowledge that made the company successful with them.
This is when a new management team approached us to help them rebuild and refocus the company.
The 80/20 rule in action: our client’s three original products generated – by a wide margin – the highest revenue. The 30 new products that added complexity were significantly lower in revenue
How can you transform a complex, unprofitable food manufacturer into a simpler, more profitable one?
Time and again we have worked on cost transformation programs where simplification was out of scope or not seriously considered by the business. This would have a major impact on the benefits that could be achieved.
Simplification involves taking some big decisions. And it can mean significant change to a business, which carries risk.
Despite this, we believe that simplification is very doable. It needs clear leadership and a meaningful reason to change. With these things in place there is the potential to transform your business.
There are four key steps to delivering transformation through simplification
1. Understand the true profitability of each product, channel, geography, and customer.
2. Design a radically simplified product range. One aligned to the needs of only the most profitable customers and channels.
3. Use a clean sheet approach to redesign end to end operations and reset the cost base in order to realise simplification benefits.
4. Establish a strong PMO or transformation office to deliver the change.
We will cover each of these steps in more detail in future articles.
In the meantime, if you would like to discuss how you can simplify your business, feel free to contact me on:
+61 408 995 207
Or email me at peter.cook@westbournefoods.com.au
Peter Cook
Founder and Director