How to Reduce Your Cost Of Goods Sold When Prices are Going Up
Think you have no choice but to raise your prices on your most important customers? Good news: there’s a lot more you can do to flip your P&L in your favor and build your relationships with your customers – no price increases necessary.
If you haven’t read the first installment in this P&L Survival Guide, go back and start there. We covered the first step in flipping your P&L without raising prices. It was all about creating new revenue.
If you’ve done everything you can to increase revenue and you’re still struggling, let me first offer a lot of compassion. It’s a scary situation in an even scarier global environment, and it might feel overwhelming at best, and perhaps downright impossible, to turn things around.
It‘s not over for you. In part II, we’ll discuss six steps to reduce your Cost of Goods Sold and help get your P&L in shape so the revenue you do have goes further.
By definition, COGS are comprised of raw materials, direct labor and inbound freight. Historically, the primary tactic for reducing Cost of Goods Sold was through negotiating and pitting suppliers against one another. It was all about finding the best price. From existing domestic suppliers to overseas options, the adage was “if you can’t reduce your price, we’ll have to put it out to bid.” Sound familiar?
This worked for many years – decades even – but the world has rapidly changed over the past few years. Constriction, bottlenecks and increases across the board have required businesses to adapt their processes and attitudes towards partnerships instead of leverage.
In the current economy, suppliers are no longer willing to reduce prices or participate in sourcing bids. In fact, they are passing along increases at an accelerated rate and threatening to cut off supply to existing customers that won’t accept the new terms and prices. If you are still relying on leverage, bidding and threat-based negotiation tactics, you likely won’t get the materials or products you need. Getting better pricing for the same product is no longer the primary way to reduce COGS.
Businesses have also often looked for ways to reduce their COGS in direct labor costs through natural turnover, training efficiencies and productivity incentives. However, from manufacturing and restaurants to retail and entertainment, businesses that rely heavily on a direct labor force are experiencing real challenges with labor. Many are at risk due to not having enough people willing to perform the work at the wages afforded by the COGS. This has led to a significant increase in direct labor as a percent of COGS over the past few years, leaving little if any, ability for businesses to reduce their COGS by tightening direct labor costs.
So, if we can’t leverage suppliers for the best prices nor through lowering direct labor costs, we have no option but to raise prices. Right?
Hold up. You might want to take another look before you press that button.
There’s still a lot you can control when it comes Cost of Goods Sold. Here are six ways that will help reduce COGS while building relationships with your customers, suppliers and team when reducing price is no longer a viable option.
Collaborate with Suppliers.
Think you’re too small to make an impact? What about partnering with your strongest suppliers and using their network and buying efficiencies? You may be surprised at how much economy of scale and influence your larger suppliers could have.
For example – Inbound Freight: If you don’t have the size and buying power to purchase freight efficiently, lean on your relationships and align with those who can. What if your biggest suppliers could source the freight and bill you for it? They may have deeper and more strategic relationships with transportation companies or have their own dedicated fleet. If so, this will likely reduce your net landed costs. Not feasible? Then perhaps try negotiating with your suppliers to move to prepaid or delivered pricing instead of FOB collect, while keeping their price to you the same. There are endless levers to pull that can create savings and help avoid increases in your COGS – and a lot of these levers will develop stronger partnerships while conserving costs, which is a win-win.
Continuing further, look into changing order cycles and purchase order lead times to gain efficiencies of scale with your suppliers. Changing from one-off purchase orders to an annual or blanket order where your suppliers stock the materials, but only charge when you pull from the stock can reduce the cost per piece, due to the larger order volume, while reducing lead times.
There are many ways to think creatively and invent options to reduce your COGS without sacrificing the quality of your products or services if you are willing to invest the time and energy to develop them.
Get Hyper Local.
The last few decades saw a massive exodus of production and manufacturing to overseas locations in an attempt to reduce costs. This backfired in a big way with supply chain bottlenecks that devastated companies and the supply chain overall. Empty shelves of bathroom tissue, cleaning supplies and anything requiring microchips are just a few examples.
As a result, consider the very real value of doing business locally – and I mean hyper-locally. Work with your area Chamber of Commerce to locate or develop new suppliers of quality materials and goods that are much closer to your operations. You’ll be supporting your community while reducing freight and helping ensure you have raw materials. The closer you can assemble your supply chain to your operation, the less risk of disruption you will have. In fact, some companies have gone so far as to start new divisions and businesses solely to vertically supply themselves inside their existing locations. Now that is hyper-local.
Do you really need aqueous packaging with four (or six!) colors on a dazzling package if it’s just going to show up to a retail distribution center on a pallet and then (hopefully) get recycled?
Probably not. Packaging is a major driver of COGS. The standard 32 ECT corrugated box with black print is likely all you need for inner and master packs. Look at creative ways to reduce the costs in the box itself, such as changing the configuration so that the inner flaps of the box are smaller. It’s easy to fall into a habit of doing what you’ve always done even when the product was created when margins were healthy during a stronger economy.
Consumer-facing packaging matters, of course, and you may have to take a different tactic if your product is for D2C or shelf-ready retail. Even with these forms of packaging, there are alternatives and ways to innovate that can reduce costs. As packaging trends toward sustainability – which is increasingly monitored by large retailers – simpler options have become a key initiative. They are often more cost effective and can be a factor in purchasing decisions.
Move from Private Label to National Brand.
Go to any large retailer, whether it be brick and mortar or online and you will find nearly all categories have that particular retailer’s private brands available. Making private brands for retailers is often more expensive than the national brand counterparts, due to requirements in product testing, packaging and sustainability processes. Private brands also reduce economies of scale in raw materials and inventory. As raw material costs increase, they will likely increase exponentially for the private brand and OEM products. Instead of passing these increases on to the customer, see if they would accept your national brand as an alternative. The savings gained from using your brand could allow you to forego presenting them with a cost increase, while also improving your brand exposure.
Reduce Pack Sizes.
Consumer psychology is fascinating. People routinely balk at paying more for their favorite products, but they’re far less likely to complain about receiving fewer items per package at the same price. That’s why shifting package sizes is such a time-honored strategy for cost reduction. And it’s not just the number of items in a pack; it’s can also be the amount per item. Take the candy bar: many of the top candy bar brands have shrunk in size significantly since their debut, but people continue to buy them, lots of them.
Smaller per-item quantities and fewer items per package also mean more frequent purchases, which maintains margins and accelerates inventory turn rates.
Much like packaging, we get accustomed to the product formulas we’ve used over time. Are there components or ingredients that could be removed or replaced with alternatives that have more available supply? Formulation applies to all kinds of products, from pet food, inks used in printing, textiles in clothing to the ingredients in soft drinks. Could you tweak your formula to make it more cost-effective without compromising the integrity of your brand? That last point is critical, because not every market or product can tolerate a shift (New Coke, anyone?), but the exercise of analyzing your formulations to look for changes that could work is important.
Of course, consumer perception is everything. You know your market, product, and customer best. Not all of these will apply or work for your business, products or customers, but don’t continue with business as usual simply out of inertia. There are always new ideas and avenues to explore to create solutions.
Explore what can be done to reduce your Cost of Goods Sold, without compromising quality, especially when prices are no longer right.
That’s a lot to consider. And we’re not done yet. We’ve already discussed how to optimize revenue and, now, how to reduce Cost of Goods Sold. Next up, we’ll dive deeper into your labor force and other expenses, and look for even more places where you can get more efficient.
Hang in there. You are almost there.