Inflation is on everyone’s mind. Recent surveys show that it’s one of the top concerns among not just CEOs but also consumers at all income levels. In this episode of the McKinsey on Consumer and Retail podcast, three Europe-based McKinsey partners discuss the varied ways in which inflation is affecting consumer sentiment and behavior, and the crucial implications for consumer companies. The following is an edited transcript of their conversation with host Monica Toriello.
How Europe’s CPG leaders can navigate inflation
Monica Toriello: Ask 100 CEOs what their top concern is in mid-2022 and many of them will probably say inflation. In many countries, inflation is at a record high, and many experts are predicting that it will persist. Rising prices could be part of the economic landscape for the rest of the year and even into 2023.
Companies are responding in a variety of ways. Here with us today are three McKinsey partners who have been working closely with consumer-packaged-goods [CPG] companies on their inflation response. We’ll hear from our three guests about how companies can not only keep their businesses going amid inflationary pressure but emerge even stronger from this challenging period.
Kevin Bright is the global leader of McKinsey’s work on consumer pricing. He is a partner based in London, and for 25 years he’s been working with CPG companies around the world to capture the full potential of revenue growth management [RGM]. Pieter Reynders is a partner based in the Brussels office. He is one of the leaders of our work on RGM in Europe and has coauthored several articles on RGM, including a recent one titled “Revenue growth management: The time is now,” which he wrote along with the two other guests we have on today’s episode. Roman Steiner, a partner based in Zurich, is another coleader of McKinsey’s work in RGM and our inflation response in Europe in both CPG and retail. Thanks to all three of you for your time today.
‘We’re seeing recessionary behavior’
Let’s start by talking about what you’re seeing and hearing among consumer company CEOs, who are grappling with very high inflation in many European countries. The European Central Bank raised interest rates for the first time in 11 years, energy prices are soaring, supply chains are being disrupted. What’s the outlook for the industry and what’s the temperature among the CEOs that you’re talking to?
Roman Steiner: There’s a mix of structural, cyclical, and supply chain issues contributing to inflation, and we believe it’s going to persist. There are five main factors contributing to inflation today: labor costs and the availability of talent, as well as rising prices in agriculture, hard commodities, freight, and energy. All of these factors together add up to a perfect storm for companies to navigate through.
Given all these factors, we don’t expect inflation to resolve in the near term, so we do believe this topic will be top of mind for CEOs for years to come. In addition to the high inflation pressure, we also now see GDP predictions across the eurozone plateauing.
Pieter Reynders: I see the conversation shifting from “inflation was a temporary blip” to “inflation is now clearly persisting.” It’s becoming a longer-term conversation around recession. If you talk to CEOs now, recession—and its implications on consumer spending power and consumer sentiment—are top of mind.
Obviously, inflation is not just on CEOs’ minds but also on consumers’ minds. We run consumer sentiment surveys in five European countries, and we see that inflation has become the number-one concern for consumers: no less than 53 percent of consumers across Europe cite it as their top economic concern. And it’s consistent across income levels: low income, middle income, high income—all of them say inflation is their top concern. So it’s not something that is only on the minds of consumers with lower discretionary spending.
Nearly two-thirds of all consumers feel negatively about the future of their economy. This then translates into consumer behavior: 74 percent of consumers in Europe have tried new shopping behaviors, 40 percent have tried private-label brands, 33 percent have switched brands, and 27 percent have switched the store or retailer that they shop at, significantly moving toward discounters.
So we’re seeing recessionary behaviors and quite a lot of pessimism on the consumer side. Inflation will continue to be top of mind for consumers, and it’s important for CPG companies to reflect that in their responses—for example, by ensuring that there are affordable options for consumers who are being stretched on their discretionary spending.
Precision in pricing and promotions
Monica Toriello: Ensuring affordable options for consumers is one response. What else are CPG companies doing, and what should they be doing at this time? And what are some mistakes or pitfalls for CPG companies to avoid?
Pieter Reynders: We would broadly categorize the actions under three components. The first is what we call revenue growth management: actions around pricing, assortment, promotions, and trade investment. That’s typically the component that provides most of the impact. The second is procurement: thinking about design to value, how to strip out product features that add less value for consumers. The third is everything around supply chain and manufacturing: finding better routes for trucks, reducing gasoline consumption, and so on.
Now, the impact of these actions is slowing over time, because a lot of the initial focus was on those elements. Companies now have to look for much more granular actions: “How can I think about promotions in light of consumers having less purchasing power? How can I simplify my assortment so that I can decrease COGS [cost of goods sold]?” It’s these nuanced elements that are now becoming more relevant.
Kevin Bright: We’ve seen a real evolution in both the urgency and the sophistication of CPG companies’ response. In the first wave, they were pretty quick to pull the pricing lever. Depending on which country and market you’re talking about, they pulled it again, and in some cases even three times. We’ve reached a point now where, as Pieter mentioned, not only are they risking long-term damage to demand—and the focus has shifted to preserving demand—but they’re also risking long-term damage to their brand equity and positioning.
The reality is that competitors within specific categories are being hit by inflationary and recessionary forces differently, and they’re not all responding the same way. It’s not as simple as, “Everybody can make pricing changes and the water level goes up.” We’re seeing that, more and more, consumers are substituting one category for another, exiting a category, or shifting to a different brand. There’s massive downshifting, particularly from mainstream brands to value brands.
What that means is, pricing was probably fine in the short run, but it’s not a long-term or sustainable way to fix this going forward, especially if elevated inflation persists, and most of us believe it will. It’s about getting into more nuanced approaches, as Pieter described. It’s not as simple as cutting back promotions; it’s about doing it thoughtfully and asking, “Where do we have consumption-expandable categories that I want to promote because I can continue to drive volume and preserve demand?” Then, in non-consumption-expandable categories, that’s where you want to be pulling back on promotions, because you’re not adding to the top line—you’re just pulling from the bottom line.
Consumers are substituting one category for another, exiting a category, or shifting to a different brand. There’s massive downshifting, particularly from mainstream brands to value brands.
Similarly, we’ve seen folks trying things like multibuy promotions. The reality is that consumers have less disposable income, so it’s hard for them to get excited about buying three weeks’ supply of a specific product just because there’s a multibuy promotion available on it. It’s about shifting these promotions into smaller sizes, single units, and, in some cases, deeper discounts. Companies must become more precise and thoughtful because the broad, sweeping actions that served them reasonably well over the first one or two or three waves are not ones that they can rely on going forward.
Roman Steiner: The other concrete example that is especially prevalent in Europe is companies taking inflation as an opportunity to walk away from unhealthy promo behaviors in the markets—usually very large discounts and very large multipacks. Those promotions served a purpose in recent years as CPG companies tried to increase sales volumes, but those types of promotions have often not been the most profitable, either for them or for their retail partners.
CPG companies should take consumers’ focus on affordability as an opportunity to roll back these unhealthy and very steep discounts and very big multipack offerings. It’s an opportunity to reset consumers’ promo expectations and behavior, which will put companies on a healthier path for the long term.
Resetting RGM strategy
Kevin Bright: Another thing that’s important to understand in this environment is that many of the classic econometrically driven insights that companies use to inform their RGM strategies are somewhat in flux. The particularly agile and forward-thinking CPG companies recognize that consumers’ historical (or recently historical) purchasing behavior may not be indicative of future purchasing behavior. I’ve seen CPG companies do two big things to compensate for this. One is replacing many of the econometric models with primary research, particularly conjoint research, to understand both current and future elasticity. The second thing I’ve seen companies do, when it comes to promotions, is utilize a rapid test-learn-iterate approach where they try a lot of new things in the market, rather than trying to learn from past performance. This provides an opportunity for CPG companies to partner with retailers and develop test-and-learn programs together so that they are able to do things in-store that, frankly, retailers probably wouldn’t have let manufacturers do two years ago. This opens a new door to a broader and longer-term reset of RGM strategy—an opportunity that I don’t think we’ve seen since probably early 2000.
Roman Steiner: Kevin is raising a very important point, which is the opportunity that lies within these unprecedented times. Right now, there is the opportunity to reset RGM strategies for the long term. If you look at past crises, we have seen that resilient companies, especially in the CPG industry, have done much better postcrisis than nonresilient companies.
We’ve seen that resilient companies were very focused on preserving demand during the most recent recession, but they recovered on the profitability side after they exited. Their shareholder performance, too, was considerably better than nonresilient CPG companies during the periods of recession and recovery.
We have seen that resilient companies in the CPG industry have done much better postcrisis than nonresilient companies.
Pieter Reynders: The success of the inflation response will ultimately depend on two components. One is the depth of the response: How much pricing are you taking? How much cost are you taking out? How much are you able to reduce promotions? The second component is speed. You cannot underestimate the shift that has occurred: in the past, CPG companies made pricing decisions once a year—essentially, when they had retail negotiations. Now they have to make decisions every three months.
Finding the right balance between speed and accuracy is important, and what we’ve seen successful players do is set up agile response teams that are cross-functional and empowered to make decisions based on what they’re seeing in the marketplace at that moment so that they can move fast. There’s a premium to speed and agility in this moment.
In the past, CPG companies made pricing decisions once a year—essentially, when they had retail negotiations. Now they have to make decisions every three months.
Monica Toriello: I want to dig a little deeper into a couple of points that you’ve made. Kevin and Roman, you both talked about the opportunity for an RGM reset, more collaboration between CPG companies and retailers, and a greater willingness on retailers’ part to try new things. What are some examples of that?
Kevin Bright: Say you get ten units for £10 or €10. CPG companies are going back to retailers and saying, “I can’t do ten for €10 anymore, so how about nine for €9.99?” Previously, there wouldn’t have been openness to that, as there are a lot of retailers who like to see multibuys as the primary promotional construct. But they’re realizing now that people don’t need three weeks’ worth of orange juice in their house. They need one week’s worth of orange juice, they want to get it at a good deal, and they need to get it now. So we move away from the multibuy and move into promotions that are much more focused on the need between shopping trips, as opposed to trying to load the pantry over a longer period.
We’re seeing that retailers are willing to let CPG companies experiment with that, especially when it fits with the retailer’s overall message to consumers of, “We’re on the side of our shopper, we’re here to protect you, we are fighting these manufacturer price increases every step of the way.” If CPG companies can feed into that messaging and find ways to align with retailers, it can be quite powerful—and there’s a lot more degrees of freedom right now.
Monica Toriello: That’s interesting. Pieter, one of the things you mentioned is agile response teams, which I believe are sometimes called nerve centers or inflation win rooms. What does that look like for CPG companies? Are they doing this well? What are some opportunities that you see for CPG companies to get the most out of agile response teams?
Pieter Reynders: There are a few things needed for a response team to work well. The first is cross-functionality. The team shouldn’t just be people from sales or marketing; it should include supply chain, finance, etcetera, so that you can get to holistic solutions. It will allow you to understand, for example, that increasing prices on a certain SKU will cause a drop in volume and will have implications on COGS.
The second is creating the team at the right level. If there’s a team at the regional level, that can help, but the translation of ideas into local initiatives is really important—so make sure the team is as close as possible to the action.
The third is that the team is empowered to make decisions. If a team has to get lots of approvals before they can make moves, that’s where things can fall down.
Speed, scenarios, and strategic bets
Monica Toriello: Any final words of advice for CEOs as they navigate inflation and, potentially, recession?
Kevin Bright: We’re at a point where nuanced, portfolio-oriented, multilever, paradigm-shifting creativity is required. We need to be thinking about this as a new normal. While we may all hope that inflation is going to persist for only another few months or a year, we have to prepare for it to persist for five, six, or seven years. Companies should be thinking through a longer-term solution around resilience, agility, and strategy.
The second thing that organizations need to think about in this context is, “Do I have the right resources, the right data, and the right technology to be able to do this at pace and with rapid iteration?” Many organizations are set up for a slow and steady trajectory rather than the rapid iteration that’s required right now.
Roman Steiner: Think more in scenarios versus forecasts. If there’s one thing the last three or four years have taught us, it’s that there’s so much change out there—the pandemic, supply chain issues, and now inflation—that the typical forecasting-based techniques we have used in the past will not be sufficient as we look forward.
Companies should strongly anchor in scenarios on bigger developments—macroeconomics, supply chain disruptions, availability of products—in order to come up with better answers. This doesn’t mean you have to give up precision in your analysis, but you have to change the way you look at your business and the way you project into the future. You need to consider more scenarios—and probably more extreme scenarios—than you would have had to in the past.
Pieter Reynders: I would just stress this through-cycle view of, “How do I get out of this stronger?” balanced with, “How do I fix my margins and top line in the short term?” I think companies that make strategic bets in the places where they want to gain market share—where they feel they already have a competitive edge and are therefore investing consciously—are going to be the long-term winners coming out of this. The more strategic you can be about where you want to invest (versus where you’re looking to recover margin losses), the better off you’ll be.