The measures are being taken due to increasing input costs and retailer power, which will continue to put pressure on operating margins, the firm says. "Forward-thinking companies in the industry are taking a close, hard look at their value chain, examining it from both input and output perspectives," said PricewaterhouseCooper. The report by the firm provides an insight into some of the best practices industries are taking to counter rising costs and other factors affecting their operations. It indicates that plant managers will come under more pressure from top management to cut more fat from their operations and to take additional measures to become more efficient. The annual report covers manufacturers in the personal care, food, beverage and household products sectors, collectively known as the consumer packaged goods (CPG) industry. Globalization, the need for continual product management, the growth of private-label products, shifting consumption patterns, health, environmental and labour standards, and increasing supply chain complexity are some of the other issues companies face in the new economy, the firm says. PricewaterhouseCoopers says CPG companies are effectively addressing some of the industry issues through targeted collaboration and openness to new ways of operating. They are also forging new relationships with logistics providers and suppliers to achieve new efficiencies, and making other long-term operational changes such as gradually reducing their exposure to volatile commodities and streamlining portfolios to focus on core products. "The new economy requires CPG companies to think out of the box," the report stated. "Industry dynamics are ensuring that convergence is here to stay and CPG companies are becoming more open to new ways of leveraging targeted collaboration to create value in this environment. They are redefining relationships with their customers as well as consumers. Improving margins also is not easy at a time when commodity prices are soaring and powerful retailers are driving hard bargains." The report noted that despite the difficulties, the CPG industry as a whole has maintained its median three-year and five-year total shareholder returns (TSR) above 8 per cent. However median one-year TSR was 4 perc ent. Overall CPG industry median sales growth remains above 5 perc ent, earnings before interest and taxes (EBIT) growth continues, and overall productivity is on the rise, said PricewaterhouseCoopers. The growth was achieved in the face of increasing retailer power. Historically, some retailers have made requests that increase suppliers’ costs in areas such as inventory management, customization, and promotional expenses. "CPG companies heavy reliance on a smaller number of key customers is diminishing their ability to raise prices and is squeezing margins," PricewaterhouseCoopers stated. "The CPG industry must develop a robust, sustainable response to this challenge through new supply chain efficiencies and other new collaborative business practices." Another challenge is rising input costs. Many of the major cost categories for CPG companies — such as energy, agricultural commodities, packaging, and transportation — are highly exposed to price increases, the company noted. Oil prices are a top concern for CPG companies since they incur high energy costs at all stages of their business, including in raw material sourcing, manufacturing, packaging, distribution, and retailing, the analyst stated. In 2006, oil rose to the highest level since trading began in 1983. Oil prices have doubled since 2003. Energy consumption in transportation is projected to outpace that in other sectors, which negatively impacts the CPG industry because of its need to move products by ship, rail, and trucks, the analyst stated. In PricewaterhouseCoopers’ consumer products barometer survey for the second quarter of 2006, 73 percent of respondents cited energy prices as a potential roadblock to growth over the next 12 months, compared to an all-industries consensus of 54 per cent. Oil is not the only commodity whose increased demand and diminished supply has pushed input prices to historical highs. For example, sugar prices reached a 25-year high in February 2006. Meanwhile, persistent drought in the Great Plains is creating wheat shortages and increasing wheat prices. The US department of agriculture recently announced it expected the annual price of corn and wheat to go up 24 and 17 per cent respectively. Other expenses have also been rising. Over the years CPG companies have been spending increasing amounts on advertising and media, trade promotion, and consumer promotion in a bid to build brand strength and gain shelf presence. Despite the pressures some companies have implemented successful strategies that have contributed to healthier margins. A common strategy has been the move to outsource some business processes. The first wave of outsourcing involved contracting functions like IT infrastructure, finance and accounting, and human resources functions to overseas suppliers. The defining characteristic of such outsourcing was labor arbitrage, seeking lower costs by employing low cost, skilled or unskilled workers in China, India, and other economies opening up to trade and foreign investment. Today, business leaders are charting the path to a different kind of outsourcing known as knowledge process outsourcing, says PricewaterhouseCoopers. This process involves building global delivery teams to support a company's core businesses. Such outsourcing is driven by a global talent pool and defined by diffusion and aggregation of knowledge across national boundaries. Within the CPG industry, Procter & Gamble Company is an example of one company that has adopting this approach in relation to the research and development of new products. The company has declared that by 2010, half of all new P&G products will come from outside compared to only 20 per cent now. In order to achieve this goal, the company has put outsourcing at the center of its innovation model, said PricewaterhouseCoopers. This policy to outsource is leading to a huge increase in both the size and number of contract manufacturers, and in the personal care field that is leading to the increasingly high profile of companies such as UK-based Cosi, which is rapidly emerging as a global player in this arena. P&G estimates that currently 45 perc ent of its product-development initiatives have key elements that were discovered externally. Between 2000 and 2006, the company’s innovation success rate more than doubled, while research and development investment as a percentage of sales decreased to 3.4 percent from 4.8 percent. "The company derives a strategic advantage from collaborative networks in its global supply chain, and it is applying the same principle to offshoring innovation," the report stated. For example, P&G uses exclusive distributors in emerging economies, which increases the speed at which its products reach far-flung areas. It has the scale to ensure that these distributors earn healthy profits by focusing their attention only on P&G. "The benefit of sourcing talent and innovation from around the world is clear," stated PricewaterhouseCoopers. "Companies can increase their pool of knowledge workers while keeping constant or even decreasing their costs of product development." A survey by by PricewaterhouseCoopers indicated that the three primary areas of outsourcing for large companies include manufacturing, back office accounting, and logistics or supply chains. "However, the results indicate that a significant opportunity still exists to expand the co-sourcing and outsourcing of product development," the report stated. As outsourcing in the area of product development becomes widespread and companies continue to look for further improvements in core processes, PricewaterhouseCooper expects more CPG companies to take advantage of the opportunity. Another strategy which CPG companies are using to cut costs is to reduce their dependency on raw materials by collaborating procurement functions across plants. Traditionally, CPG companies have relied on procurement strategies that lock in fixed volumes at budgeted prices. Many also view procurement in terms of risk management and use financial hedges to reduce the impact of price volatility, says PricewaterhouseCoopers. "These strategies, though useful, meet only short-term objectives," the report noted. "Today’s environment, in which the global fight for resources is intensifying right when pricing power is weakening, calls for a more robust and sustainable response. That is why instead of concentrating on fighting price variability, many CPG companies are making operational improvements that aim to reduce long-term dependency on raw materials." PricewaterhouseCoopers cites measures taken by personal care and food manufacturer Sara Lee as an example. Procurement had historically been handled separately by each unit of the company, but last year the company established a centralised, strategic procurement function. In addition to commodity buying and risk management strategies, corporate-wide procurement is building long-term relationships with strategic suppliers, the firm stated. Sara Lee has created cross-functional teams made up of purchasing, plant, and supplier representatives who participate in knowledge-sharing and problem-solving initiatives. One team was able to reduce the number of packages some plants used. The company estimates that new ideas and the ability to implement them quickly resulted in annualized savings of about 10 per cent, says PricewaterhouseCoopers. In many instances, operational improvements are extending beyond measures like reducing the size of packaging and the thickness of bottles. Such efforts are integral to company’s overall business strategy and operations. When the company calculates the return on investment of any project, it takes into account environmental and societal risks, the report stated. "Managing input costs through long-term operational improvements contributes to healthier margins and makes businesses sustainable over time," PricewaterhouseCooper advises. "This is a necessity for today’s companies because the supply and demand cycle of resources is becoming increasingly unpredictable. We also are in the age of global information explosion, where environmental and social concerns are actively debated." CPG companies, especially big brand owners, are often questioned about not only their activities but also about those of all entities along their supply chains, the report noted. The industry is demonstrating similar openness in its relationships around traditional back-office functions such as procurement, IT, and logistics. Some CPG companies are moving away from a narrow focus on cost reductions and are taking a broader approach to achieving the appropriate balance between revenues and expenses and attaining steady improvements to margin, the report stated. Cost-cutting measures such as outsourcing back-office operations and procuring commodities at hedged prices have been tried, tested, and adopted by some in the industry. But such measures alone are not adequate. That is why many CPG companies are moving away from piecemeal measures of cost cutting and instead taking a holistic approach to sustained margin improvement, the report stated. "They are, for example, looking at ways to derive higher value from targeted outsourcing, a more selective focus on resources, and making operational improvements to achieve better utilization of inputs," the report stated. Making the environment even more competitive for CPG companies is the increasing impact of private labels. Retailers are aggressively using own-branded products to entice consumers with quality products at consistently low prices. The overall size of the private-label market in food, beverage, and personal care is still relatively small — accounting for $108bn out of total estimated grocery industry sales of $863bn in 2005. However the impact of private labels is expected to grow in the next two years. In the US the market for private labels grew at an annual rate of 5.3 percent between 2000 and 2005, with the strongest growth occurring in the food sector. By 2010, the market value of private-label food alone is expected to surpass $100bn the report stated. Another trend has been the move by some retailers and manufacturers to cross over into each other’s industries where they have traditionally been separate. Some CPG companies manufacture private-label products that can potentially compete with their own branded goods. In other instances, retailers’ manufacturing operations produce their own private-label goods and also supply products to others. About 45 per cent of respondents to a PricewaterhouseCoopers’ survey in the second quarter of 2006 said that they engaged in the manufacture of private-label brands for another reseller. The result of this consolidation and shift is that CPG manufacturers are now serving a smaller number of powerful customers. The top 10 supermarket chains by sales in 2005 were Wal-Mart, Kroger, Albertsons, Safeway, Ahold, Publix, Delhaize America, H-E-B, SuperValu and Winn-Dixie. The report also concludes that the size of the enterprise continues to matter, as larger companies outperform all other industry segments in terms of overall sales growth and margins. "This relative success by larger companies means that small to midsize companies need to strive to create scale and ruthlessly focus on efficiency while meeting specific, emerging customer needs through focus, openness and targeted collaboration," PricewaterhouseCoopers concludes. Another trend adding to the bottom line costs for CPG companies is the increasing demand that they follow ethics, fraud, and compliance regulations. In addition to increasing regulatory pressure from US Food and Drug Administration and European Union regulators, CPG companies face increasing scrutiny from the Securities and Exchange Commission and local governments in the global market. "The cost and complexity of meeting these requirements is growing, and the increasingly global nature of many CPG manufacturers adds further complexity," the report stated. CPG manufacturers generated revenues of $2.1 trillion and contributing more than $1 trillion to the total gross domestic product (GDP) of the US in 2004, said PricewaterhouseCoopers. Despite the general decline in the industry, several companies stood out as strong performers in 2005, continuing to demonstrate strong growth of sales and EBIT. According to PricewaterhouseCooper, these companies include Abbott Laboratories, Church & Dwight Co., Parlux Fragrances, The Procter & Gamble Company, Jarden Corporation, and Physicians Formula Holdings. Even with the decline in sales growth, the household and personal care products sector continues to generate the highest gross margins and return on assets as companies keep costs in check.