Costs soaring? Overhaul your business

Rising above higher commodity costs is challenging, but savvy owners can stay strong by adjusting to changing conditions.

Ahmad bin Saripan
I manage a food-processing business, and our sales are declining as costs and the price of raw materials escalate. How can I improve and grow the business?

By Herman Wong, Fortune Small Business contributor
Dear Ahmad: Making and selling a simple cookie isn’t as easy as it used to be. The rising costs of energy and ingredients challenge the recipe for success in the food industry – just as consumers cut back on their spending. Fighting against this inflationary tide takes smart cost-cutting.

“What you don’t want do is to start willy-nilly cutting costs. Be strategic about it,” says Bob Goldin, executive vice president of Technomic, a food industry consulting firm.

Fat to trim can come from the traditional places like headcount and company inefficiencies, but sourcing presents another good opportunity. Take a hard look at your production process. Can you replace any expensive ingredients with cheaper options that won’t affect the product? Outsource your manufacturing if possible and prudent, and do some research to see if you can find new suppliers with better prices. Also consider amending your contracts with suppliers: for example, offer to extend the contract length in exchange for lower prices.

But a business can’t cut its way to prosperity. It must also enhance revenue. Goldin suggests optimizing the price you charge (possibly by passing higher costs along to consumers) while also attempting to increase sales volume. Promotional activities can be a good investment: A sales slump can be a catalyst for more effective marketing.

Seek out new niches or channels to pump up sales. For a retailer, this could mean looking into specialty food stores or food services. Companies dealing in fresh foods could research expanding into the frozen arena. “You really have to explore the gamut,” Goldin says.

Looking deeper

Reacting to price increases may only be addressing surface symptoms, however, says Eric Flamholtz, professor of management at UCLA's Anderson School of Management.

“It’s not just the question of 'Costs are going up, how do I handle this? Do I negotiate a little better?' That’s only going to be a transactional perspective, as opposed to a management perspective,” Flamholtz says.

He suggests looking at the big picture – the current environment, your competition and industry trends – and then figuring out something unique about your business to build on. For example, Bell Carter Olive Company became a dominant player in the black olive industry by focusing on being a low-cost producer, which required a reassessment of both its business operations and its raw material purchases.

Once you've decided on a course, evaluate all aspects of your operations and determine how well they meet your company goals. That means taking a hard look at your market position, the services you offer, your operational and management systems, and even your company culture.

“What he really has to do is to step back from the immediate problem, take a more fundamental look at his business, and do a strategic assessment,” Flamholtz says.

Adjusting your business model

Judith Moore of Charleston Cookie Company has been battling cost increases all year. Her five-year old South Carolina company, which does around $1 million in annual sales, has seen the price of a 50-pound sack of brown sugar rise from $19.95 before Christmas 2007 to $26.95. Flour is up 25%, as is the European chocolate that gets folded into Moore’s double-fudge chip brownies and white-chocolate pistachio cookies. The falling dollar made importing from Europe a pricey proposition, so Moore is looking for a less expensive domestic chocolate producer that can provide the same level of quality.

She is also taking advantage of her growing wholesale business, which accounted for 40% of total sales in the past but will reach 50% by the end of 2008. Moore is leveraging her larger volume of purchases to negotiate better rates for ingredients.

But she’s not content to sit still. The company recently attended the recent Fancy Food Show in New York and came away with leads at four major wholesalers.

Moore is also sinking money into upgrading her company's Web site, an initiative aimed at increasing online sales. A new, monthly e-mail promotional campaign will cultivate existing customers.

Web sales currently make up 20% of revenue, but Moore plans to double that in 2009. She's hoping changing consumer habits will play into her online growth strategy: “It’s entirely possible given the price of gas that people may shop more online now than they are shopping in person," she says. "So that could be timely as well.”