Episode 20 Dec 03, 2020

Optimizing Contribution Margin in Food Production

Zilliant Chief Marketing Officer Lindsay Duran and Senior Director, Solutions Consulting Vishal Asatkar have logged many hundreds of miles visiting customers and prospects together over the years. The pair teams up again for an intensive look into the factors that drive total margin in the food production industry – the volatility of cash crops, the delicate balance between price and cost, and the differences between contract business vs. spot business. Duran and Asatkar also provide a peek behind the curtain into how this highly essential industry is adjusting on the fly to a global pandemic.

To read the blog post mentioned in the episode: How Food Producers Win With Zilliant Campaign Manager

Vishal Asatkar

Vishal Asatkar

Having a model or a data-based approach to setting those contribution margins right away can help you with better profitability across a whole bunch of transactions whether it's contract or spot. You can get better contribution margins if you're using broader sets of data, using more data, or using a model to come up with that guidance.
- Vishal Asatkar, Zilliant

Episode Transcript

Lindsay Duran: Welcome to B2B Reimagined. Hello everyone. My name is Lindsay Duran. I'm the chief marketing officer at Zilliant, and I'll be your host for this episode. I'm joined today by Vishal Asatkar, director of business solutions consulting at Zilliant. Vishal, welcome to B2B Reimagined.

Vishal Asatkar: Thank you, Lindsay. Excited to join everyone here today. I've always wanted to get on this podcast, so today's a good day for me.

Lindsay Duran: I'm so glad to hear that. Before we get started, why don't you tell us a little bit about your background?

Vishal Asatkar: Sure thing. I've been in the software space coming up to 24 years now. I had an MBA before that, and I started with retail banking of all things. I moved on from there to software development with marketplaces. I've been with Zilliant now for 16 years. I started in a role where I was deploying our pricing solutions to our customers. Then the last 10 years, I've been on the sales side of things, whereas a sales engineer, I [00:01:00] and my team tried to understand what drives pricing and value within the business and see where Zilliant solutions can drive value for the business. So, in that, I have been able to meet with multiple industries across different verticals and domains. I got an insider's view into how those businesses operate. It's been a great learning experience from here.

Lindsay Duran: Excellent. One area that I think you are probably equipped more than most to talk about is food producers, and the market, pricing dynamics, the challenges they face, and the opportunities for that particular industry. Now, the type of company that I'm talking about is really at, I'll say the start, of the supply chain or close to the soil as we are sometimes here. They're converters, so they might take a commodity like wheat grain, corn, or cocoa and convert that into a product. Then sell that to a manufacturer that's [00:02:00] the next step in the supply chain. Can you give a little bit of the lay of the land for these types of food producers or converters? How do they think about and quantify value in a commodity business?

Vishal Asatkar: Absolutely. In my years here, I've had the chance to work with food producers who are in the poultry business, in the beef, or cattle business. Or in the business where there's some kind of a grain involved, whether it's wheat, soy, corn, or oil. So, I feel like I've got a view across several of these businesses, and in lot of them, the common theme is they are essentially trading businesses or might have even started as trading houses. What that means is they're basically taking a position in the commodity that they're producing from. So, they're essentially trading, and they make money, not just in the product that they sell, but also in the trading aspect of it. From a [00:03:00] Zilliant pricing point of view, we don't touch the trading side. We are mostly dealing with the value that they sell the final product for.

That's one aspect of it. It's useful to think and appreciate that these businesses are out there "trading houses." Now, the second aspect of dynamic that's common to all of them is that they're very capital-intensive. Whether it's the plant or the facility at which they are converting this raw commodity into some converted or product, all of those plants or facilities are a significant investment for any business to make. There's a high barrier to entry for new players, which means that the landscape, if you look at any geography, is fairly stable. There aren't new entrants overnight. If anything happens, it might be that a plant or a facility changes hands, or one business might acquire a few plants from another. So, the landscape in terms of the [00:04:00] companies that are operating, and the plants that are in a different geography is fairly stable. The other thing is that these businesses, especially the really upstream ones, the ones who are, as you said, getting the produce out of the soil, whether it's wheat grain, corn kernel, or soybeans, they are not keeping a lot of inventory on hand after they've processed whatever the commodity is.

What that means is that these industries are already prone or are susceptible to supply chain disruption should it occur. They aren't really keeping a lot of finished product on hand. There are really a few days in some cases of inventory that's going to the network or the system. On the supply side, or the origination side as it's called, the farmers may have some grain or extra quantity of commodity in elevators. But even then, it's not a whole lot that's in the system. That's another useful thing to understand and keep in mind. The last [00:05:00] piece that comes out of this is out of nature these products. So, it's very unpredictable. You might have good range one year. You might have good crops or harvest one year, and you might not the next year. For several of these cash crops, you might even have two or three harvests in a year. So, this unpredictability, this volatility, or this change that can happen on the supply chain side, it's a very constant and prevalent thing. It can change based on the season and the weather and all of those factors. The businesses have to be able to react to that end and deal with those kinds of changes on an ongoing basis and make sure that their customers are getting what they need. Because if you think about it, the customers who are taking the product, the site, or the output from these companies are customers or businesses who have to put that bread on the shelves of your [00:06:00] grocery store or have to put that box of corn cereal on the shelf of that grocery store. Also, they have to meet some quality specifications. As a consumer, you notice it right away if that corn cereal tasted different. So, there's a lot of consistency that needs to be maintained. These food producers are an important link in that whole value chain.

Lindsay Duran: I think you bring up a good point about consistency of product. Years ago, you and I had the opportunity to tour a facility where they were testing the flour output that they would sell to a large multinational food producer. To your point, you would expect that the national brand of crackers that you regularly buy tastes the same time and time again. What strikes me is that even though this is a commodity business, it seems like there is some incremental margin to be made because of the [00:07:00] effort that has to go into maintaining that consistency and dealing with the volatility that the weather might bring. Can you talk more about how companies in this space think about total margin, and what opportunities they have to, I'll say differentiate price, even though this is heavily commodity driven?

Vishal Asatkar: It is really interesting when you get into it, how pricing works in this space. Maybe we go back several decades, but there wasn't a very mature Chicago mercantile exchange or NYMEX. Those exchanges both didn't exist at some point back in history. You can imagine that there was no predictability and price and cost. That just won't do because you and I, as consumers, are used to paying that $4 or $3.50 or whatever it is we paid for that box of cereal. It's just not going to work if we have to $3.50 one week and $6 the next week. What that means is that General Mills, or that Kellogg's, that producer of the cereal needs a stable [00:08:00] cost structure underneath. That in turn means that these food producers have to offer a level of price, stability, or consistent price or cost to those companies, to those manufacturers. How they achieve that is really interesting. For one thing, there is an exchange on a board or a market where there are instruments ways where you can have consistent look at what the futures of any of these commodities might be. So, you and I, we are very familiar with how because the, the cost or the price of the barrel of oil is very talked about. So, we all know when that fluctuates. But a lot of you would also know that there's also commodities traded for wheat, corn, cattle - all of these things are traded on these exchanges and there is a contract price or a formal quote that you can get for any of the futures for several months in advance. That's essentially what's used to [00:09:00] price out, and you have these commodities into the future periods. That's just looking at the variability in the raw commodity itself. The corn, grain or the meat involved, whatever it might be, the raw commodity is what we're talking about. Those things are being quotes as futures on the exchanges. But if you think about the price, there's a whole host of other things that make up price. If you think about it, the farmer is growing the corn or the wheat in some place in the Midwest. That's then being transported from there to wherever the mill is, and there might be some interior mills or some far away mills, so that would change what the freight cost is of getting that commodity to the mill itself.

The freight of just getting the product to you. Oftentimes, it's railroad, or it might be barge is how do that. But then once it's in the mill, then you have to think about the costs of converting that raw commodity into a flower or refined oil. [00:10:00] That's where the conversion costs come in. Because you can think about it, this is a manufacturing process, and there's a unit associated with it. If you have whatever unit of raw commodity, when you convert it, how much flour are you going to get or how much oil are you going to get out of crushing those beans? So, that's just the production yield from the commodity into its converted form. Beyond that, there's the cost of labor. There are the energy costs, which can be significant in these processes. There will be some wastage that happens. All of these factors need to be considered. In addition, we have all seen how at the gas station, gasoline has the ethanol component to it. That's an important by-product, for instance, out of crushing corn for creating oil or creating the high-fructose corn sugar or for creating corn flour. One of the by-products can be X amount. So, you can see that for a business, [00:11:00] that's doing these things there is some money they can make from these by-products. Or the corn, you might be creating some seed that you can then go on and sell to the cattle producers. You have to factor in the credit that you get from these by-products and the value of these by-products. That also goes into the making up of the price. If you think about it, price really has all of these components in it. It has the raw commodity, which would be the futures value. If you're buying it in the stock market or for today, it would be the cash or the stock value or quote for that commodity. If you are looking out into the future into the next three months, six months, eight months, nine months, then you're talking about the futures. That's just the commodity itself. You're talking about the conversion cost. You're talking about the credits you might get some using some of the by-products. Then along the way, you are talking about the contribution margin itself. This is the piece where you're charging the customer a [00:12:00] premium for all the things that you do, which make you. It's the reliability of service. It's the ability to deliver that set amount of quantity at quality spec to that customer reliably and over time. That's the premium or what we would call the contribution margin.

Across a lot of businesses, we know that margin is different too in terms of just the gross margin over the costs. But in these commodities businesses, because cost is so volatile - we all know when oil goes from 30 bucks a barrel to even 110 - you can't apply a margin percent on that cost basis. Hence in a lot of these businesses, they talk more in terms of the contribution per unit. How much money per barrel are you making or how much money per ton, per pound, or per a hundred weight of a commodity are you're making. That's essentially how they measure how profitable [00:13:00] any customer or any part of the business is going to be. So, that's the piece that Zilliant helps optimize. What's the right contribution margin you might charge for different customers under different circumstances.

Lindsay Duran: I would imagine, Vishal, that a good portion of a food producers' business is likely on contract given just the supply chain reliability that customers would expect. How much do you typically see on contract, and how are those managed versus let's say materials are bought on the stock market?

Vishal Asatkar: That's an interesting thing to talk about. I keep coming back to these examples because all of us eat cereal, and we all buy bread from our local grocery store. So, these are familiar examples. But there is a very steady level of demand that most of these products have. We can give up everything else. We can give up our [00:14:00] fancy gadgets, but you're not going to stop eating. So, that is based on the population in any geography. Food has a pretty stable demand there can be macro trends for people going gluten free or cutting down on fats and so on and so forth. But in general, there's a pretty stable demand for a lot of these things.

What that means is that the food manufacturers, people like General Mills or Kellogg's or any of those, they have a steady state of demand that they place on these food producers. That's a good thing, because like you said before that these mills and plants and facilities are capital intensive. They need to be running at a certain rate of utilization to keep the lights on, as they say.

I would say typically 80 - 90% of the volume for any given plant or facility maybe spoken for or committed in these contracts or long-term agreements where it's run rate business, as we call it. It's customers who have established contracts and volume commitments, [00:15:00] whether they're written commitments, implied or implicit, but in some form or fashion, a volume commitment.

80 to 90% of that facility may be committed to satisfying that demand, and that's a good thing because everybody in the supply chain wants that level of predictability for the business to run at peak efficiency. Now, that gets into an interesting thing as to how these contracts do get priced. We talked a little bit about the reasons why there's a stability and demand and supply. In terms of the pricing itself, it's interesting because some of the customers of food manufacturers can be really sophisticated and savvy given the scale at which they do business and the resources they have. They might actually drop the market themselves and make conscious decisions about when to take up a position or when to pick up significant volumes of a commodity because where they see the trend or the cost price of that commodity moving in the coming periods. Or it [00:16:00] can be that a business, even if it's large and operating at scale, may decide that's not complexity that they want to deal with. They want to stick with whatever their core businesses is, which is producing the Cedar or producing those loaves of bread.

So, they might leave that responsibility entirely on the food producer itself, as far as managing the vulnerability and the ups and downs in the marketplace. That really allows me to put two kinds of labels on the types of buyers. One case it's a component customer, in which case they're negotiating every component of that price. You remember just to a short moment back I was talking about how price has several components to it. The part that's the raw commodity cost, the part that the credit you're getting four by-products, the part that's the basis, which is the difference from the exchange to your local and freight packaging - that can be various elements. So, the savvy, I'll call it savvy, [00:17:00] but the customers who choose to do it that way are component buyers who are negotiating every part of the price independently. They might even lock in the price or cost of some elements independently on their own, and just state that as an input to these food producers. So, for instance, they might procure their own supply of the raw commodity, whether it's the corn or the wheat or the soybean. Then that just becomes an established thing that the food producer works with because they've owned that on their own. In contrast, the other customers are what we would call flat customers. What they're doing is they're basically saying that we'll pay you the $3 per pound or whatever the price costs might be per unit of the finished product.

They're really not getting into the what the commodity aspect of it is, what the freight aspect of it is. They're just scared that they're getting a flat price that makes sense to them, and [00:18:00] that they can use to then work up their price and cost and so on and so forth. It's an interesting look at how buyers may buy. These are still both contractual type of customers where they're entering into long-term agreements and long-term volume commitments. In sharp contrast to these kinds of customers, there are the spot customers. So, you remember we were talking about how 80 to 90% of the volume of food from a plant may be committed, but there is that flex of the 10 to 20%, which is spot. It is the output, which the business, the food producer will sell on the open market or the cash market or in the stock market. Now there's various reasons for this. It might be that in general, and this might not be true for a specific plant. It might be that a specific plant is almost entirely committed to meeting contractual obligations. I'm speaking more in terms of across the [00:19:00] network, here is a reference to the collection of plants and facilities that a business might own. Across the network in general, there might be 10 to 20% of flex or spot capacity that the producer has, and that allows the producer to wax and wane or able to deal with the vagaries of the market. Or if one contract customer does not pick up as much as they want or picks up more than they would want. That's where that flex is allowing them to do just that - flex. The other aspect of it is these spot or cash transactions yield usually a much higher margin than the contractual ones.

That's an opportunity for these producers to make additional margin, and it's interesting sometimes to see how a much smaller portion of the volume makes a disproportionately higher amount of the contribution margins that the business might be making.

Lindsay Duran: Vishal, how do companies that maybe have [00:20:00] not invested in any kind of sophisticated pricing technology typically make decisions about contribution margin? What are the methods that you see most often?

Vishal Asatkar: In that sense, Lindsay, these businesses are no different from most businesses that we've seen. If there aren't sophisticated tools or a systematic process for setting off the margins, it defaults to what you and I are accustomed to seeing. It comes down to the seller or the account person because they're making, if we can call it a subjective decision, for that individual customer, based on their gut instinct, their knowledge, and what they know about the market and the marketplace. Now, don't get me wrong. These are not all suboptimal. A lot of these sellers are veterans of the industry. They might have been in these jobs for 20 or 30 years. They've grown up in it. They've done different parts of the business. They're not uninformed, far from that. But beyond [00:21:00] that, us as humans, we have biases, and we don't always make the best decision based on the time of day, and which side of the bed we got out of, we may end up making a poor price decision than we would otherwise make on any other day. That subjectivity does creep in cases where there aren't the tools. The default is that the seller is using his or her instinct and their knowledge or database of what they know and how they've priced before.

Lindsay Duran: Recency bias I know, certainly. Before we get to talking about how companies can approach this a little bit better and opportunities to maybe eke out some incremental margin, I want to take one more step down the supply chain path and talk more about the companies that these converters, if you will, sell to. So, you mentioned companies like General Mills or Kellogg's. Can [00:22:00] you talk a little bit about how they tend to approach pricing and some of the challenges that they might face?

Vishal Asatkar: Personally, and Zilliant as a company, we haven't focused too much on the B2C side of things. So, we're not typically in the business of pricing that loaf of bread that you're buying at the grocery store or that pack of cereal. We are in the middle of that. So, what I mean by that, is just like the food producers are creating this output, which is being purchased by these food manufacturers and to assign the labels to the companies, food manufacturers is the label I'm using for companies like General Mills and Kellog's. But there can be intermediaries in between. So, for instance, think about that local donut shop, think about that local bakery, or think about that restaurant even that's around your street corner. All of these businesses, which are using food products, food ingredients, whether it's [00:23:00] cooking or frying oil, it's the base for making the donuts or they're making their own corn tortillas. All of these businesses are consuming these food ingredients, and guess what? They're buying them from somebody. They're buying them from food distributors at what's called foodservice distribution. Foodservice distribution are procuring their products from these food producers. That's how one part of that value chain looks like. So, to come to your question and just staying with that example, if you think about, a food producer that's making wheat flour, corn flour, or cooking oil in various packaging sizes with various brands or performance characteristics is then turning around and selling those to, for instance, a foodservice distributor. That broadline foodservice distributor is then turning around and selling those to people like that bakery shop, that doughnut shop, or that restaurant around your street corner.

That's how all of that works, and without getting too much into [00:24:00] it because every one of those handoffs and transitions has its own set of pricing, nuances, and challenges, and is interesting in its own end. We could spend another 30 minutes talking about each of those, but in this case, we're specifically talking about how does the food producer price to that foodservice distribution business. Then how does that foodservice distribution business price down to the bakery shop or that restaurant?

Lindsay Duran: Thanks for that, Vishal. I think it's helpful to just paint the picture of what at least one part of the supply chain looks like for food. As I think about the past year and in the pandemic, I think many of us saw images on the news of milk being dumped out and essentially wasted because there was nowhere to store it. It couldn't be bottled fast enough. I also think we saw as consumers going to the grocery store and being told that you might be only able to buy a dozen eggs, rationing [00:25:00] milk, or rationing meat. What we saw was a significant disruption in our food supply chain overall, and not necessarily due to nature or other natural disasters, but more so in meat packing plants and other facilities. I think it gave us a pretty good reminder of the interconnectedness that we have in our economy and really in how we get our food. What have you seen in talking with companies in this space, broadly speaking, about how they're trying to recover and certainly manage through all of the disruption that we're all seeing?

Vishal Asatkar: Oh, boy, this could again take time to talk about this. But let me relate back a couple of things that I found insightful or interesting. It is really, if you stand back, interesting to see how what an interconnected web all of it is. Because people can't work at the meat packing plant, their outputs are lower [00:26:00] and certain types of products aren't available as much. Or because people are doing more takeout, and when you're doing a takeout. You're more prone to buying a certain type of takeout dish. It's going to put a much heavier demand on those kinds of products.

For instance, I doubt there are too many people eating steaks today as compared to what it was before COVID. Think about all the steak houses people are going to, and that's not something you're going to audit as a takeout dish. That's just a simple example of saying that this is a perfect storm. Any one of these disruptions could have taken place as a natural event. When a plant has a fire break out, there is a salmonella breakout, or there's a much higher demand of a particular type of product in one market, which sucks it all up and puts a premium on that product. It's like perfect storm that all of these phenomenon dynamics are happening together. To me, some of the interesting things where were just what I [00:27:00] mentioned with the takeout and how that's changed the characteristic. I was talking before about the whole value chain of the food producers supplying to the foodservice distribution supplying down to that local restaurant. Just think about that for starters, the restaurants closing down means that there's a huge chunk of demand that's just dried up even for a short period of time. Now you have to repurpose that output or that product and make it available as an aisle product because people stop going to restaurants, but they're now flocking to the grocery stores to buy those same meats. They're cooking them at home instead of eating them out at a dine-in. So now as a food manufacturer or a food producer, you have to be able to react to that and respond to that by taking something that you would have normally sold unpackaged, maybe as fresh, and now you're having to package it. Maybe sending it as frozen versus fresh, or maybe it's still fresh, but it's not going into a grocery aisle versus going [00:28:00] to a kitchen in a restaurant. That's just one simple example of demand changing.

Then it's also true for some aspects of the food business that it is regulated. We like to think that some of these businesses should be able to stay home because where there is higher demand maybe they're making more margins on taking more price. The reality is that some aspects, at least several important aspects of this business, are regulated by the government where it is watching the per unit price. It's in the interest of the consumer. So, this is not a bad thing. They are making sure there's not price gouging happening. There are checks and balances and counterbalances or counter effects to the extent to which a business can actually try to offset some of their losses with making more margins elsewhere. It's a challenging environment for businesses with them having to reshape what kind of outputs they create, and then seeing just demand go away.

Lindsay Duran: Absolutely. I think it's a good reminder that we all need each other. Vishal, to wrap up, one [00:29:00] thing that we like to talk about on this podcast, as the name would suggest, is reimagined solutions to common problems in any industry. When I ask you specifically how companies that are in the food production space can about how data science or technology might help them move the needle on contribution margin, and the type of impact that it can have on their business.

Vishal Asatkar: There's a couple of ways that being data informed or using data to inform your decisions can help. For starters, I'll go back to my comment before about the subjective nature of pricing lacking any of any tools or lacking data insights. So, having a model or a data-based approach or a data informed approach to setting those contribution margins right away can help you with better margins, better profitability across a whole bunch of transactions whether it's [00:30:00] contract or component flat spot transactions. So, that's one thing, right? You can get better contribution margins if you're using broader set of data, using more data, or using a model to come up with that guidance. That's one thing.

The other aspect of it is there's a level of complexity with stringing together all those complex price elements when you're trying to quote a price to a customer in any given situation. What I mean by that is, I was talking before about how price is not one single number. It's made up of various components, which includes things like the futures, the basis, the credits, the yields, the future periods, packaging, freight - all of those things. To be able to bring all of those reliably, consistently and balancing various things out, it can be a challenge. When I say balancing, if you think about it within these businesses, freight might be owned by a [00:31:00] different department or group. Packaging costs or plant operations are often owned by a different SNOP group. There can be people pulling in different directions really is a good way to mentally think about it. When you're trying to come up with a price, and if there is too much conflict between those departments and processes, you can end up with a final number, which is not really competitive or good for the customers. It can be a pretty complex and challenging task to get that final number to look right and be right, considering all the elements that go into it. So, that's the price build function as I call it. Within that price build is a very dynamic aspect to it that we talked about before, but I'd like to call it out again.

The fact that price is made of futures, which are, if you went to the marketplace or to the exchange or board, you could get a different futures quote every second. It really is very dynamic. [00:32:00] You want to make sure that, as your plant yields change, your production yields change, your labor or utility costs change, your freight changes, your packaging costs change and your raw commodities changing. All of those things are changing, you want to make sure that your price is being maintained and being offered in the right way to the customer. That price build and the dynamic aspect of the price can be challenging and is something that we absolutely help with. Often customers businesses can benefit from that. The other piece that these businesses can benefit from is having the visibility, the closed loop or reporting, or analytics, which give you a view into how business is performing. As we were saying before, a lot of these businesses are around rate businesses. The volume I was talking about, 80 to 90% of the volume, being committed, but guess what? The customer who's committing to buying, let's say 120,000 weight of a product over the course of 12 months [00:33:00] may not buy or a ship or pick up 10,000 weight every month. They might've committed to that, but they might actually have a different practice. They might buy 20,000, 30,000, 50,000, and then nothing over the next few months. How they're complying with their commitments, whether it's consistently picking up the volume they said or picking up all of it. All of those things have material impact to the profitability and efficiency and operations of a food producer. So, having the visibility to that and being able to see if a customer is a repeat or habitual offender on that front, it would be a good thing to be able to call those customers out. Maybe you want to charge a premium for that or question whether you even want them as a customer. Finally, there is not a business warehouse, business reporting, or business intelligence visibility into the data what's going on. It [00:34:00] never hurts. It never hurts because you need to be measuring something before you can improve on it. So, that's definitely an area we help these businesses with, and as well as getting a handle on what your profitability looks like, so that you can start to measure it, track it, and improve on it.

Lindsay Duran: Perfect. Thank you, Vishal. Is there anything else that you'd like our listeners to know?

Vishal Asatkar: No, if we kept talking, we could keep going for another hour. I think this is some of the high-level things that, to me, are interesting and exciting about this space. It's Interesting to work in this domain, so very happy to do this podcast. I hope it's useful and interesting to anybody who happens to be listening.

Lindsay Duran: Thanks so much for being with us today, Vishal. I think this was a great conversation and very informative. As always, you are a wealth of knowledge. I want to thank each of our podcast listeners for being with us for this episode as well. Please see the show notes for a link to a recent blog post about how food producers can translate business strategy into sales action [00:35:00] with Zilliant Campaign Manager, which is a brand-new product that we just launched a few weeks ago. We also had a dedicated podcast episode to talk about Campaign Manager that we just published a few weeks ago. I'd encourage everyone to look at that as well. Thanks again for being with us and stay safe and healthy.

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