Rethinking cost paradigms

For the most part we all love to simplify things. Making the challenges we face easier to understand and communicate is a key part of the CEO’s toolkit, essential in making incisive decisions that improve performance quickly.

As intelligent humans, as we gain more experience, we accumulate increasing numbers of ‘ways of looking at things’ that have been successful for us in the past and provide us with the key ingredients of the recipe for good decision-making.

But these paradigms can trip us up too. For example, our sector is dominated by gross margin as a measure (sales less cost of sales) of efficiency, and this is often seen as the key yardstick for the performance of cost management.

I would argue instead that as a means of taking corrective action on cost it’s almost totally meaningless. Gross margin is the combined outcome of the volume of customers, the prices we charge, the level of waste in production, and the cost of inbound ingredients. Yet many operators I speak with don’t view margin through the lens of these measures.

In the past couple of months I have asked pretty much every operator I have met (excluding our clients) what the level of inflation on inbound food and drink is in their business. Every answer provided examples of large increases in price for specific products or action being taken to mitigate supplier cost increases, but only one was able to give me an actual number for their food inflation.

Almost every hospitality business has a core list of products which are bought all of the time and constitute a core basket of goods. So, it’s not difficult to create a weighted basket to determine the level of inflation – so that performance can be monitored against market level indicators such as the Foodservice Price Index (FPI). This becomes even more helpful when inflation is then measured by product category, and even by supplier. Measure it, compare it to the whole market, and then manage it – is the simple key to success.

If gross margin is the prevailing current paradigm in food and drink, it’s particularly ironic that inbound cost inflation seems to be the prevailing paradigm in energy. Every CEO seems able to articulate their increase in gas and electricity costs year-on-year, but when I question the level of reductions achieved on consumption in their business the numbers are not generally at their fingertips.

Buying energy well is of course critical, but spending huge sums of cash on energy that doesn’t add value to the operation is surely an unaffordable waste in the current environment.

In the pursuit of simplicity some operators are now working with third parties who provide funding for intensive energy volume reduction programmes and amortise the cash investment into the price of utilities. The outcomes appear encouraging and may provide a route to more moderate times in the years ahead.

But above all in my view, the creation of new paradigms through really clear critical thinking about what gets measured, linked to a focused review of performance and correction, may well be the key to survival in the months and years ahead.