Cadbury, Kraft, and the myth of economies of scale

I spent the first ten years of my career in the food industry so the recent takeover of Cadbury by Kraft was particularly interesting.  Apart from a general sadness that another major British food company has gone (and there ain’t many left) I was interested in a comment by the Kraft CEO that there won't need to be big staff reductions because they will make huge savings from better procurement.

As well as my general cynicism about savings measurement and credibility, that brought to mind some of my personal experience in the food industry in the 80’s (and since) around the issue of economies of scale. And that was where I formed the view that economy of scale is one of the biggest myths in the procurement world.

Now, I don't deny that in many industries and for many purchases, economies of scale do apply up to a point.  Clearly, as a procurer, I want and need to have some market power which volume does bring. But too many people make the assumption that the economy of scale curve continues indefinitely; that the more volume I buy, the better the price I will obtain.  This is simply not true in all category areas.

I had direct experience of this in the food industry.  I bought flour (amongst other raw materials) for a couple of years. I was a big buyer but not one of the giants in the market such as the bread makers and top biscuit manufacturers. But I knew that we got better prices than most – if not all – of the bigger  users.  Why?

Simply, we could move faster, be more entrepreneurial and take more risk. If you need hundreds of tons of flour a day, you can't take supply risks.  You must have guaranteed supply, you need to lock it in some way ahead, and you may well be buying 50% or more of a flour mill's entire output. The mill cannot supply you on a marginal pricing basis when their whole business depends on you.  As a friend pointed out to me,  'if you buy a supplier's entire output, you must be paying the average price”.

We bought tactically and aggressively. A long list of approved suppliers, and a quarterly price competition (before the days of e-auctions but the same principle.)  And we bought enough quantity to be interesting to suppliers, but not so much that they couldn't afford to offer us marginal volume at marginal pricing.  I have heard similar stories in other markets; for instance, the group of airlines who failed to get a great deal from hotels at an airport because their combined volume was just too much.

A friend who until recently worked for one of the largest food firms in the world also confirmed that when you are the major global buyer in a raw material market, you do not necessarily get 'the best prices'.  Other factors such as security of supply go to the top of the priority list.

So Kraft / Cadbury will need to be careful.  Maintaining agility in their combined supply chains will be key to generating savings, not merely relying on volume and economies of scale.  Of course, we’ll never know the truth as no doubt in a couple of years time Kraft will declare how tremendously successful the procurement integration initiative has been, but without any public evidence. (A favourite topic again – the unreliably of procurement savings numbers).  But let’s hope they are genuine and great procurement does turn out to mitigate the need for job cuts.

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  1. Mini Seal:

    As a veteran of a 90’s food industry consolidation I certainly recognise the ‘diseconomies of scale’ that come with great size, but would contend that we did indeed make big savings as a result of better procurement (although I too am a ‘savings’ sceptic).

    Leveraging volume works, to a greater or lesser extent depending on market and size. What always works is leveraging knowledge. Both parties will bring their own knowledge and skills to the new organisation – and if the best of these are retained and well-harnessed then they are well on their way.

    I remember reading about a famous work-study experiment (so famous I cannot find it on Google!) in which productivity was measured while room-temperature was varied. The conclusion was that productivity improved – but it was not the environmental factors that influenced this, it was the interest of the monitors – the very act of measuring and the focus / attention it placed on the activity.

    Cadbury / Kraft procurement will find itself in this experiment! Having made the savings claim they will have full C-suite attention. All of the resource / budget battles of the last few years will be swept away at a atroke, with the single requirement – deliver.

    And they will. ‘Difficult’ stakeholders will suddenly realise the game is up; Contracts that went untendered for years will find themselves the subject of scrutiny. New hires, fresh energy (not to mention a legion of consultants) will swarm around the business, and they will deliver (however hard it feels).

    In the end, the result will be ascribed to ‘greater size’, as this is an accepted (false) wisdom, and doesn’t reflect badly on either legacy company.

    I loved post-merger procurement…. everything you ever wished for came true 🙂

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