Managing for Value, Part 4: How grocers can drive sustainable profitable growth

In this series, we discuss how an approach known as “managing for value” can help grocers develop a powerful reinvestment advantage. We’ll cover five steps in the process: aligning on a single measure of success; identifying internal and external concentrations of value; establishing management’s key priorities; creating differentiated strategies and resource allocation; and building a culture of ownership.

Setting goals can be easy. Reaching them is always hard. Once a grocer’s management team has developed a value growth agenda to focus the company on its most profitable opportunities — the “what” of its goals — their next task is defining the “how.”

We have found that the most successful companies tackle agenda items by exploring multiple possible paths to the ideal outcome and selecting approaches that will create the most value. Often, that requires eschewing intuitive options in favor of novel solutions.

It might be tempting for grocers to hew to “best practices,” but we have observed that it’s actually very risky to only ever take the paths that are obvious. Benchmarking to best practices limits a company to what’s already been tried — and ignores the reality that sometimes even the best solutions in use still aren’t particularly effective. Less conventional or unique tactics are also harder for competitors to imitate and therefore unlock more value.

As a grocer evaluates how best to pursue each of the opportunities on their agenda, it must bear in mind that it shouldn’t be looking for siloed solutions; they all need to fit together. The right combination will produce a differentiated strategy that serves customer needs better than competitors and captures a greater share of market profits.

Naturally, since items on the agenda are strategic priorities, they must also be budget priorities. In the near term, given razor-thin industry margins and increased cost of capital, many grocers may need to support those priorities by reallocating existing money. While it should be intuitive that resources should always be shifted to the areas delivering the greatest ROI, we have found the impact of making those changes is often much greater than companies expect. In the long term, organizations that are disciplined in prioritizing their most profitable opportunities build a reinvestment advantage, as greater returns create more flexibility to either fund more initiatives themselves or cover more debt to fund them.

Finally, just as the budget should prioritize the projects driving the most profit, so must the daily decisions being made at all levels. Executives can’t make every call, so the only way to make changes sustainable is by training and equipping employees to think and act like owners and independently make decisions that keep focus on big-ticket opportunities. 

Put simply, reaching the goals of the value growth agenda requires management teams to embrace an uncommon process from planning to execution. The steps are as follows:

1. Develop differentiated strategies across agenda items.
2. Allocate resources based on the value at stake.
3. Empower employees at all levels to make value-maximizing decisions.

Developing differentiated strategies and solutions

While some agenda items may have straightforward solutions and can be addressed quickly (e.g., discontinuing value-destructive promotions), the issues with the greatest value at stake are often more complex. These require careful identification and evaluation of options to determine which set of solutions will produce the most value across the whole agenda.

Consider a grocer focused on better serving busy customers who value products and services that save them time. This customer base is highly profitable for competitors — but not as profitable for this grocer. One driver of that profitability gap, impactful enough to make it an agenda item, is a shift in demand toward unprofitable national brand frozen meals. 

The grocer’s first step may be to see if profitability can be improved through vendor negotiations, supply chain changes, or increased pricing. The grocer shouldn’t stop there, however; rather, it should explore a full suite of alternatives to see whether other solutions could drive greater differentiation and more profit.

In this scenario, a private label that offers options not available through a national brand would be a differentiator. However, if the grocer doesn’t already have a robust private label program, developing one could be expensive and time intensive. The grocer would need to assess both the investment required to create an appealing product and the likelihood of customers switching away from the national brand.

The grocer might also find that customers are not, in fact, committed to buying frozen foods but rather are purchasing them simply because better options do not exist. To explore whether it could meet customer needs through a comprehensive prepared foods offering, the grocer would need to instead look at the costs and capital required (e.g., labor, kitchen space) to deliver in a way that would meet customer demand. 

Let’s say our hypothetical grocer also decides the best solution for another agenda item is to offer curbside pickup. If so, they would need to assess the feasibility of selling prepared foods through this channel. If customers value the convenience of ordering online but prefer to select their prepared foods in-store, these two solutions could be at odds.

If the grocer finds those solutions are indeed at odds, it has more work to do. Solutions must be complementary. Every activity selected to achieve an agenda priority should also support — or at the very least, not detract from — the other big priorities, too. The ideal set of solutions is the one that delivers the most Economic Profit (EP) across agenda items.

There’s one more essential filter grocers need to apply as they decide which tactics to employ in pursuit of their strategic goals: Does this make life better for the customer? If a solution makes financial sense but doesn’t work from the customer perspective, it won’t drive the expected value. The best solutions don’t require a tradeoff but actually serve customers better and produce more EP in the long term. 

Allocating resources based on value at stake

Agenda items will need to be funded, and for many grocers that may mean reallocating resources. To appropriately pursue its most profitable opportunities, a grocer may need to pause, scale back or abandon activities that contribute less. A grocer that understands where its value is concentrated will know what belongs in each bucket.

Building new capabilities to drive longer-term initiatives may also require investing capital. By ranking options by EP growth potential, a grocer can prioritize investments in an unbiased manner – opting for those that will produce returns well in excess of their costs. While capital often isn’t truly constrained, it certainly is expensive, so hard decisions will likely be part of the process of concentrating resources where they will be most impactful.

One recent example was a company with decreasing operating cash flows that decided on store rationalization as a next step. It planned to consider for closure the locations generating negative cash flows on a “four walls” basis. What wasn’t captured by that view of performance, however, were the stores that were struggling to a lesser but still problematic extent: the locations not producing enough to cover their share of centralized costs of supporting the whole store network — field services, merchandising, finance, HR, etc. — or the capital employed by these stores.

As a result, that initial view understated the extent of improvement needed across the portfolio. Adding the lens of fully burdened profitability uncovered a significant number of additional stores that were consuming value.

A strategic review also found that the company had a set of opportunities (i.e., other agenda items) where investing capital could generate very high returns. The company had historically based store decisions on its corporate weighted average cost of capital (WACC), but these opportunities had the potential to generate returns at twice that rate (e.g., 20% internal rate of return vs. 10% cost of capital). 

When the true opportunity cost was considered — what the money tied up in the underperforming stores could be accomplishing if applied elsewhere — the company realized it made sense to close even more of its underperforming owned locations and reallocate that capital to initiatives that improved the performance of the remaining portfolio. In doing so, it traded its losing investments for much more promising ones.

Simply put, when the company added fully burdened profitability and opportunity cost to its evaluation, it discovered that its worst-performing stores were even more value-destroying than it initially thought, while the best stores stood out as far superior investments – meaning the tradeoff of shifting money from unprofitable stores to profitable ones yielded much greater value than expected.

Ultimately, the company used the different views of profitability to segment stores and develop strategies for each situation (e.g., fix stores that were close to breakeven on a fully burdened basis, and close stores that would be immediately accretive to close on a “four walls” basis). As a result, what could have been a straightforward store rationalization exercise became a self-funded, integrated strategy with much more value growth potential.

Empower employees at all levels to make value-maximizing decisions 

Capital is one precious resource, and executive attention is another. As finances are funneled away from other projects to support the priorities on the agenda, management focus should follow. If the five opportunities chosen for the agenda comprise the “go” list, everything else should be placed on a “stop” list for executive attention. It might sound severe, but the difference between the management team engaging in 10 activities at 80% and attacking five at 100% is the difference between status quo performance and actually moving the needle on the business.

This “managing for value” mindset, which requires management dedicating focus to a short list of big-ticket opportunities and setting aside others, has to extend from executives to the whole organization. While delivering on agenda items is critical, companies that only manage initiative by initiative generally don’t sustain outperformance over time. Instilling a philosophy of prioritizing activities based on profitability enables value-driving decisions to be made independently every day — most without the involvement of senior leadership.

Just as executives need to reserve their attention for the most significant opportunities of the overall company, employees throughout the organization need to prioritize their own projects based on the value they can deliver.

To encourage this, grocers should start by making EP growth (and total shareholder returns, for public companies) the primary measure of success organization wide. Provisional business unit EP targets should be aligned to support corporate goals and framed in that context. 

From executives down, managers should train their direct reports on what managing for value means for their function and day-to-day responsibilities, and value growth should be a recurring theme in their conversations with team members collectively and individually. 

Additionally, for senior leadership, compensation should be tied to longer-term EP growth and total shareholder returns. For line and lower levels of management, subordinate measures work as long as they correspond with the EP growth objectives. Overcomplicating performance metrics often results in underperformance on all metrics, so simpler is better — again, provided there is alignment with EP and shareholder value growth goals.

One caution: simply incentivizing a new metric can have unintended consequences, especially if employees do not fully understand the rationale. For example, lowering capital by reducing inventories would increase EP in the near term, but if the strategy is to grow a product line, maximizing long-term value would instead require increasing inventories. 

To combat perverse incentives, companies must create strong, straightforward decision-making processes. Competing priorities may arise (for example, marketing pushing revenue growth and product aiming to protect margins), so it is critical to have a consistent standard of maximizing EP. Companies also need to define early who makes the final call in such cases. With clarity in those areas, companies will be less likely to miss opportunities through inaction, and decisions will be more likely to support the company’s overarching goals.

Such alignment doesn’t happen overnight, but once “managing for value” is ingrained in the culture, it delivers superior results that persist over the long term. 

Consider this example. A company, lagging peers in total shareholder returns, focused on capturing market share and encountered an unintended consequence: reduced profit. Management was measuring success through a complex mix of earnings per share (EPS), revenue growth, and share of sales. During an organizational transformation, this company adopted EP as its key metric and revamped its resource allocation processes. Budgeting and incentives were overhauled and pushed down to business units and product groups. Finally, more than 1,500 employees were trained on the principles of managing for value. Over the past 10 years, the company’s total shareholder returns have grown twice as fast as the S&P 500.

Putting it all together

Transforming management’s high-level, thoughtfully composed wish list into a clear-eyed, comprehensive set of actions requires more time and more creativity when thinking about the “how” than is standard in most companies. Going beyond the first instinct of how to address issues and instead exploring multiple paths to the desired outcome will reveal solutions that deliver more value in the long term.

Following the full “managing for value” framework — from agreeing on a single measure of success, to identifying concentrations of value within the market and within your customer base, to selecting and prioritizing agenda items based on value potential, to differentiating strategies, resources, and organizational capabilities to execute on those priorities — takes leadership commitment, diligent fact finding, open-minded analysis, and disciplined execution. It takes a willingness to pivot away from approaches that worked historically but might miss opportunities that will best position the business for the coming decade.

Throughout this article series, we’ve provided examples of how grocers can use this framework, and we’ll go into further depth on how aspects of the “managing for value” approach can be applied to specific situations with several deep-dive articles that cover topics of high industry interest. Stay tuned for the first of those in the coming months.

Want to catch up on the earlier articles in this series? Check them out at the links below.

Managing for Value, Part 1: A new way to think about winning in grocery

Managing for Value, Part 2: What grocers gain from a closer look at profitability

Managing for Value, Part 3: Prioritizing an agenda for profitable growth