How much is a brick? That depends

The building-materials sector is struggling. Agile margin management can help companies in the industry protect profitability.

The building materials sector is in turmoil: Demand is at a record high, and the price of raw materials is soaring. At the same time, customers are demanding more full-service and end-to-end project support rather than merely purchasing products. The past two years have upended long-standing business prac­tices, but many suppliers were not equipped to adjust their margin management, discount, and rebate schemes as quickly and as flexibly as they should. As a result, their profitability is suffering despite surging demand. In this article, we present the success factors, from transparency creation to capability building, of agile margin management.

Supply shortages and demand shifts find many building materials players unprepared

Sidebar

Until 2019, both supply and demand were relatively stable in the building materials sector. However, in the past two years, volatility, uncertainty, and ambiguity have gripped the industry. The prices of raw materials have seen steep increases. The price of steel, 1 for example, has increased by 60 percent since January 2021, while the price of crude oil 2 has increased by 17 percent. Lumber sold for about $300 per square meter in May 2019; two years later, the price peaked at more than $1,600, only to plummet to less than $500 in August 2021. As of June 2022, it was about $1,300. Similar volatility can be observed across other key materials as well as in transportation (Exhibit 1). 3

We strive to provide individuals with disabilities equal access to our website. If you would like information about this content we will be happy to work with you. Please email us at: McKinsey_Website_Accessibility@mckinsey.com

The situation has been exacerbated by surging inflation worldwide, to the tune of 8 percent in Germany 4 and roughly 9 percent in the United States as of June 2022. 5 Some of the root causes of inflation, such as the high prices of energy and freight, are likely to persist, especially given the ambitious—and costly—decarbonization goals set by many governments and companies. The implications for building materials players are substantial: a global producer of paints and coatings with €6 billion in annual revenue, for example, reports that the price of acrylic resin has increased by 60 percent since the beginning of 2019; the price of epoxy resin has increased by 50 percent.

The demand side is also changing. In the past, many customers bought building materials off the shelf, no questions asked. Now, an increasing number of customers expect suppliers to help them with project planning, connect them with reliable installers, support them in reducing carbon dioxide emissions, and provide customized solutions. A builder says: “I’m overwhelmed by ever-more-complex building regulation and by the constant onslaught of new products and new technologies. I need end-to-end support, from planning to installation, to find the best solution.”

Customers expect suppliers to help them with project planning, connect them with reliable installers, support them in reducing carbon dioxide emissions, and provide customized solutions.

In other industries, such as chemicals and energy, price volatility and demand for customized solutions were already the norm. Companies in these sectors have found ways to master their margin management using advanced approaches for forecasting and smart contracting—for example, offering a portfolio of different contract types. In the historically more stable building materials sector, however, these trends have caught many players unprepared. Even leading suppliers don’t always have full transparency about the discounts they grant for different types of products and customers or the surcharges they impose for value-added services. As a result, they often have trouble assessing the profitability of potential added services or potential loss when the prices of raw materials are fluctuating. Additionally, many suppliers are bound by long-term contracts; these contracts limit their ability to adapt their rebate structures to constant changes in the cost of raw materials. In short, their profitability is coming under pressure.

Agile margin management will enable companies to protect their bottom line in a dynamic marketplace

These two trends—the imperative to decarbonize the global economy and the turn toward value-added services—are here to stay, and nobody knows how the supply situation will evolve in the coming years. This kind of volatility shows that building materials players will have to step up their margin management game to protect their bottom line. At the same time, they must stay afloat of the complexity in the industry, such as local needs and preferences, nontransparent data, and a complex multistep go-to-market setup. Inspired by the practices of pioneers in other industries, we present below five elements of agile margin management: margin transparency creation, agile price setting to adjust to cost changes, value-based pricing for added services, a coherent margin management and discount scheme, and investments in tools and capabilities that enable state-of-the-art agile margin management (Exhibit 2).

We strive to provide individuals with disabilities equal access to our website. If you would like information about this content we will be happy to work with you. Please email us at: McKinsey_Website_Accessibility@mckinsey.com

Create full margin transparency

Today, many building materials manufacturers don’t have a clear view into the drivers of profitability and potential margin leaks. This is partly because the sales function is often disconnected from other functions in the earlier stages of the value chain, such as procurement. Take the case of a prominent building materials manufacturer. At this company, it was not uncommon for sales repre­sentatives to negotiate contracts based on list prices that reflected the cost of raw materials at the time the negotiation was conducted—even up to 18 months prior to delivery. But because there was no clear communication between sales and procurement, the contract terms were never adjusted, not even when the prices of raw materials increased substantially and inflation grew. As a result, the company suffered significant margin leakage. In the future, building materials players will have to increase visibility, not only into past transactions but also with respect to future developments—for example, by taking advantage of state-of-the-art forecasting tools. Additionally, pricing agreements should allow for flexibility, and companies must use the best and the most recent data available when managing margin and defining discount schemes. More broadly, procurement and sales need to establish clear communication channels to facilitate the flow of information about changes in buying prices and other sources of uncertainty (Exhibit 3).

We strive to provide individuals with disabilities equal access to our website. If you would like information about this content we will be happy to work with you. Please email us at: McKinsey_Website_Accessibility@mckinsey.com

Adjust to cost changes with agile price setting

Traditionally, the building materials sector moves slowly. For example, a leading player used to conduct price negotiations with customers only once a year. The recent surge in the prices of raw materials, however, caused some products to become unprofitable within as little as six months. To make matters worse, the company’s pricing scheme included no precautions or buffers for cost increases. This gave rise to long and cumbersome renegotiations, causing further margin leakage and sometimes frustrated customers. The company has now introduced different types of contracts, including transparent rules for surcharges tied to the prices of relevant raw materials and shortened notice periods for postnegotiation changes. The company is also now supporting customers with planning tools and has adopted a more transparent and nimble approach in pricing.

The new scheme not only helps the company avoid renegotiations but also ensures that changes in the prices of raw materials—increases as well as decreases—can be shared with customers quickly. As a side benefit, this kind of transparent approach strengthens the supplier–customer relationship, which previously could be damaged by factors beyond the supplier’s control.

More generally, outperformers adopt agile price-setting practices to be able to react quickly and adjust their prices when the market situation changes. For example, a multinational engineered-plastics company experienced significant margin leakage when raw-material costs increased, but a lack of transparency meant the leakage initially went undetected. In response, the company set up a margin management control center and established an agile margin management squad. To enable the company to detect and counteract cost-induced margin leakage, the squad was tasked with systematic data collection and analysis, especially regarding cost drivers such as market price indexes for key raw materials.

Introduce value-based pricing for added services

Increasingly, building materials players see demand for services, such as planning support in the early design stages or help efficiently managing the flow of goods and pace of construction, in addition to their actual products. In the past, such services were sometimes offered as a courtesy or priced in ways that neither reflected the resources they absorbed nor the full value they created for customers.

In the case of one building materials manufacturer, because there was no clear pricing scheme for added services, construction companies and archi­tects kept requesting more and more planning support. (This was also partly due to increasingly complex regulation.) The time and effort that went into these services ballooned. Before long, the building materials manufacturer found that the resources committed to these services were interfering with other parts of the business.

In response, the company defined a surcharge catalogue in which value-added services were priced according to the effort on the part of the manufac­turer and the value created for customers. Additionally, the company defined rules for discounts to long-standing, strategic, or high-volume customers. This helped it to prioritize where to offer support and tailor that support to customer needs. Alternatively, if these services are still manageable by a company in terms of costs and resources, they could be used as a differentiator to competitors if offered free of charge. Effectively, building materials manufacturers must make a deliberate decision about which services to offer for a surcharge, for free, or at all.

Establish a coherent scheme for margin management, discount, and rebate setting

Sales representatives at most building materials players still have ample room for negotiation and price setting. As a result, the spread of profitability across products, accounts, and transactions can be considerable. Even the terminology is often inconsistent; for example, different sales represen­tatives may use different names for the same type of discount or rebate (for instance, loyalty rebate, long-term customer rebate, or simply customer rebate), making it nearly impossible to compare margin performance across sales representatives and accounts. In the future, building materials players will want to set net prices based on a more coherent scheme. This scheme should include a standardized terminology, clear criteria for granting discounts and rebates, and maximum discount levels for predefined types of products and customers.

One of the most powerful tools to ensure agile margin management is the microsegmentation of customers to determine the value created for each customer. Companies then must define target prices at all relevant intersections of customers and products or services; the input factors include customer type, current order volume, expected customer potential, and regional competitive intensity. The output can be combined with existing, attribute-based pricing schemes to boost profitability. Within each micro­segment, prices should be set consistently for all customers, using analytics to ensure effectiveness. Pioneers of data-driven microsegmentation and similar tools report EBITDA increases in the magni­tude of 3 to 4 percent with minimal customer loss and often higher customer satisfaction as loyal core customers get preferential treatment (Exhibit 4).

We strive to provide individuals with disabilities equal access to our website. If you would like information about this content we will be happy to work with you. Please email us at: McKinsey_Website_Accessibility@mckinsey.com

One of the most powerful tools to ensure agile margin management is the microsegmentation of customers to determine the value created for each customer.

Invest in state-of-the-art tools and capabilities

To enable agile margin management, building materials players should invest in capability building and the right tools for the job:

  • margin management tools to identify margin volatility and derive customer value with a mix of central steering and local autonomy, including support for e-commerce, to help building materials players react fast without extensive regular analysis effort
  • quoting tools, so sales teams can make fast decisions in the field by having the right quoting options and respective margins at their fingertips
  • performance management tools to monitor margin execution over time, to assess mitigation needs, and to identify priorities

When it comes to capabilities, building materials companies need to assemble dedicated analytics and data science teams to facilitate data analysis and derivation of initiatives. Bringing together data insights and market expertise from the sales teams enables building materials players to accelerate data-driven and agile decision making. At the same time, they should develop the capabilities of their sales teams, such as pricing products in line with the value they create for customers instead of the cost of production. To succeed, it is essential to ensure that sales representatives understand the value for customers and are prepared with the right talking points. Also, sales managers and sellers should receive training to make sure they are familiar with the functionality, the benefits, and the pitfalls of any new tools that are introduced.

Early movers can expect disproportionate rewards

The primary objective of establishing agile margin management in the building materials industry is to curb margin leakage—that is, to protect current profitability levels. That said, the comparatively low degree of margin management sophistication in the sector means that early movers can hope to reap disproportionate rewards. According to a recent McKinsey analysis, companies that use analytics effectively to drive marketing and sales performance are 1.5 times more likely than their peers to achieve above-average growth rates. 6 The paints and coatings company mentioned above, for example, took the steep increase in the prices of resin and other raw materials as the impetus to reinvent their entire margin management scheme with data and analytics. In an analytics sprint, the company unleashed the power of advanced analytics on their enterprise resource planning (ERP) data to identify margin opportunities and gaps. Based on those results, the company developed new margin manage­ment playbooks and implemented rigorous performance management to track target achieve­ment. After a successful pilot, the new model was rolled out globally. The entire sales force—more than 2,000 representatives worldwide—was trained to apply the new approach. The impact? A 7 percent increase in return on sales.

Companies that use analytics effectively to drive marketing and sales performance are more likely than their peers to achieve above-average growth rates.

Getting started doesn’t have to be difficult. The key point is for senior leaders to consider margin management as a primary strategic issue with the strongest potential for value creation. As a first step, building materials players should create end-to-end visibility in margin leakage. This will give all relevant stakeholders in a company a sense of the magnitude of the issue. Next, they must establish data-driven tools to define target prices and invest in negotiation training to empower sales repre­sentatives. Representatives must be equipped with clear reasoning to explain the price changes to existing customers.

A first rough analysis doesn’t have to take long. Depending on the data quality, four key levers for B2B margin management and pricing can be analyzed in only a few weeks. This gives companies the opportunity to evaluate quickly how to proceed and what to focus on (Exhibit 5).

We strive to provide individuals with disabilities equal access to our website. If you would like information about this content we will be happy to work with you. Please email us at: McKinsey_Website_Accessibility@mckinsey.com

An executive at a building materials OEM sums it up as follows: “Agile margin management isn’t rocket science, and the payback is substantial. We could have saved a lot of money if we had introduced this earlier. The recent price rally and resulting margin leakage was the wake-up call we needed to get going. Now, we are well prepared for future cost changes and evolving customer needs.”

Explore a career with us

Related Articles