No Twinkie Defense for Rising Commodity Costs: Hostess Files for Bankruptcy

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Having spent the better part of a day earlier this week attending a seminar on Effective Financial Management, led by Glenn Waring of Effective Organization (a great seminar, I would add) and re-learning how a company can calculate its “Z” score (defined as the likelihood of ending up in bankruptcy), I found it ironic reading about the latest manufacturer, Hostess Brands (you know, of the Ho-Ho variety) filing for Chapter 22.

A Chapter 22 bankruptcy filing indicates a firm has filed for bankruptcy once before (I guess that makes sense: double Chapter 11 and get Chapter 22). What struck me as interesting involves the reasons behind the bankruptcy. According to the Wall Street Journal, Hostess “has been facing a cash squeeze amid high labor costs and rising prices for sugar, flour and other ingredients.”

The bulk of the article covered the labor angle of the bankruptcy, the typical pension costs and labor agreements with various unions. The article did also mention that additional financing would be required to update outdated and inefficient equipment.

MetalMiner sources have also suggested the bankruptcy came as a result of too many layers of top management, high CEO bonus pay, and some plants not operating profitably. In addition, big box retailers such as Target and Wal-Mart set the prices for key products, often leaving little to no margin for suppliers.

But we can’t help but think that some of the bankruptcy filings by manufacturing organizations in general — and Hostess in particular — may have more to do with managing commodity volatility than labor costs. Couple that with tough customers, and if a manufacturing organization does not have world-class commodity management skills, one can see how companies get in trouble when it comes to cost risk.

Managing Commodity Volatility

Though I’m clearly not a bankruptcy expert, I know that a slight upward tick of a company’s cost of goods sold can quite profoundly impact gross profit. And manufacturing organizations automatically have higher COGS as a percentage of sales than other types of companies (e.g. services firms). We have to ask a few questions about how Hostess Brands managed their volatile spend. For example:

  1. Does the company make use of a hedging strategy? (Formal or informal?) By formal, we mean actual use of futures contracts on exchanges e.g. wheat, sugar, butter, fuel or informal contracts such as off-take agreements or annual contracts.
  2. Does the company regularly engage in purchase price benchmarking both with others in the industry as well as key industry suppliers?
  3. Does the company build forecasting and predictive models for key raw material inputs and then develop strategies to mitigate price risk?

MetalMiner spoke with Beth Fahey of Creative Cakes, who also sits on the board of the Retail Bakers of America, about how bakers can stay competitive and manage ingredient volatility.

“Bakeries need to focus on what sells,” Fahey said. “We cut a good portion of our miniature pastry line because we can’t afford to put anything in our case that doesn’t sell.”

Part of her strategy with her own staff involves teaching her team about product costing so that everybody pays attention to sugar and flour. She likes it when the whole team knows how to calculate margin on products and where and when the bakery can raise prices. Creative Cakes recently raised cupcake prices by 31 percent, but still comes in far below the competition.

“As long as the price point is under $3, we’re in good shape,” she said.

–Lisa Reisman

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