Overcoming the Impact of Global Inflation
As inflation gets worse and worse, it’s up to Procurement professionals to work harder and harder to help keep costs under control – and there are several steps to take, as Gary Wollenhaupt writes
Tesla has quietly raised prices on its cars over the past few months, and Elon Musk has tweeted he would lower prices if or when inflation “calms down”. Prices for essential materials like lithium for car batteries and carbon black for tyres are skyrocketing due to the conflict in Ukraine and higher costs for production elsewhere and shipping.
Companies like Tesla are caught in the grip of inflation, and some procurement pros are using innovative strategies to reduce the impact on their budgets.
A few companies have found ways to fight back against inflation. A U.S. seafood restaurant start-up bought its own lobster wharf in the coastal state of Maine. Although headquartered in the desert city of Phoenix, Arizona, owner Tony Christofellis spent millions to buy a lobster fishing and processing operation to control procurement and supply chain costs. His goal was to vertically integrate procurement to cut out layers of distribution that added costs from the seaside to the table for Angie’s Lobster stores.
Some companies are sharing higher costs with customers. Restaurants like Burger King have cut back on the number of chicken nuggets in a serving but kept prices the same. McDonald’s has allowed franchisees to raise prices.
Unfortunately, inflation is a fact of life right now. The United Nations projects global inflation will increase to 6.7 percent in 2022, twice the average of 2.9 percent between 2010-2020. The United States has reached its highest level of inflation in 40 years. Annual inflation across the Eurozone is expected to peak at 7.6%. In developing regions, inflation is rising in Western Asia, Latin America, and the Caribbean.
On top of the disruption from the COVID-19 pandemic, the Russian invasion of Ukraine has magnified the slowdown in the global economy, which is entering what could become a lengthy period of weak growth, according to the World Bank’s latest Global Economic Prospects report.
In March alone, data from the Department for Business, Energy and Industrial Strategy (BEIS) reported the cost of reinforcement and other commodities affected by the Ukraine crisis rose by over 30%.
Once again, procurement leaders are being called on to overcome the double jeopardy of rising inflation and supply shortages.
There are few industries or products that have escaped this squeeze. Consultants Bain & Company reported some of the all-too-familiar effects of inflation:
- An agricultural raw materials converter experienced a 275% year-over-year cost increase on its most critical ocean freight lane.
- A consumer products company was hit with 25% cost inflation on critical packaging subcategories, lowering product margins.
- A global automotive supplier saw rubber costs increase 30% due to rising crude oil costs, freight rates, and constrained supplies.
- Russia supplies Europe with between 25% and 40% of the contents of ammonia found in fertilizer, leading to shortages in basic food stocks.
- Although lumber and steel prices have fallen from their 2021 peaks, they are substantially higher than in mid-2020: more than 75 percent for lumber and more than 200 percent for steel. Polyethylene prices also reached historic highs in 2021, diverging from long-standing correlations between the price of oil and ethylene.
- Ukraine furnishes half the world’s supply of neon, a gas used in the lasers that make semiconductors
These economic pressures have accelerated procurement’s transformation from a transactional function to a vital enabler of business growth, supporting multiple objectives of agility, transparency, resilience, collaboration, and social impact.
To help mitigate the impact of surging prices, procurement leaders are finding success with these steps:
Share Best Practices and Resources
Procurement teams can become the center of excellence for best practices across the enterprise’s diverse lines of business. Procurement often has a unique view of direct and indirect spending, monitoring the purchasing patterns and habits to find commonalities in needs, such as using common applications or machine tooling.
Work with finance, sales, and marketing to review opportunities for indexes in supplier contracts to be symmetrical with those used in commercial contracts to allow inflation costs to be passed on.
Look Beyond Basic Spend KPIs
Work with internal stakeholders to understand the business value that particular products provide. For example, specifying premium machine tools means acquisition spend goes up, but production and longevity improvements more than cover the additional expense compared to low-price options.
Focus on categories that present the worst inflation risk for the company in categories with significant spend. Assess contractual levers such as duration/term, indexing, limits to price escalations, and price adjustments frequency. Any risk potential should be evaluated, and contract terms adjusted accordingly.
Procurement Becomes a Crisis Response Resource
Before the pandemic, products like face masks, gloves, hand sanitisers and Personal Protective Equipment (PPE) were just another line item on a PO. But they quickly become a strategic item that directly impacts the organisation’s ability to do business. Those procurement organisations that could deliver PPE added strategic value to the company.
Going forward, the only sure thing is uncertainty. When the next unimaginable event hits, highly responsive procurement teams must be prepared to help to minimise the impacts of events on the organisation.
Mobilise the procurement organisation to coordinate efforts with the finance, sales and marketing functions and gain buy-in from leadership to launch an inflation-protection program.
Dig Deeper Than Spend Analytics
Although procurement teams have a wealth of data, they may miss powerful opportunities to create value. Many professionals have never encountered an inflationary environment like this one. Focus on the things you can control—oil prices are out of your hands. Break down cost models to understand the drivers behind them and create short-term forecasts based on the factors within your grasp.
Reconsider the sourcing strategy to mitigate inflation’s effects and create long-term benefits. Consider shifting sourcing to regions with a cost advantage or explore adjusting product formulations and specifications to account for differences in input prices.
Don’t Look Back
Exploring short- and long-term solutions to invigorate the pricing perspective is critical. Though complacency is not an option, things won’t go back to the way they were. Protecting against inflation typically requires changing procurement’s operating model to incorporate new analytics and building a cross-functional approach to manage rapid price changes and other challenges. A practical, coordinated inflation management program will demonstrate the impact of the procurement organisation on strategic issues and financial outcomes.
How is your company managing rising prices due to inflation? Let us know your strategies in the comments below.