It can feel like there are few benefits to inflation — especially now, with prices shooting up right across the economy. But the crisis also presents opportunity, no more so than for industrial goods firms. We examine what firms can do now to protect themselves against the worst of high inflation, while using the time to deliver a leaner, more productive firm in the long-run.
Think in scenarios
Open up any financial newspaper and the odds are good you’ll find a columnist barracking the central banks and other forecasters for missing the signs of runaway inflation. It’s not that long ago that respected European analysts were predicting inflation might peak at around 4 per cent. Unfortunately, inflation is difficult to predict.
It is unclear at this moment just how strong and long this inflationary phase might be. Much of the muscle behind today’s upwards push comes from geopolitical events — both Russia’s invasion of Ukraine and the effect on energy prices, and the impact of China’s ‘zero-Covid’ policy which has played havoc with global supply chains. Uncertainty around those two add to other question marks, especially with currency fluctuations leaving — for instance — the euro at its weakest against the dollar in years. So firms in the industrial goods sector need to plan, soon. Prudent companies not only prepare for the ‘soft’ scenario, with inflationary pressures petering out and the world avoiding recession, but for the worse and indeed worst case. The best time to plan is yesterday, but the second best is today. Doing that helps you stay ahead of the competition, no matter what happens to inflation.
Understand the root causes
While we can’t predict inflation, we can broadly understand its root causes. While some inflation is temporary, some is here to stay. Each type needs to be addressed in a different way.
The inflation that results from temporary supply chain shortages (gas, wood, containers, etc.) will reverse over time. What will remain, however, is a strongly increased volatility in commodity prices, at least when it comes to geopolitics. Therefore, companies will need to up their game in fighting volatility.
Some cost inflation is here to stay, however, especially as (partially temporary) price increases work their way through wage and salary increases, further fuelling inflation. That vicious circle – a so-called wage spiral – can seriously bite into profits. For example, currently discussed wage increases of 8% - that requested by one of the largest industrial worker unions in Europe – would cost an average industrial goods companies more than 25% of their profit if no action is taken. Companies who embrace the opportunity to build a leaner and more resilient business will emerge stronger.
The violent price hikes and volatility in raw material need to be addressed by risk and margin management techniques; industrial companies need to up their game in these traditionally less developed capabilities.
In build-to-order and project businesses, companies need to ensure that there’s an in-built connection between commodity prices and sales prices — using tools such as index clauses or price hedging. In build-to-stock companies meanwhile, price increases — though inevitable — are best done early on and at shorter intervals, with a more conservative approach to price reductions.
And on the procurement side, companies need to be wise to what on the High Street is called ‘ripflation’ — where inflation is used as an excuse to ramp up prices more than is warranted by cost increases. Indexation or temporary ‘supplements’ can be viable instruments here, and firms should particularly keep an eye on part categories that are often under the radar in the current supply constraint situation.
Build a leaner and more resilient business
To address the cost inflation that is here to stay, companies need to follow more traditional cost management approaches and embrace the opportunity to rethink parts of the operating model. It’s often in these tougher times that firms make themselves stronger: not just by cutting budgets, but by addressing cost bases in the longer term (as well as fighting short-term volatility).
It will mean doubling down on long-term productivity. The automation and digitisation agenda, for instance, needs to be driven harder at goods firms, with investment now paying off with cost savings in the future.
Reconfiguring supply chains should be on the agenda too, weighing supply security and shipping costs higher than in the past, which should lead to supplier diversification and some level of near or re-shoring. This may result in cost increase in the short term – but better cost control in the long run.
Rethinking operational scope can help, too. Creeping energy costs have been one of the key drivers of inflation. But what if you could become independent from market rates? Renewable technology gives firms the chance to bring their power generation ‘in house’ while also helping firms get closer to net zero.
A watchful eye on working capital and fixed assets is also more important than ever, as inflation forces the hand of central bankers who across the world are hiking interest rates.
The tough get going
Bosses at Blackrock say the era of steady growth and steady inflation is over — and they’re probably right. Whilst that presents plenty of challenges, it means those firms who become complacent will struggle — while those who adapt will thrive. Firms will need to be leaner and smarter than ever to pivot with the global economy’s many changing demands. Positioning yourself for the future may require some hard thinking now, but it’ll certainly pay off down the line.