Many businesses are facing increased costs
This is not necessarily a new business challenge… but the COVID-19 pandemic is driving significant and unpredictable “price spikes”.
Let’s look at what business leaders should be thinking about in this environment.
First, what is driving these changes?
Here are some of the important factors influencing the cost of goods and services:
- Many manufacturers reduced capacity early in the pandemic. When demand increased faster than expected, they were not able to ramp up capacity to meet the demand.
- Prices of many commodities and raw materials have risen dramatically. Steel prices are about three times higher compared to one year ago while aluminium prices hit a nine-year high in June 2021.
- The semiconductor chip market is facing global shortages which affect the manufacturing capacity of everything from new cars to power supplies.
- Global supply chains are unstable, as different regions deal with lockdowns and other business interruptions.
- Demand is also volatile as buyers consider their options during a period of great uncertainty.
This results in higher costs and limited supplies of production materials, which are expensive to transport.
What’s the outlook?
The outlook is uncertain. In some cases, we may return to pre-pandemic prices and, in other cases, there have been structural changes that will not be reversed. Business leaders have the tough job of navigating through this uncertainty!
What are our options as business leaders?
One option is to “wait and see”. This may be the most prudent choice in some circumstances but there is a risk that competitors will do a better job of managing their response to increased costs.
Another approach is to try and address some key questions… and then develop a strategy. The list of questions will vary by industry/business, but here’s a general approach:
1. What’s happening in our business exactly?
Which input prices are going up and by how much? Are these increases temporary or permanent? Are the price increases predictable or erratic? Are we near peak pricing? Clarity (or at least a theory) on these basic questions provides a foundation for strategy.
2. What is the (potential) impact on our business in different scenarios?
Whether we “wait and see” or raise prices, we should understand:
- What happens to our product profitability as input and sales prices change?
- How is customer demand impacted by increased prices (price elasticity)? At what point will customers look for substitute products?
While your customers are critical in this analysis, consider also how employees are affected due to rising costs, e.g. higher energy bills.
3. What actions can we take?
There could be various options such as:
- Improving procurement practices: Competitive bidding? Renegotiating terms? Changing suppliers? Hedging? Long-term contracts? Holding suppliers to account should ensure that price increases are occurring due to market forces.
- Updating incentive systems for sales and procurement teams: If these are based on lagging costs versus actual achievement, we may not encourage the best commercial decisions.
For those who pass on cost increases to customers:
- Price indexing versus price renegotiation: Both approaches have advantages and disadvantages
- Customer Communication: A price hike is unlikely to be well-received… but ‘softening the blow’ can positively distinguish a business from the competition.
4. Is our financial reporting frequent and accurate enough?
Management’s challenge is ongoing, not a one-time decision / event. We need:
- BOTH analysis of historical data AND an understanding of forward-looking gross margins on a monthly or quarterly basis. This requires transparent and accurate cost accounting.
- To understand the time lag between taking action and seeing results.
- A dedicated team overseeing this and presenting recommendations. Some businesses are establishing an ‘inflation team’ for this purpose.
Not surprisingly, seismic shifts in the business environment present opportunities as well as challenges. Your competitors are dealing with a similar situation, and you may capture additional business from existing or new customers who are disgruntled with other suppliers due to volume or price issues.
And the benefits from revisiting procurement practices to drive margins can be significant and long-term.
The challenge and impact of cost increases are specific to each business. And while things remain uncertain, management should expect the unexpected and make judgment calls, based on solid strategies, market insights, and a clear understanding of cost drivers.
Where necessary get advice from experts in this field.
Need help with cost accounting to drive your profit?
Contact Alliott NZ Chartered Accountants and Business Advisors in Auckland on 09 520 9200.