Raw material prices aren’t the only growth in an inflationary price increase – margins are inflating too
Post-pandemic inflation has arrived and price increases are far reaching. But increases based on raw material and supply chain challenges are likely not the only elements in your new pricing. Past experience, as well as more recent reporting indicate there is a high probability that margin increases are also a part of the new bottom line. Purchasers must be diligent in understanding cost inputs and current market conditions to ward off price creep in their procurement and supply chain.
Demand Is Running Away From Supply
The Ivey Purchasing Mangers Index (PMI) is a leading economic indicator of economic activity based on purchasing managers activity in all sectors of the Canadian economy, as well as a tool used by manufacturers and suppliers to inform pricing decisions. The Ivey PMI also quantifies related data on aggregate delivery of purchased items and pricing. The story these numbers tell fit with the lived experience of mining procurement departments today - buyers are working overtime to source materials, deliveries and availability are not keeping up with demand, and prices are creeping higher all the while.
In some sectors, inflationary prices are already being felt. Lumber prices have been a leading story in Canada as the overall the overall price increase for building materials has skyrocketed. Look no further than two-by-fours, which have doubled in price and are still in short supply.
In other sectors, price increases are coming online now and a pricing crunch is just around the corner. In the OEM space, demand is high; major manufacturers have reported surprising 2020 Q4 sales as dealers moved pandemic-stalled inventory and, moving forward in time, early 2021 Q1 reporting shows very promising, double digit growth in orders for other manufacturers.
Increased Demand is Just One of the Challenges Facing Suppliers
Meeting increased demand isn’t the only pressure fueling inflation, as trickle down supply chain challenges ignited by COVID continue. For OEMs, a global shortage of semiconductor chips are likely to be a stumbling block for production and could stall deliveries as the year progresses.
Plastics are another category struggling to meet demand after experiencing a litany of external disruptions and raw material shortages, and create a broken link for categories ranging from food packaging to PPE.
As we have learned over the past year, ongoing management of the pandemic and regional outbreaks also impact inflation as manufacturing shutdowns throw another wrench in the supply chain.
If all this isn’t enough, freight rates and container availability are front page news. Between backlogs in multiple ports, a recent blockage of the Suez Canal, and a shortage of shipping containers (for which container manufacturers do not even intend to increase production to meet demand in order to keep their prices high), shipping is another aspect of production poised to push prices higher.
The Price you See May Contain More Than Cost-Push Inflation
To counter the brew of rising costs brought on by raw materials, material shortages and shipping delays, many manufacturers’ prices are delivering a one-two punch to recoup their own increasing costs; through price increases and reductions in discounts.
While purchasers will be well versed on cost-push inflationary increases onboarding now, buyers should also be diligent in ensuring that extra margin isn’t built into new pricing. Recent research from Credit Suisse Group shows a strong historical correlation between passing on manufacturing cost increases with profit margin increases at the same time.
As the season of early financial reporting commences, there is more data to support the need for a critical eye for pricing; industry analysis from the steel market notes that gross margin increases are already in place and will persist through this boom; reporting from the tire industry indicates that profitability is on the upswing, with Q1 2021 gross margins increasing nearly 25% compared to Q1 2020; and another major OEM noted "significant margin improvement" in a 2021 Q1 report.
Rising costs are a real struggle for suppliers in the current environment and inflation is the reality for much of miner’s spend in 2021 and into 2022. In this buying environment, procurement specialists must be well versed in market analysis and must be doing their pricing homework to understand rising costs to ward off supplier margin increases and price creep.