Introduction
A flourishing economy. A squeezed labor market. Two of the biggest red flags of inflation have been apparent over the past few months. And concerns have been further driven by two factors - tariffs and trade disruption stemming from the protectionist measures in developed regions and supply chain pitfalls due to increasing shipping expenses and ongoing truck-driver scarcities.
The costs for several commodities have already climbed up, and things might go out of hand before getting any better. For instance, the U.S. Consumer Price Index (CPI) rose 5.4% over the 12 months that ended in June 2021. That is the largest gain since August 2008.
The world will witness a lull before the storm, and small and medium businesses (SMB) are currently stamping out their greatest brunt. Furthermore, the dynamics are all set for a possible long-term inflationary ecosystem that would be uncharted waters for many supply chain management experts, particularly with the trade-war rumors showing no signs of subsiding.
Beroe has been deeply embedded into procurement intelligence and supplier compliance for over a decade. It provides an end-to-end platform that offers a snapshot of category cost-inflation risk distribution alongside sourcing country risk. Beroe’s proven expertise in category/commodity price projection and cost modeling has made it a trusted partner for more than 17,000 businesses globally, including 400 of the Fortune 500 companies.
Check out Beroe LiVE.Ai, weigh the internal and external factors to devise the right approach for your business, and succeed during inflationary times.
The Impacts of Cost Inflation on Procurement
The post-COVID-19 inflation is already here. Organizations and people are already taking a hit. According to the European Central Bank (ECB), the consumer price index inflation in the European Union (EU) surged to 0.9% in January 2021, up from -0.3% in December 2020.
Moreover, the worldwide inflation rise is posing short-term threats to the economic structure. The OECD’s projections reckon that the current inflation rate in the G-20 countries will clock 3.7% in 2021 and 3.9% in 2022.
When procurement professionals analyze how inflation will make their jobs more challenging, reduced buying power is their primary concern. A long inflation period might be on the cards, and several professionals have never endured the kind of double-figure inflation that could be brewing.
Furthermore, escalated prices make it difficult for buyers to figure out the price hikes their suppliers require to counterbalance the effects of inflation, compared to the opportunistic price surges. This is particularly true in commodity industries, where manufacturers have survived years of low margins and will look for a rebound in an inflationary ecosystem.
5 Inflation-fighting Strategies for Procurement Teams
Inflation warnings are hitting the headlines, and the impact of increasing prices is visible across several industries. Indeed, the services purchasing managers index (PMI) hit an all-time high of 63.7%, while the manufacturing PMI reached 64.7%, surpassing the 1983 numbers.
Procurement teams can implement five battle-tested strategies to navigate an uncertain market – cost inflation and unemployment, supply-chain disruptions, and capacity constraints.
With that said, the ideal strategy will rely on the situation.
Revisit your Financial Risk Roadmap
Several companies dealing in commodities will implement measures, such as hedging to shield them from increasing prices. Should you relook at your financial risk appetite and hedge more to curb the scale of inflationary risks?
The answer will vary for every company based on the commodities that they bank on. However, organizations eventually need to take a deeper dive into their projections and financial structures to determine whether their assumptions about future cost volatilities still remain valid and their effect on the overall business.
Rank Categories based on their Exposure to Inflation
Businesses should prioritize categories depending on an exposure matrix considering inflation and the scale of exposure to the market forces.
Identifying which categories are facing inflation - and how much of that inflation is structural - is quintessential. A nodal assessment will be an effective starting point. It enables the procurement team to split independent spend categories into various regions (or nodes) to plant level, as per the organizational structure. These nodes can then be classified by whether a contract prevails and if it is indexed.
Exposure is maximum in index-driven contracts (those that utilize indices for cost adjustments), alongside contracts and spot buys that are ready to negotiate over the coming 3-6 months. This approach provides a crystal-clear view of which categories procurement teams must protect from cost inflation, and which reflect opportunities.
The Concept of “Should Costs” and “Embedded Costs”
Negotiation provides further scope to tackle cost inflation. Methods, including bundling separate purchases to trigger bulk discounts and leveraging should-cost models as per the current costs to understand suppliers’ underlying price exposures, can create potential saving opportunities.
A more elaborate method forms an embedded-cost assessment to clarify further what is driving the costs, what is happening with those price drivers, and how to use this data during negotiations.
Establish a Broad Array of Mitigation Forces
Having an extensive range of technical and commercial levers at hand strengthens a company’s defensive position against cost inflation. While some levers have an immediate effect (to alleviate price hikes), others are forward-thinking (to level up resilience).
Technical: Firsthand technical forces to minimize fluctuations consist of expediting value engineering and tweaking order frequency or batch sizes. Businesses can often find a longer-term technical lever to enhance resilience through decreasing SKUs or high-cost attributes by changing the specifications. To tackle near-term fluctuations, opportunities include maximizing the vendor foothold for better management of cost, logistics, inventory, and tariffs. For the longer term, technical levers that counter fluctuations might include
- strategic inventory hoarding,
- more reliance on supplier-controlled inventory,
- collaborating via end-to-end supply chains to de-risk specific nodes, and
- extending cross-sector partnership to distribute commodity exposures
Commercial: Firsthand commercial opportunities generally incorporate optimizing the expenditures on the present agreement that are not echoing inflation or demanding restorations on commodity declines over previous time frames wherein the costs prices stayed flat. Tech-based solutions deliver should-cost models faster for significant portions of expenditure, letting the procurement team gauge the magnitude to which inflationary pressure on materials will impact the supplier prices. To enhance future agility, vendor partnership can fuel collective efficiencies and boost the total cost of ownership (TCO). At last, organizations must ramp up the collaboration between pricing and procurement crews to assess the potential impacts on the costs the company itself demands.
Time is a paramount factor with both the mitigation forces.
Work with your Suppliers to Discover Solutions
One of the best ways to handle increasing costs is to sit down with your vendors and discuss your issue with them. Often you will find that they will be willing to team up with you to devise new solutions.
The tweaks you make along with your vendors will not only help you manage prices but also offer new options that boost efficiency and improve ways of operating.
Prepare your Business for Inflationary Risks with Beroe
No matter the industry, organizations need a robust operational and financial strategy to tackle the negative effects of inflation on their business and implement measures to minimize them.
Count on Beroe.
We regularly help our customers boost cost savings, reduce spend, and avoid inflationary risks – all through our category cost inflation solution. Businesses can deep-dive into the possible effects of inflationary headwinds on a specific category. Consequently, this will help them understand the supply-demand trends over the coming 6-12 months based on logistics, market, and macroeconomic conditions.
Our AI-driven platform understands your sourcing requirements and provides contextual insights in a flash. Such accurate industry data will help you present your case better during quarterly business reviews (QBR) with your colleagues and shareholders.
Time is precious (and money, of course), and we understand that completely. Our inflation-combating solution provides all the relevant compliance information - ethical, financial, and environmental certifications – about suppliers at a click.
And as leading procurement consultants, the professional experience we bring through years in the field is unparalleled.
Book Recommendations
Measurement of Inflation for Unique and Long-term Procurement Contracts: Defence Perspective
This research study helps readers determine how to calculate the relevant measure of inflation for price fluctuations in defense contracting. Written by Olivia Oi Yi Tsang, it runs deep into a “three-stage modeling strategy.”
The first phase discusses choosing a suitable index or indices, the second phase discusses correcting the index number bias, and the third stage walks readers through index forecasting.
With a demonstrative example of combat vehicle procurement, readers can understand the implications of leveraging such a model. Moreover, the author has included a comparative assessment between the single and multiple index approaches throughout the study to compare the resulting inflation under each category.
The research points out that the single index approach provides undervalued inflation with indexes. On the other side, the multiple indices approach provides an overvalued composite inflation, stemming from a broad range of cost component indices, if productivity is left out during calculation. Following these findings, the talks about correcting the adjustments to offset these challenges in the research paper.
Check out the preview of this book here.
Money, Inflation and Business Cycles: The Cantillon Effect and the Economy
Economists worldwide are yet to properly uncover the cost inflation problems concerning the Cantillon effect - distribution and coat impacts due to irregularities in the money supply and their effect on the economic structure.
Arkadiusz Sieroń bridges this crucial gap in “Money, Inflation and Business Cycles.” This literature categorizes multiple channels through which businesses can add new cash to the economy. Additionally, it explains the importance of money supply upsurge and how it occurs.
By investigating the increase in money supply (under the flag of Richard Cantillon), the author provides a critical analysis that fosters the development of several sub-categories within economics and offers a deeper knowledge of numerous economic functions. Moreover, he underscores the theory of money and inflation, the business cycle and price bubbles, and the idea of banking and central banking.
As such, this book will help readers understand the role of monetary factors in the economy and the legitimacy of a lax financial system. Further, the focus on the distribution effect of cost inflation makes this book a must-read for policymakers, researchers, and anybody associated with monetary economics. On Amazon, it has secured a 4.0/5 rating
Check out the preview of this book here.
Frequently Asked Questions
How do cost inflations affect businesses and consumers?
The risk of cost inflation has returned to the radar screen of policymakers and businesses, with a gradual upsurge in goods and services pricing over time. It devalues the currency units (INR and USD), leading to repercussions, including a higher cost of living. Besides, cost inflations pose the following challenges for businesses:
- Customers might not be able to purchase as many services or products as earlier
- Companies might have to pay higher sums for basic materials and components, and particular items might be in short supply
- Running a business can consume more capital resources
- Concerns of rising workforce costs
How can procurement teams address cost inflation risks?
In times of inflations, procurement leaders can follow five steps to grab the maximum value available to minimize unnecessary costs, optimize supply availability, and look for potential avenues:
- Go back to your financial risk strategy and check if your future cost assumptions still hold true and determine the impact of price hike on your business
- Sort the categories as per their exposure to cost inflation risks
- Know the potential of should-cost and embedded-cost models
- Define a large set of mitigation forces to bolster your defense against inflation – both from technical and commercial standpoints
- Create strong partnerships with your vendors to look for suitable solutions
How can businesses spot efficiencies in their supply chains?
Nearly every business can identify further efficiencies from their supply chain management. While there are several ways for this, obvious examples include stepping up order quantities or modifying the same product organizations are ordering to fetch a better value.
This is about systematically looking over your prices - going contract by contract and locating where you can perform things distinctly to manage prices or cut them down (offering you better flexibility to absorb cost inflations in other domains where you have relatively lesser control).
What are the major inflation mitigation forces?
Businesses can focus on two critical mitigation forces to protect from cost inflation: commercial levers and technical levers.
Commercial levers to mitigate price volatility include increasing the spends on the existing agreement that are no longer vulnerable to inflation or issuing claw-backs on commodity slumps over the past one year where costs have remained steady.
Immediate technical levers include speeding up value engineering to slash the demand, as well as modifying order frequency or batch sizes. On the other side, longer-term technical levers include strategic inventory stockpiling and stretching cross-sector cooperation to distribute commodity fragilities.
Why should we approach Beroe to minimize the cost inflation risks on our business?
Beroe creates the category-specific inflation-fighting strategy that suits your overall business strategy, risk appetite, end-product industry dynamics, operational limitations, and vendor relationships. To build the index, our category cost inflation mirrors the category cost model, inflation parameters, and logistics expenses. In addition, you can spot no-risk substitute vendors and sourcing destinations.
Beroe brings expertise and experience gathered from collaborating with thousands of customers and fuses industry best methods with a solution tailored to your environment and devised to meet your organizational goals.
Monitor prices in real-time, react promptly to address immediate problems and execute plans to mitigate the potential inflationary risks. Check out Beroe LiVE.Ai.