For 20 years, inflation has been nearly flat, edging up only modestly. But that’s changing, and it’s throwing a curveball at procurement organizations in businesses across the country.
“The combination of overall price inflation and commodity price inflation that’s happening right now is a trend we haven’t had to deal with in quite a long time,” says Lane Burkitt, managing director at the Institute for Supply Management.
For most procurement leaders, this shift is creating a lot of uncertainty when it comes to meeting corporate needs and continuing to grow.
In a survey by ISM and global management consultancy A.T. Kearney, 48 percent of procurement leaders reported that they lack certainty about how to plan in this environment, while 46 percent cited concerns about how inflationary factors might stunt their businesses’ competitiveness.
What’s Causing Inflation? The Commodity Pinch
“Right now, in the beginning of what we feel is going to probably be a long trend, the inflationary environment is being driven by the commodities markets,” Burkitt says.
That’s a real fear that procurement officials are already voicing. In the ISM survey, 62 percent said they are “very concerned” about inflation of raw materials and commodity inputs.
Prices in many of the metal markets are “increasing at a fairly rapid rate and have been doing that for a bit now,” Burkitt notes. Oil and gas prices are more volatile but also are trending upward.
Prices are going up because of increased demand during a strong economy, he says. Recent tariffs on products imported into the United States are further fueling price increases and reducing supply sources for some commodities, Burkitt adds.
The Millennial Factor
For longtime procurement professionals, the inflationary pressures might feel familiar. But that won’t be true for everyone, Burkitt says. Given that many procurement offices now are run by or have many millennial workers, some businesses have teams that simply have never had to manage around inflation.
Some younger procurement professionals haven’t “really experienced the kind of inflation that we’re seeing or that we’re expecting to see — especially in the next few years,” Burkitt says.
In the recent past, when spot product prices from suppliers edged upward, procurement shops simply negotiated and used hardball tactics to keep prices down by cutting into their suppliers’ margins.
But that approach could fail in an environment where raw materials and commodity inflation come into play, Burkitt says. There’s no mythical margin to negotiate around.
No Way Around the Shipping Dilemma
Inflation’s impact on product pricing can be seen clearly in the transportation industry. Demand for freight and shipping has simply outpaced supply, with the load-to-truck ratio the highest it has been in five years, according to ISM.
In the short term, ISM predicts that will translate into a price hike of 4 to 8 percent for road transport rates. That has a trickle-down effect on manufacturers and suppliers, which in turn must raise their prices to make even a minimum margin.
“Knowledge of the cost breakdown of the product you’re buying gives you real information to understand your suppliers’ cost models.”
Good Times, Higher Prices
Another big factor causing this inflation is the healthy economy, Burkitt says.
“Globally, economies are growing, so there’s more demand,” especially for raw materials and labor, he says.
Once again, the transportation industry provides a good example. “There’s a real squeeze and bottleneck in the logistics area and transportation right now,” Burkitt says. There simply aren’t enough truck drivers. “Truckers who might’ve made $80,000 or $90,000 in a good year in the past are making closer to $150,000 now.”
Learning to Manage Around Rising Costs
These evolving pressures will slowly begin to affect business overhead costs in the form of price hikes for the many goods used daily for basic needs (office and cleaning supplies, for instance) and more strategic items (such as technology and support services).
To manage finances effectively in an inflationary environment, procurement teams need a thorough understanding of total supply costs — an explicit breakdown of what makes up the price for any product a business buys. Just because the price for a specific type of steel goes up 30 percent, should a business accept a comparable price increase for a product using that metal? Of course not, Burkitt says, as it’s only part of the pricing equation.
“Knowledge of the cost breakdown of the product you’re buying gives you real information to understand your suppliers’ cost models,” he says. It lets a buyer know when a price increase is a pass-through of commodity cost increases and when there may be room for negotiation.
Procurement experts also will want to set their sights on potential opportunities and be proactive, Burkitt suggests. The ISM survey found that 58 percent of procurement teams rely on ad hoc, in-house and institutional knowledge about their supply markets.
That’s no longer going to be viable, Burkitt says. Procurement organizations need to leverage market analytics based on public and private data to better read market trends and understand how the fluctuations impact their costs.
Then, procurement can collaborate with other internal teams to set financial targets and establish agreements with suppliers that will benefit the company in the long term, Burkitt says.