According to Gartner research, 74% of CFOs believe lower profitability is the biggest risk of input price inflation. Input inflation is usually caused by non-equal supply and demand- which could be anything from transportation to raw materials to labor.
Some of these challenges may sound familiar in today’s market, and input price inflation pushes up the costs required to produce goods and services across the board. Rising labor costs seem to be the biggest issue, as this applies to every company- whether it be physical goods, or services with few raw materials on the input side. But labor costs are often organizations’ largest line items.
While the automatic reaction to rising input costs and shrinking margins is to raise prices, this isn’t always the best answer. Being that rising costs are not slowing down anytime soon, CFOs need to take long term action in order to develop effective ways to mitigate the margin pressure they create. Finding ways to manage margin pressure and avoid raising prices whenever possible is key to keeping customers, maximizing profits, and staying ahead of the competition.
1) Rethink Price- Setting Decisions
The automatic reaction to input price inflation is to increase product and service prices arbitrarily. But there are many other influencing factors to take into account:
Necessity vs. luxury- If the good is a necessity (food, water, rent, etc.) then consumers are left with little choice but to pay the increase. However, if the product or service is a luxury, then many people might give up on it if the price is raised. Will the price increase chase more customers away than the profit margin lost to input price inflation?
Competition- Even if the product is a necessity, consumers will likely go elsewhere if there is competition for it. In addition, if competitors are not raising prices, pursuing volume adjustments over price increases is a better strategy.
Temporary- If the input price is temporary then avoid raising prices, as consumers will automatically associate the raise as a negative aspect- even if it’s only short term. It may be worth it to absorb a smaller profit for a specified period of time and keep long term customer loyalty.
Profitable customers- If certain customers are profitable, reserving supply for them and introducing premium versions of the product or service in order to pass on price increases is a good way of avoiding negative consequences of outright raising prices.
2) Improve Insights into Supply Chain Dynamics
As a reaction to input price inflation, many companies look to diversify their supply chain in order to improve their availability and competition. Gartner research found that 46% of companies have attempted to do this in face of rising inputs. While this is a great start, those who want even more of an edge need to pursue other options such as gaining greater visibility and control over inputs and using technologies to forecast cause and effect scenarios.
- Taking on supply head on- With price increases here to stay, companies should consider making capital investments in direct suppliers or service providers by cutting out the middleman, increasing capacity, and improving cost positions. Sometimes these relationships or deals are expensive and international, but the long term vision and significant impact on final prices can make it worth the effort.
- Automation technologies- Getting a better grip on the overall finances of the company will help identify what needs improvement, even when it’s not directly related to price input. FP&A solutions help automate and accurately analyze budgeting, forecasting, and most importantly, what-if scenarios, which all help a business understand how the profit margin directly affects different business aspects.
- Deepening the supplier base- This doesn’t just mean broadening the amount of suppliers you work with, rather deepening the company’s understanding of suppliers’ capabilities and long term product roadmaps. Similar to taking supply head on, deepening the understanding takes a lot of time and resources but can greatly help reduce risks from input price inflation and improve supply chain resistance.
3) Rethink Hiring and Retaining Talent
The biggest reason for input price inflation- one that affects everyone- is labor prices. Assessing recruitment and salary setting approaches can mitigate this.
- Skills over experience- Oftentimes it is far more efficient to find employees with the necessary skills and motivation for the job, even without the usual experience that is expected. These employees are more abundant, and developing retraining programs or upskilling can solve the problem of input price inflation rather easily.
- Different types of employment- With the rise of remote work, there are far more employment options available. Freelancing, outsourcing, or part time positions can open up the talent pool far beyond what most people are looking for and cut down on time and costs simultaneously.
- Adapt to new working conditions- This includes modifying compensation packages that fit better for both the company and the employee. 62% of newly remote employees said they would consider moving away and taking a pay cut in response to the greater flexibility allowed in where to live and work/ life relationships. Whether it’s hiring completely remote employees who fit the business or flexibility for current employees, adapting to the new working environment can provide greater efficiency.