INFLATION - How to mitigate

INFLATION – How to mitigate

Among the numerous challenges we face today, Inflation ranks the highest for majority of the business houses and general public, if not for all. Prices have gone up since the wane of the pandemic. Food, transportation, clothes – all have become more expensive. Inflation, in simple words, is measuring how much prices change over a period of time. Inflation is driven by supply and demand. As example, lower supply and higher demand can both lead to higher inflation. There have been many reasons for higher inflation in calendar year 2021, to name a few:

·??????Weakening of US Dollar

·??????Higher Energy Prices

·??????Reopening of Economy spurring demand

·??????Government stimulus packages that pent up demand

·??????Supply Chain logjam

However, my article is not about what is inflation and reasons for it. How do we combat and mitigate the same? It’s not easy to pass on the cost to client or consumers and in some case not possible if you are tied up in bad contract where prices are fixed for more than a year.?Even as many companies deal with inflation by devoting more energy to adjusting prices or finding new sources of growth, cutting costs remains an important part of managing in this economic environment.

1.?????Measure / Monitor in other words get clear visibility on your spending

The first and foremost common problem is whether you are measuring your internal inflation verses the external inflation. Many companies don’t really go to details and the devil lies there. We have data but we don’t arrange it well enough to analyze. Whether its raw material cost, labor cost or other direct costs, each business house must develop their internal indices and compare the same on how they fare vs the CPI (Consumer Price Index) and the PPI (Producer Price Index). In an inflationary period, it is critical to establish repeatable, end-to-end, actionable visibility of spending by cost category, business process, function, and business unit.

2.?????Where to Spend and the drivers of spending

Not just when we have a monster in name of Inflation right in front of us, companies must regularly use consistent, accessible financials to prioritize higher ROI investments. There should be a clear distinction between strategic and non-strategic cost cutting and build up a sustainable cost management system that fuels the company’s strategy and out-invest competitors, at scale, both in good times and bad times. Company should be well positioned with less fat to make well informed decisions that could improve the return on operating expenses.

The above sets stage for major moves – for example, establish a preferred vendor program to increase buying power, buy or rent decisions, and what I would recommend is EASE strategy – Eliminate, Automate & Standardize (tasks) for Efficiency (more on EASE later).

3.?????Reduce Consumption

There are various ways to reduce consumption whether is raw material or labor (time). Operations with help of other functions must find ways to reduce consumption which could be either through reduction of wastage, recycling, time management, product innovation, energy conservation, etc. If the first two steps are done well, identifying ways to reduce consumption cost is a mere exercise.

4.?????Supplies and Suppliers

The procurement department is constantly under pressure to deliver the product at the most economical cost. Ensure suppliers can clearly articulate the impact of price increase in the market on suppliers’ prices. In times of upward price increases, sellers often overstate the share of raw materials in input cost, taking the opportunity to inflate their margins. I also believe that while we invest time on Sales incentive policies, its time to motivate the buyers and incentivize them to buy better.

5.?????Work with sales to pass on the price increase

The ‘not so easy’ one is to pass on the price increase to your client. It could be easier to pass on the price increase in retail market, however, in businesses where we have long term contract for providing services, it’s a challenge. There could be two situations:

a.?????Where the contract allows for a periodic price increase: I would recommend this to be mandatory.

Life becomes bit easy here, the challenge is though what is the methodology or formula that you have agreed with client and references. This clause must be automatic and mandatory and should be triggered at end of agreed period. We could either agree on a fixed increase rate or refer to national statistic records for the CPI or PPI. The composition of formula is key.

b.?????Where the contract is for long term, 2 years and longer and does not allow for a periodic price increase

The mistake done at the time of contract designing, not to have a price increase clause on a periodic basis can be very detrimental to the long-term performance of contract. Surprisingly, most of the government contract and oil and gas companies don’t allow for a price increase, though their policies are reason for inflation. Despite not having a price increment clause, we must approach the client with all the data, steps that has been taken to mitigate the inflation so that contract doesn’t become untenable.

Please also ensure that you factor inflation in costing and pricing decision for new projects or during renewal of contracts.

Recent IMF projections show that inflation will continue to rise before returning to pre-pandemic levels in 2022, but there are some factors that could keep inflation elevated for longer. In advanced and emerging markets, these could be surging housing costs and prolonged supply shortages while in developing and low-income countries, rising food prices and falling currency values could be contributing factors.

Thank you for your time for reading the above and appreciate your feedback.