In March, the Bureau of Labor Statistics announced that the Producer Price Index rose a staggering 11%.
Inflation is an inconvenient truth--it rebalances supply and demand. As a result of globalization and a vibrant economy, we have had the luxury of over-indulgence and unlimited, unfettered access to products from around the world.
This version of inflation is different from what most of us have seen before. We had a supply shock as a result of the pandemic and tariffs in China, followed by a demand shock due to a wage-price spiral, the Russian invasion of Ukraine, and escalating energy prices. Markets will correct--they always do. However, some economists fear the U.S. is headed toward stagflation not seen since the '80s.
But, with chaos comes opportunity. Companies will be forced to reevaluate:
Optimizing the supply chain
We are headed toward a new global supply structure. The U.S. and China are embroiled in an economic, military and digital rivalry. In lieu of free trade, it feels like the global economy will be split in two: the East and the West, governed by trade lanes, security, transportation costs and trade policy. This will promote trade hubs in Central America. Supply chain shocks will amplify trends toward vertical integration.
Redefining customer relationships
Given the aversion to price increases, inflation is prompting new dialog with customers. Imagine the following conversation: "Mr. Client, I can pass on an 8% price increase, I can stop serving you, or we can discuss how to be more efficient partners." This is a time where vendors can hold customers accountable for paying on time, providing timely purchase orders, adopting digital transformation and communicating their buying intentions.
Passing on price increases
Providers have literally forgotten how to pass on price increases. Vendors should not be apologetic when costs rise or when they deliver more value. Now is the time not only to pass on price increases, but to create an annual system for doing so. For example, some contracts have "price riders" that automatically increase prices on an annual cadence.
There has never been a time when customers were more accepting of price increases than now. But the timing and method for communicating them is important--consider incremental increases supported by data. By communicating clearly, your customers can be more prepared for the realities ahead.
Embracing dynamic pricing
Today, algorithms drive real-time pricing for hotels and flights. Ridesharing services not only price in real time, but also use surge pricing when there are more riders than there are drivers. While wildly unpopular, surge pricing does instantly rebalance supply and demand.
Surge pricing will impact the behavior of buyers and sellers in way that will optimize markets. Marketers need to find ways to capture premium pricing when available. For example, speed is a driver of value. Companies should be charging more for expedited orders and access to inventory.
Famously, KLM hedged their fuel cost in 2022 while American, United and Delta did not. On the common international routes where they compete, KLM will have a significant cost saving and competitive advantage. Progressive companies are investing in various risk mitigation techniques such as currency hedges.
Slow labor costs
The wage-cost spiral is a trap. Companies are raising prices in part because of escalating labor costs. If companies create situations where a higher percentage of revenue is in salaries, labor becomes a fixed cost. Whenever possible, providers should try to build a structure where labor cost is variable with demand. This can be accomplished by skewing compensation toward incentives and outsourcing when possible.
Companies are seeking even greater efficiencies through digital transformation, robotics and automation. But it takes time to realize a return and efficiencies from these investments.
We find ourselves at a unique intersection in history, where providers will have to make hard decisions about where to place their chips. Automate more and employ less? Pass on price increases or protect customers? There are no easy answers, but companies who approach these problems from 40,000 feet with a long-range view are more likely to sustain advantage than those who react to the rising costs of the day.