This article originally appeared on HBR.org.
A long-forgotten problem, higher inflation, has eroded the finances of many companies. Right now, many are struggling with high costs for raw materials, labor, energy, and other inputs, along with supply bottlenecks. At the same time, demand is surging as economies reopen for business in the wake of falling Covid-19 cases.
Some businesses have started to raise prices in response, with producer prices in the OECD countries up 9% in the 12 months through April 2021. Consumer prices were up 3.3% over the same period (with the U.S. consumer price index well above that at 5.0% through May). Kimberly-Clark recently raised list prices on consumer products in North America, with percentage increases in the mid-to-high single digits. Consumers will now pay more for Pirelli and Yokohama tires and Energizer batteries. Hercules Industries boosted prices by an average of 15% on heating and cooling equipment, mainly due to rising costs for steel. Various chemical companies are charging more for polyethylene, one of the most widely used plastics.
Yet even companies that increase prices will still feel the pain of rising costs if they simply take incremental steps. For example, one landscaping equipment manufacturer recently signaled challenges to its earnings despite strong revenue growth and three price increases in the past year.
Prolonged inflation has not reared its head since the 1970s. While chronic inflation might not occur, companies need to hedge now against a medium- or long-term inflation scenario. Most corporate leaders have not dealt with macro inflation during their careers, leaving them unsure of how to proceed.
At one manufacturer, for instance, the CFO recently told us that although revenues have grown steadily, the bottom line fills him with dread, as spiking costs for raw material, labor, and energy have reduced profit margins from 15% to 10%. A food manufacturer is suddenly staring at a $200 million hole because of exploding commodity prices. And a building products manufacturer, experiencing the highest sales and worst margins in 20 years, discovered that one of its distribution channels—historically an attractive, high-volume channel—is now unprofitable in absolute terms, as weekly cost fluctuations and supply chain delays wreak havoc.
Moreover, many business-to-business (B2B) companies granted their customers pricing relief due to the pandemic, meaning they’d already sunk into a pricing hole even without inflation.
The pinch point is especially acute for midsize firms that have global supply chains but have not invested in the capabilities required to ensure their pricing keeps pace with market changes. Bain & Company’s recent survey of more than 400 industrial companies worldwide found that midsize companies (under $5 billion in revenue) are less confident than large companies in their ability to handle inflation through price increases, to respond dynamically to market conditions, or to equip their front line with the right tools to make good pricing decisions.
Some executives seem paralyzed, because fixing the problem involves breaking informal arrangements with channel partners and customers. It’s tough to give customers bad news twice—higher prices and longer waits for the goods. Still, the current environment favors companies that act quickly to make the right pricing moves.
For one thing, most business leaders view price increases due to inflation as fair. These customers will not, however, give their suppliers much credit for delaying price increases only to push them through six or 12 months from now.
For another, in supply-constrained industries, buyers have limited alternatives with which to negotiate. Price may be less important than supply and inventory availability.
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