Growing concern about rising inflation is adding to the pressure on manufacturers at a critical time – just when demand is increasing and economic recovery is gathering pace. Rather than allowing inflation to erode margins, businesses must decide whether to pass the increase onto customers or reduce their cost base to offset the financial impact.
With US inflation rising to 5% in May (above market forecasts of 4.7%) and factory prices in China rising by 9%, it is clear that inflation is already having a significant effect on many businesses, especially those with global supply chains. News that consumer price inflation jumped above the Bank of England’s 2% target in May, and is likely to exceed 3% in the coming months, also suggests that there could be significant pressure on operating margins for businesses sourcing raw materials and products in the UK too.
The price of commodities, such as iron ore, copper and aluminium, has soared during the pandemic. This is partly due to supply shortages and pent-up demand, which has been released into the market faster than expected in some industry sectors, just as economies began to open up. The price of Chinese aluminium, for example, surged to its highest level in more than ten years in May, but has since fallen back slightly after the government decided to auction reserves in order to cool the market. This has had a knock-on effect on automotive and aerospace manufacturers in the UK.
For manufacturers sourcing raw materials and other goods globally, price increases can erode margins and compromise profitability. They also have a ripple effect across the supply chain, affecting businesses in adjacent or ancillary markets. Faced with significant downward pressure on prices from higher up the chain, some small and medium-sized businesses could be priced out of the market.
The combination of market disruption and inflationary pressure on prices is proving a perfect storm for some industries. For example, in the aerospace sector, demand for narrow-body aircraft has increased sharply in recent months due to an increase in domestic air travel in the US and China, and airline manufacturers have responded by ramping up production. For OEMs in the sector, the sharp increase in demand has come quicker than expected and rebooting supply chains after recent closures is proving challenging. At the same time, rising metal prices are pressing them to accelerate the switch to sustainable, high-performance composites – a strategy that requires significant capital investment in new processes and sourcing arrangements. For some, the downward pressure on margins has come at just the wrong time, making it harder for them to respond to disruptive market forces.
There is no time to waste however. OEMs facing the cumulative effects of market disruption and increased demand can’t afford to wait until inflationary pressures are brought under control, they need to take action now. Some might choose to increase inventory to get ahead of the inflationary curve, but this is a significant capital risk and they could end up with surplus supplies. Others may find there is scope to share the impact of cost increases with others in the supply chain. Taking such action could buy them more time, but it’s not a sustainable solution.
Investing in smarter procurement systems could provide a longer-term solution, enabling businesses to become more agile, so they can control their cost base more effectively and buy exactly what they need, when they need it. To achieve this, businesses must capture and collate critical procurement data, and create bespoke algorithms to inform their sourcing decisions. Access to dynamic data, built from real-time information, could prove invaluable in helping businesses to get their strategy right – allowing them to stay ahead of the inflation curve while supporting their transition to greener products. Such solutions require investment of course, and cost reduction strategies should be considered as a means of offsetting this.
For some industries, the perfect storm of inflation, raised demand and market disruption is proving incredibly challenging, and more government support may yet be required to bridge the gap as recovery gets underway. This could prove vital to the long-term future of the UK’s aerospace and automotive industries, which are already struggling to remain competitive.
While more funding would undoubtedly help, the choices businesses make now about how to manage price increases and reduce costs in order to offset expenditure in smarter procurement systems and green transformations, could determine their success or failure.
LEFT: Nick Harrison, partner, Vendigital; RIGHT: Paul Cooper, director, Vendigital