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Inflation, supply chain snarls and the incredible shrinking margin: What do manufacturers do now?

Feb 16, 2022

Douglas Anderson
Consulting Solutions Partner, PwC US
Meghan Murray
Consulting Solutions Partner, PwC US

Stubborn price inflation, supply chain woes and labor costs and shortages have been putting the squeeze on many manufacturers and aggressively chomping up their margins. For many, this may signal the beginning of a period of increasing pass-through costs leading to hiked product prices and service fees.

The Consumer Price Index (CPI) climbed by an annualized 7.5% in January 2022—on the heels of a 7.0% increase in December—making it the highest in four decades. Meanwhile, many input costs for manufacturers have been rising by a much wider margin. West Texas Intermediate crude, for instance, spiked by 35% over the December 2021-January 2022 period. Soon after, on February 10, 2022, the aluminum prices hit an all-time high, rising about 25% over the previous three months alone.

Input cost pressures are not expected to ease soon. According to a January 2022 PwC Pulse Survey, 68% of manufacturers agree that inflation is likely to remain elevated at the end of 2022. To offset increasing input costs—of everything from raw materials to parts and components to energy—nearly three-quarters (73%) of industry leaders expect they’ll need to increase prices of their goods and services through 2022, presumably to protect both gross and profit margins.

Supply chain disruptions are likewise expected to persist. Fewer than half of US manufacturers (43%) expect supply chain disruptions to ease by the end of 2022, according to our survey. And supply chain challenges (in both availability of supplies and clogged logistics) are perceived to become a strong determinant of future growth. Most (58%) agree that improving supply chain resilience and reevaluating inflation-related pricing strategies (55%) are very important to their ability to grow in 2022. This compares to 41% of sector leaders in our October 2020 survey who said changing their supply chain footprint was very important to their company’s profitability over the next two years.

How can manufacturers regain control over their margins?

With manufacturers hit on multiple fronts, they’re looking well beyond the traditional cost-containment playbook to preserve margins. Pricing that perfectly aligns with cost of goods or just-in-time inventory management approaches seem like quaint and distant memories. Most industry leaders now realize that they will need to find ways to inject agility and resilience into their organizations. And fast. Sixty percent agree that increasing agility to better operate in a turbulent business environment will be important to their growth this year, our survey finds.

So what paths to resilience and agility are at their disposal? Let’s explore where manufacturers should focus to preserve margins (as much as possible) during this stormy business environment.

Fixing the supply chain, link by link: While rising input costs grab the headlines, manufacturers are simultaneously struggling with a crisis of supply availability—from raw materials to parts and components sourced by Tier 1 and Tier 2 suppliers. Alleviating this crisis could mean making longer-term contracts and improving cost transparency with supplier partners. Some manufacturers have decided to take more aggressive actions with their suppliers to secure availability. Take chips, as one example. Some manufacturers (especially in the automotive sector) who source products requiring semiconductors are taking it upon themselves to secure purchase order contracts for chips on behalf of their suppliers. Such actions are aimed at both lowering input cost and easing product and materials availability issues.

Taking such action means forging much closer relationships with suppliers via increased data-sharing to improve supply chain transparency and better anticipate—or even predict—supply chain snarls. It also means improving supply chain productivity through warehouse and production automation and improving logistics, using predictive analytics empowered by artificial intelligence and cloud technologies.

Containing the impact of rising price inflation: As the prices of energy, raw materials and other commodities rise, manufacturers need to find ways to cushion the impact on costs of goods sold. Numerous levers can be pulled, such as reassessing all contracts. Which indexed contracts for commodities need to be reconsidered? Which contracts should be fixed-priced? Has every contract renewal been scrutinized for renegotiation? Is your trading strategy aligned with today’s price volatility? It could also mean being more aggressive in finding alternative suppliers that offer more attractive pricing, or suppliers that are closer to your operations in order to trim delivery costs.

Pricing: How much to pass through? Because so much uncertainty surrounds the trajectory of rising input costs, manufacturers can be hard-pressed on whether or not to pass through these costs to customers by hiking product prices and service fees. If they feel they need to do so to protect—or at least control the shrinkage of—their margins, crucial questions arise. How great will those price increases be? How long will they likely stick? To what extent could higher prices prompt customer defection?

To get the right answers, procurement and product prices teams need to work much more closely. Some manufacturers clearly have more dynamic and agile cost structuring and pricing than others, based on numerous factors: For example, whether they’re B2B or B2C, the degree of complication and cost of the product, and the extent of repair and maintenance included in service contracts. Additionally, each manufacturer needs to determine to what extent costs have to rise before triggering a price increase. Some will be able to hold down cost increases of, say, 5% before they need to pass through price increases. For others, that threshold might be 10%—or even more. In any case, companies need to get a precise measurement of how input cost increases are impacting their P&L now, and do scenario planning for possible future impacts.

Addressing labor costs and availability: Even before the pandemic, manufacturers struggled with acquiring and retaining talent. As with other sectors, the pandemic—coupled with the Great Resignation—has exacerbated the challenge. The industry’s entrenched talent shortage shows no sign of abating, with about three in four (77%) manufacturers agreeing that hiring and retaining talent is very important to their ability to grow their business in 2022, according to our survey. Just 34% of sector leaders expect talent shortages to ease by the end of 2022, while over half (57%) expect to invest a lot in hiring and retaining talent in 2022. 

With wages rising and the job openings and hires gap widening, sector leaders can add labor costs to the suite of inflationary pressure. However, while there seems that there’s little to do to contain these costs, companies can move to strengthen retention rates to avoid overtime and recruitment costs and expand automation strategies, particularly those that tackle repetitive tasks

Stay close—and transparent—with your customers: As manufacturers get a clearer idea of how input costs are affecting their margins, they’ll get a clearer understanding of any price increase of their product and service that they may need to pass through to customers. While future cost swings are unpredictable, it’s nevertheless crucial to keep a transparent and open dialogue with customers to manage expectations and provide visibility. Any price increases ought to be explained—preferably well before they are made. You may also want to come up with ways to ameliorate the pain of such increases, perhaps by discounting service fees or spare-parts prices.