Manufacturing and Inflation Explained

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Consumers see rising prices at the gas pump, see rising bills for household items, or face the reality of an expensive real estate market. But they may not understand the additional market forces swirling beneath the surface, squeezing their paychecks.

The relationship between manufacturing and inflation is more complex and multifaceted than most news stories realize. Here, then, is an overview of how the two go together, the underlying causes of inflation throughout the supply chain, and what manufacturers can do to soften the blow.

First: how big are the increases?

The consumer price index soared to 8.5% in March, its highest level since the early 1980s. The index – the country’s benchmark measure for inflation – had held steady at or below the Fed’s 2% target for more than a decade, but the metric began to rise in 2021.

In March, the Fed announced it would raise interest rates by a quarter of a percent, a step to curb buying and balance supply and demand. Spending fell in February from the previous month, but another interest rate hike could be on the way.

What factors along the supply chain contribute to price increases?

To help understand how manufacturing and inflation co-exist, it’s worth exploring the root causes of price increases throughout the supply chain. We are currently experiencing three key factors:

Supply chain disruption: This phrase has become a buzzword that many use but not all understand. By supply chain disruption, we mean significant events that make it harder or more expensive for manufacturers along the supply chain to get what they need. When it comes to the pandemic, a key factor has been a shift in buying behavior: after a rapid but dramatic drop in spending in the spring of 2020, some manufacturers scaled back operations, just for stimulus funds and social distancing to cause an increase in demand for goods (because, with social distancing measures in places, few people were spending money on travel or services). Not everyone along the supply chain could keep up, so we saw shortages of various items, like computer chips. The war in Ukraine is causing further disruption, with some products made in that region now less available.

The cost of labor: With the percentage of Americans entering the workforce declining, labor dynamics were already changing when the pandemic hit, accelerating change. Manufacturers struggled to keep operations running at maximum capacity with fully staffed floors. Those who have offered employees salaries that are sometimes considerably higher – and rightly so – than just a few years ago.

Gas prices: Oil and gas were also up when the supply chain was disrupted, with the United States imposing sanctions that hampered Russia’s ability to sell crude oil. The average cost of a tank of gas hit record highs in March. Gas prices aren’t just hitting consumers, which means we’re adding yet another price increase to the pile for manufacturers.

How do these factors trickle down the line to consumers?

Most people understand that when raw materials are more expensive to source or produce, they will also have to pay more for the products they buy at the store. But how do these increases occur? It helps to imagine the scenario, starting at the top of the chain with supplier A.

Supplier A has to spend more on labor and gas, so he raises his prices. Supplier B, buying from Supplier A, then has to swallow these price increases, in addition to taking into account that labor and gas are also costing them more money on the balance sheet. Supplier C is in the same situation, now swallowing both the increases from Suppliers A and B, as well as the higher prices of running its own store. And so on until we get to supplier F, who sells directly to customers. Nominal price increases along the way added up at this point, creating a noticeable spike for consumers.

There’s also the simple dynamics of supply and demand at play. In times of disruption, when certain products are harder to find, manufacturers have only two options: either find ways to produce their products without certain supplies, or accept that they will have to pay more for them. Most often it is the latter. Over time, manufacturers have learned to anticipate price hikes before they happen and protect themselves against being the “last company standing” in a bizarre, cost-escalating game of musical chairs.

These increases reverberate in all directions, from the clothes you wear on your back to the food you eat. A pound of bacon now costs nearly $2 more than it did in March 2020. Long seen as a benchmark for what’s happening in US prices, a gallon of whole milk could well hit $4 very soon, up from about 17% over the past two years. Gas, of course, is perhaps the worst of all, dropping from a U.S. average of $2.27 for a gallon of unleaded in March 2020 to $4.31 in March 2022. These price increases have also a profound impact on the housing market. Although lumber has deservedly been in the headlines, wholesale prices for everything from windows to tiles to steel have risen since the start of the pandemic. When prices to build are prohibitive, builders pause projects, limiting market supply and driving up property values.

How should manufacturers prepare for higher inflation going forward?

With all these changes, manufacturers might be tempted to sit back and ride out the uncertainty. But if they’re smart, they’ll take the opposite approach. To be better equipped to deal with inflation is to become a more modern, more competitive manufacturer, with a product strong enough to justify charging a premium. And on that note, companies that haven’t already should start raising their prices now, gradually, so they’re not the last company standing when the music stops. From there, it’s about managing for the long term by investing in people, wages, and smart technology, come what may, in 2022. The competitive advantage of manufacturers in the coming decades is in game, and those who can distinguish the forest through the trees will be the ones who will grow and succeed.

At its core, inflation is a devaluation of currency, often stimulated by injecting more money into the economy. This instance is no different. Manufacturers therefore cannot control or avoid it. But by seizing the opportunity to strengthen their foundations, they can lessen the impact on their individual businesses while helping to build a supply chain that is more resilient to the next wave of disruption, no matter when it happens. .


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