After years of hard competition, competitive pressures, and price wars, manufacturers are taking advantage of the COVID-19 crisis and the current fast-paced recovery to readjust prices. They are not in a hurry to re-open production plants or to scale capacity back up to pre-COVID levels. For many categories, we are reaching record pricing levels not heard of for several decades. It is payback time, and we should not be surprised by the cost explosion coming our way and severely impacting value chains.
Let us look at some of the recent business announcements in the news:
- “After bottoming out around $460 last year, US benchmark hot-rolled coil steel prices are now sitting at around $1,500 a ton, a record high that is nearly triple the 20-year average,” (“Steel prices have tripled. Now Bank of America is sounding the alarm” – CNN). Some of the steel companies that were almost bankrupt a few years ago have seen their stock rise between 100 to 200% in just a few months.
- “According to Goldman Sachs, 169 US industries embed semiconductors in their products. The bank is forecasting a 20% average shortfall of computer chips among affected industries, with some of the components used to make chips in short supply until at least this fall and possibly into 2022”. “The global chip shortage is going from bad to worse. Here’s why you should care” – CNN.
- “Chip constraints are already pushing up the price of vehicles in the United States because dealers have only a fraction of typical stock levels. The average new car price climbed to $37,200 in the first quarter, an 8.4% increase from the same period a year ago, according to JD Power.” “The global chip shortage is going from bad to worse. Here’s why you should care” – CNN.
- “Random-length lumber futures hit a record high of $1,615 on Tuesday, a staggering sevenfold gain from the low in early April 2020. That’s a big deal because lumber is the most substantial supply that home builders buy.” “Why lumber prices are so high and what it means for home building costs” – CNN
- “Soaring lumber prices that have tripled over the past 12 months have caused the price of an average new single-family home to increase by $35,872, according to new analysis by the National Association of Home Builders (NAHB). This lumber price hike has also added nearly $13,000 to the market value of an average new multifamily home, which translates into households paying $119 a month more to rent a new apartment.” “Skyrocketing Lumber Prices Add Nearly $36,000 to New Home Prices” – NAHB
So, what is really behind this cost explosion? Is COVID-19 really the only possible explanation for this alarming situation? I propose COVID-19 is part of the problem, but there are other reasons as well.
- Real COVID Disruption: In some industries and some regions, the COVID-19 crisis has indeed hit the economy fast and hard. Companies have taken drastic action to put workers’ health first and have simply shut down assets. Sometimes they were forced to do so despite strong demand. Sometimes, they simply had no orders in the pipeline. We cannot ignore the devastating effects of this health crisis on the economy. Many companies have adjusted their production process and capacity to account for this new normal. Some of them have since re-opened and are catching up with their capacity.
- International Supply Chain Disruption: The last year has also shown us how dependent we are all are on the global economy and the international supply chain. The ripple effect of the crisis in many countries has paralyzed entire industrial sectors that rely on foreign supplies. The blockage of the Suez Canal did not help the situation. Nor did the political tensions and 2020 tariffs that were imposed on key commodities for which we are paying dearly today. Many companies are reshoring or near shoring as a result of these factors to improve supply chain reliability. Some might bring manufacturing and supplies back to the United States as a result.
- Shortage of qualified labor: Right now, many sectors are suffering from a lack of qualified labor. Some workers have decided to switch industries while others are still benefiting from very generous government incentives to stay home. The trucking industry is one of them. The shortage of truck drivers might penalize the industrial supply chain and create transportation cost increases. There are talks about shortages of fuel at gas stations right in the middle of busy driving season. Who would have thought?
- Asset Rationalization: It is never easy to make the decision to close a plant or to fully depreciate an asset. Write-offs are easier to justify when a business must adjust for a crisis or put itself in survival mode with the blessing of shareholders. In these cases, it is the right time to write off all plants, equipment, or other assets as part of the overall restructuring program. I assume that many companies have taken advantage of this crisis and closed plants with the plan to never re-open them. With demand collapsing in 2020, they have re-evaluated their footprint and made the necessary supply chain adjustments to prepare for the crisis and for the recovery. Now that the recovery is here, these assets are not available to support exploding demand levels.
- Customer Prioritization and Allocation: Similarly, a good crisis is a good time to look at your cost-to-serve and to prioritize your customers based on a few strategic criteria: profit margins, willingness-to-pay, buying style (value or pricing buyers for example), cost-to-serve, brand loyalty, contractual obligations, and share of wallet. I would not be surprised if, right now, marketing teams are looking at these criteria and giving guidance to sales teams on whom to prioritize with short term supplies. In other words, if you are a difficult customer or a price buyer, and if you are draining your vendor’s resources, you might be at the bottom of the list. What goes around comes around!
- Profit Maximization: Finally, we can all be certain that many suppliers are taking advantage of the current shortages to hike prices and enjoy high profit margins and increasing stock levels for publicly traded companies. Why should you do anything differently and why should you rush to re-open plants and accelerate capacity utilization? It is in the vendors’ interest to get prices back to where they were many years ago and to reset their pricing strategy. Of course, no one is going to admit that, and they are all blaming COVID-19 and the exceptional demand levels. There is nothing illegal in this situation in the content of free market and a capitalistic model.
This crisis and the position adopted by some manufacturers might have long lasting consequences:
- Inflation is coming, and the impact to the economy might force aggressive actions by the central banks to raise interest rates and cool off the economy.
- Customers who are paying higher prices now and waiting for goods might be forced to find alternatives elsewhere and consider competitive alternatives they had never tried before. The Chinese economy is also booming and companies there are not sitting idly. They are surely contacting your customers and securing contracts for the future at lower prices.
- R&D labs are actively reformulating and re-engineering their current products to remove bottlenecks and allow for faster recovery in production. Procurement teams are frantically searching for other strategic suppliers to qualify new sources very quickly.
- Some market players might decide to invest in their own raw materials production and to forward integrate to secure supply and to remove costing risks in their long-term strategic plans.
- What goes up must come down! We might enjoy the current pricing levels for a while. But the next recession is around the corner and artificial price bubbles are bound to pop! Procurement teams have good long-term memories. They might strike back with a vengeance once prices collapse.
Many companies are printing money these days, and the GDP growth in the first quarter of 2021 is going to fuel record stock market levels. Top executives can celebrate record corporate profits and stock levels for now. Maybe this overall reset is good for everyone to re-establish the value of products and services and recover the impact of the commoditization trends at play since 2010. But let us be honest with ourselves. Experts predicted a K-shaped recovery. It is looking like a V-shape now as vaccination efforts are working and the economy is re-opening. The fact that some industries were “caught by surprise” with the boom in demand is surprising to say the least. How can the world run out of computer chips? How can we be out of Chlorine in the USA right before the summer season?
Bottom line: if your company is caught in this shortage situation and your costs are rising dramatically, you have no choice but to implement price increases until things cool off. There should be no hesitation at all. This is not a question of when but how. Things are moving quickly, and costs increases are on the way if you have not received any yet. It is time to prepare your teams for the impact and to brush off your price management processes. It might be rocky for a quarter or two.
Managing pricing dynamically during disruption periods is a required capability. Doing so ethically and with the best interest of supply chains is also important. We cannot forget that short-term profits might damage reputation and credibility for the long-term.