Procurement in a high inflation environment
During the 1970’s oil crisis and the rampant inflation that followed, skilled procurement professionals were in demand more than ever before. Now we find ourselves in a similar situation.
While professionals have superior technology and analytics on their side, the challenges associated with procurement in a high inflation environment remain the same – and so do the solutions. It’s critical that teams familiarize themselves with best practices now if they’re to survive the onslaught.
Why does inflation present such a challenge?
Typically, procurement is expected to deliver year-on-year savings. But when inflation pushes costs up, life gets tough for procurement teams. While passing increased costs onto the end consumer might seem like an obvious solution, this can have a detrimental impact on a company’s reputation and damage customer demand and sales.
There’s also the risk that competitors will manage fluctuating procurement prices more effectively, and steal market share. Therefore, getting procurement strategies right can be a real game-changer for organizations in this environment.
Assessing whether cost increases are fair game or taking the mic
One of the biggest challenges procurement leaders face is knowing whether price increases are justified – or whether suppliers are taking advantage of volatile market conditions. For example, price gouging is a fairly common practice that procurement teams need to watch out for. This is where companies take advantage of supply-demand imbalances to extract an unfair price from buyers. This becomes more prevalent during periods of supply chain disruption, such as those caused by the COVID-19 pandemic.
Procurement professionals can address these problems by using cost and “should cost” analysis. This involves looking at published commodity indices to understand whether the price increases – in terms of energy, materials, or component parts – are in line with these.
There are also circumstances where suppliers have genuine reasons for demanding higher prices, such as their own costs increasing. In these instances, procurement teams need to work with suppliers to overcome their shared challenges. Often, suppliers will come forward with a request to renegotiate their contract if they anticipate issues.
Ultimately, it is vital that procurement leaders do their own research into the factors behind cost increases, because determining whether these are fictitious or genuine – and accepting or disputing them – can make all the difference to profit margins.
How to avoid unexpected price rises?
We live in an uncertain world, and the risk of price volatility or unexpected price changes always exists. Professionals don’t have to wait for these to catch them unawares though. Instead, they can use hedging strategies like forward contracts, futures, and commodity options to lock in prices. Locking in the purchase price of fuel for several years, for example, can significantly mitigate the risk of energy costs shocks.
Professionals can also work closely and strategically with suppliers to identify opportunities to streamline processes or fine-tune specifications in a collaborative setting. It’s also best practice to regularly review product and service specifications to ensure the suppliers used are as reliable and cost-effective as possible.
What steps should be taken to prepare for ongoing inflation?
Procurement leaders should take the opinion of industry experts. If evidence and expert opinion indicates that inflation is likely to continue, using hedging strategies to lock in prices would make sense. For those that are vulnerable, a strategic review starting with product specifications through to streamlining of processes needs to be undertaken.
Procurement leaders must also work collaboratively with their suppliers, to jointly find ways to reduce total supply chain costs. Putting cost price adjustment clauses in place to show the agreed amount that prices can be adjusted, based on commodity price changes, is a standard practice that should be in place.
If you would like to learn more about any of the strategies discussed, or how we can help your team operate effectively in a high inflation environment, please get in touch.