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Fighting inflation? Strategies to justify cost recovery

November 10, 2022 / 6 min read

Labor, raw material, logistics, and utilities costs have skyrocketed. Cost and margin data are manufacturers’ superpower for justifying cost recovery while protecting invaluable customer relationships. We share four areas to focus on.

Ask anyone today in manufacturing, purchasing, or sales what their greatest pain point is, and they’re likely to give you the same answer: inflation.

Since the beginning of 2021, labor, raw material, logistics, and utilities costs have skyrocketed, heavily outpacing customary inflation rates. Companies used to be able to absorb the increases through cost-cutting measures and efficiency gains; today, however, the strategies manufacturers used to deploy to dull the impact of inflation are no longer enough.

Today, however, the strategies manufacturers used to deploy to dull the impact of inflation are no longer enough.

Whether your company is on the supplier or customer side, you’re pressed — to justify cost increases if the former, and to determine if costs are reasonable if the latter. For both customer and supplier, it takes hard data coupled with margin intelligence to mitigate inflationary cost increases. We share road-tested strategies to address increases in four common areas. 

1. Justifying increases in material costs

When negotiating with your supply base or your customers, candid, fact-based discussions with supporting data are important. Both help maintain transparency and show that due diligence was done to pass on the lowest cost increase possible.

When companies realize their cost increases surpass their contractual agreements, the first instinct often is to pass them on directly to customers. But without an understanding of which specific parts or customers are impacted, it’s extremely difficult to negotiate. Before initiating a discussion about a cost increase, you’ll want to determine: 

To help build a business case around the data, consider these actions:

Pricing can be adjusted monthly, quarterly, semiannually, or annually. As you might imagine, semiannually and annually are the least desirable — when possible, you want to avoid lagging debits and credits on the balance sheet.

And keep in mind that customers will want to see, if not require, justification when reviewing cost increases not tied to a market index.

Keep in mind that customers will want to see, if not require, justification when reviewing cost increases not tied to a market index.

2. Justifying increases in labor costs

According to the National Association of Manufacturers, manufacturing lost nearly 1.4 million workers during the pandemic and, as of Q2 2021, had only recovered 63% of the sector’s pre-COVID-19 workforce. That translates to a dearth of skilled labor, causing additional downtime and inefficiency across industries. Add training costs and the intangible damage to your customer relationships for not meeting due dates, and the costs add up quickly. These labor impacts are three-fold:

If you’re trying to justify labor increases presented by a supplier, or you’re presenting price increases to a customer:

3. Justifying increases in freight, logistics, and warehousing costs

Freight and logistics have seen severe increases since the pandemic began. Given the shutdown of major ports and highways in China, port congestion in the United States and Europe, and labor shortages in warehousing and all modes of transportation, getting parts on time and on budget is nearly impossible. Throw in Russia’s invasion of Ukraine and its impact on fuel prices, and freight and logistics bottlenecks get even more complex.

Consider the following factors when justifying freight increases:

The impact per piece is crucial to quantifying increases, with the best-case scenario being a schedule by part, based on actual invoices. However, time and detail of cost data are two constraints that may drive the decision to use standard costing as a baseline or assign freight as a percent of material. Regardless, having a firm understanding of product- and customer-specific freight and logistics costs from the balance sheet only adds to the confidence in your data.

4. Justifying increases in utilities costs

Utilities are a headwind for the U.S. economy. The United States spent 4.8% of its GDP on energy in 2020 and is on pace to spend 13% this year — a record. And according to the U.S. Chamber of Commerce, Europe is seeing the same issue and spending over 9% of its GDP on energy, the highest share since 1981. Rising natural gas prices in the United States are negatively impacting energy-intensive manufacturing processes, forcing interest groups to petition Congress for “policies that will unleash the potential of inexpensive and efficient American energy” (Wisconsin Manufacturers and Commerce association).

Just as with freight, logistics, and warehousing, knowing the utility cost per SKU helps identify which products are consuming the most gas, water, and electricity. Oftentimes, companies know anecdotally which products are high-utility consumers, but customers typically don’t want to deal in anecdotes; they want facts and figures. Having the information available at the parts number level helps accomplish that and strengthen the case for cost increases.

In conclusion

Proper cost allocation methodologies — that also are sustainable, flexible, and appropriate for your particular business — are especially critical today. In our inflationary environment, cost and margin data are your superpower for maximizing cost recovery while protecting your invaluable customer relationships.

Concerned about rising financial risks? A detailed inflation assessment is your first step toward cost recovery. 

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