Commodities & Inflation: The Five Hard Truths You Need to Know About Your Costs

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Inflation is accelerating, but from a low base 

On January 12, 2022, the Bureau of Labor Statistics released data showing the highest annualized inflation rate since 1982. Headline consumer prices rose 7% vs. a year ago, primarily driven by energy, food and non-food commodities (and cars). 

While this year-over-year increase in the Consumer Price Index (CPI) is quite dramatic, it comes from a relatively low base. Looking back further, to pre-pandemic end of 2019, the CPI has “only” risen by 8.5% in total over the 24 months. For many consumer goods categories, the rise in prices to consumers at the shelf is in the range of 6%-10%, but in some categories (e.g., Meat and Paper Products) consumer prices have risen more than 10%. 

Manufacturing and distribution costs are rising much faster

These consumer price increases are dwarfed by the larger increases in input costs for Consumer Packaged Goods (CPG) manufacturers, who have seen a double-digit inflation of their cost structure, driven by red-hot commodities, high energy prices, and – more recently – strong upward pressure on labor costs amid labor shortages. Our research shows a significant gap opening up between increases in CPG companies’ delivered costs and the price changes to consumers, across all key categories:

While our research shows that many CPG companies have taken price (as well as throttled promotions and changed pack sizes) to counteract the cost increases,  significantly more may be needed to preserve margins going forward. Temporary cost mitigation strategies such as fixed price contracts, forward buys, hedges and inventory have run their course, and margin compression is likely for those who don’t take decisive action.

The Five hard truths you need to know about your costs

As a first step to enabling the right strategies and action, we believe it is critical to develop much deeper analytics and visibility into your cost structure.  You need to have full clarity on what we call the “five hard truths about your costs”:

  1. Commodity Impact. Based on current commodity markets, what is the predicted future impact on my costs? This may be substantially more than realized cost increases to date, since the full commodity impact on P&L costs usually has a lag time. 
  2. Labor Impact. What will I have to pay my white and blue collar workers to attract and retain them this year? What will be the impact of my suppliers having to pay their workers more?
  3. Pricing Impact. What percent of my cost increases have I been able to pass through to my customers so far? How much more do I need to pass through to mitigate total forecast cost increases? What has been the impact of price increases on volumes sold?
  4. Supply Chain Productivity. How will my supply chain productivity programs perform next year given labor shortages, supply chain constraints, and potential delays, e.g., in equipment and technology upgrades? 
  5. Demand Volatility. What are likely demand scenarios to plan for? What will total unit costs look like in each scenario, and how can I manage the demand uncertainty proactively?

Levers to manage margins going forward

Getting as much analytical clarity as possible on the “Five Hard Truths” is critical for taking clear and decisive action that protects and grows margins. The analytics provide the underpinnings for the levers that are available for strong margin performance. Most of our clients are currently pulling a combination of the following margin management levers: