Chief Financial officers (CFOs) across numerous industries are facing higher costs as the economic rebound continues to drive up demand for raw materials, components, energy and transportation. Wages are also on the rise, adding to the expenses executives need to pay out. All of this is also putting additional pressure on the Federal Reserve to raise interest rates sooner than their stated strategy and timeframe.
Pandemic-related backlogs and shortages have created a difficult supply crunch exacerbated by the easing of lockdown restrictions fueling consumer demand. This intense combination is sending inflation surging to levels not seen in more than several decades. Many of the current generation of chief financial officers have limited experience in managing inflation, following years of low-cost increases in the U.S. and elsewhere, making them seek historical data and case studies for possible strategies.
“Today’s CFOs have rarely experienced high inflation like in the 1970s or 1980s,” said Hardik Sheth, a partner at Boston Consulting Group and leader of the consulting firm’s CFO excellence practice.
The Federal Reserve last month raised its median forecast for inflation this year, projecting consumer prices will rise 3.4 percent in the fourth quarter from a year before, up 1 percentage point from the March forecast. Companies in the second quarter said they expect input prices to grow 4.4 percent over the next 12 months, up from the 3.1 percent increase they forecast in the first quarter, according to a recent survey of finance executives by the Association of International Certified Professional Accountants, an industry organization.
From increasing product prices to strategically cutting costs, savvy CFOs have various resources they can use to restrict the impact of inflation. Here are some of them:
An inflation forecast can help CFOs get a better understanding of how costs and expenses for supplies, transportation and wages might develop in the coming quarters, allowing them to prepare and take actions (e.g., customer price increases) if needed to offset any increases.
Based on its internal projections, food manufacturer J.M. Smucker Co. , for instance, expects higher inflation rates for this year and the beginning of next year, finance chief Tucker Marshall said last month. The company said it is increasing consumer prices across the product portfolio while also looking for productivity savings.
“When you have an unstable market situation, you want the ability to push a button to run multiple scenarios,” Mr. Sheth said. “The ability to forecast and do so quickly is critical in such an environment.”
While the Federal Reserve and many economists predict that inflation will be “transitory” in nature and level down next year, many questions remain. Officials of the Federal Open Market Committee expect inflation to slow to 2.1 percent by the end of next year and 2.2 percent by the end of 2023, but a majority now think that there is a greater chance that inflation will be higher rather than lower than expected.
Many CFOs in recent weeks have said that they expect elevated inflation until the end of the year, and that inflation would ease in 2022 and 2023.
Companies face a balancing act when raising prices. They have to make sure the changes are in line with what competitors are doing to avoid losing customers, and determine whether the new price covers expected cost increases in the coming quarters to minimize successive price increases to consumers.
“You don’t want to keep having pricing discussions with your customers every three months,” said Mike Smith, CFO of spice seller McCormick & Co. The company, which is raising prices by an undisclosed percentage, expects its costs will go up by a mid-single digit figure this year.
“We take prices when [we] feel the cost increases are not transitory in nature,” Mr. Smith said. “With the recent increases in transportation costs, we waited until it was clear these costs were staying higher than in the past.”
CFOs can make operations more efficient, lowering costs across the business by cutting or reallocating certain spending, often in combination with other steps. “The traditional way of combating inflation is by controlling expenses,” BCG’s Mr. Sheth said.
Johnson Controls International PLC, the building-products company, is working to offset higher costs through productivity programs launched earlier this year, CFO Olivier Leonetti said. Several teams within its research and development group now coordinate their spending efforts based on shared priorities and growth potential, he said. The firm also brought all manufacturing and distribution under one leader.
Johnson Controls also is raising prices across the board on goods and services. The company, which expects inflation to continue in 2022, is unsure if it will have to stay on that course. “We’re all assuming it [inflation] will last for longer than not,” Leonetti said.
Companies are ramping up efforts to boost revenue for either a particular business line or across all divisions to shield their bottom lines. More revenue can help offset costs as they usually don’t rise as much as companies’ sales.
Restaurant chain Red Robin Gourmet Burgers Inc. will likely consider new sales initiatives, cost-cutting measures and more price increases should inflation persist, CFO Lynn Schweinfurth said. Such sales efforts would include loyalty programs and expanding partnerships with other businesses.
Companies also expect to benefit from increased U.S. consumer spending, which has risen well above pre-pandemic levels. Spending on goods in May rose nearly 20 percent from February 2020, according to the Commerce Department.
Some businesses attempt to limit their exposure to inflation by making strategic purchases when the price is low or before it goes up. Such buying usually only covers a portion of the supply that companies need and can occur when the opportunity presents itself. Of course, there can be a negative impact on cash and working capital levels by accelerating or increasing these purchases of inventory and supplies.
McCormick is one of the companies that looks to buy when the price is attractive. The strategy helps the company secure supply and moderate product cost cycles, Mr. Smith said. The company is also working to introduce lighter packaging to reduce the impact of higher transportation costs on its finances, among other measures, he said.
Companies are also looking to expand their network of suppliers to increase their bargaining power and to be less affected by the pricing policy of a few vendors. Signing longer-term contracts with preferred vendors can also help with locking in better prices, as it gives the company and its suppliers better visibility into the future and allows them to plan ahead.
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