How to Deal With Inflation in the Supply Chain

Inflation is rising everywhere, impacting all economies, including the wealthiest. Supply chain disruptions, high demand for products and services outstripping supply, military conflicts, trade wars and labor shortages have contributed to create an inflationary environment.

Additionally, governments have responded with higher interest rates as a contractionary monetary policy, which significantly reduces consumer and business spending by making credit more expensive.

Inflation, if left uncontrolled, can have a severe impact on purchasing power. 

In this article, I would like to provide some perspective around the inflationary context that we all are living in, and also, I will provide some alternatives for companies in our supply chain to address high inflation and its associated pressures.

Inflation is eroding companies profits and purchasing power. As an example, the aerospace industry has experienced significant increases in raw materials costs, which has put a lot of pressure on small and medium enterprises (SMEs) in Mexico. Ninety-nine percent of companies in Mexico are SMEs. Most of these SMEs have signed fixed-price contracts with buyers, not accounting for anticipated increases in raw materials, energy, and logistics costs. Several of these companies have not been able to meet their contractual obligations, have absorbed unexpected cost overruns and some have gone bankrupt.

What can companies do to mitigate the impact of inflation? Aerospace companies in Mexico can adopt one or more of the following actions to better face the inflation challenge:

1. Review your current contractual obligations: Review your existing contracts with customers and determine if they already include provisions to address inflation. One example could be price escalation if raw materials costs go up. If there are already provisions to address inflation, use them in your favor.

2. Renegotiate Terms and Conditions: Look for opportunities to improve your current contract terms and conditions. Enable your company to adjust pricing in line with your costs. Talk to your customers and reach an agreement that can benefit both. Your customers can be a great ally to help you navigate inflationary environments.

3. Limit your exposure to inflationary impacts when drafting new contracts and agreements: Include mechanisms that can help your company address an inflationary environment. Push for a win-win approach and share risks smartly.

4. Effectively raise prices: Raise prices so you can be profitable. Raising prices would increase revenues, improve profits, and will protect you from absorbing unexpected costs.

5. Communicate with transparency: When raising prices, make sure you clearly communicate that price adjustments are in line with inflation. The more details you can give to your customers about the cost drivers, the more trust you can build with your customer base.

6. Deeply understand your cost drivers: The more you can understand your cost drivers, the better you can manage cost and maximize revenues. Understanding cost drivers will also help companies to negotiate better contractual conditions with customers and suppliers.

7. Create opportunities to make your processes more efficient: Analyze your complete production process and look for opportunities to reduce costs or eliminate steps that are not adding value to your customers and not capturing value for your business.

8. Invest in supply chain resilience: Having a resilient supply chain will give your business the flexibility to navigate the tough times. By investing in supply chain resilience, companies have better chances to achieve better price stability.

9. Invest in technology: Investing in technology can give you the ability to automate processes and optimize costs; additionally, technology can give companies an edge to generate powerful market insights that will drive more strategic decision-making.

10. Partner with your customers and sometimes with your competitors: Strategic partnerships with customers and sometimes with competitors can boost business performance. One option to mitigate the impacts of inflation can be consolidated purchasing. You can consolidate purchases with your competitors or your customers. If your customers are big companies that can get better contractual conditions, use that strength in your favor. Consolidated purchasing will enable your business to bundle products into a single procurement. This strategy can significantly lower costs and make the procurement process more efficient.

In my opinion, inflation is here to stay. Eventually, we may get back to “normal,” but it will take some time. Just to provide some perspective, according to several studies and expert opinions, once inflation is above 5 percent in advanced economies, it takes on average 10 years to drop to around 2 percent. This may give you an idea of how hard it could be for developing economies to get back to lower levels of inflation.

The current drivers of inflation will continue to have a significant impact on the global economy. Companies must have a plan in place and use all the resources they have available to better negotiate contractual terms and conditions to address the serious effects of inflation on their bottom lines.