How Inflation Affects Manufacturing

When prices begin to rise and the profit levels of production are threatened, it can be a trying time for manufacturers. During times of rising inflation, it is helpful to understand just how rising prices affect manufacturing and what to do about it. We will identify contributing causes, correlating conditions, and mitigation measures you can take to protect your operation and weather the storm.

Inflation is marked by a rising consumer price index (CPI), the given price for a chosen basket of goods or services. A period of inflation is generally considered to be a sustained period of time in which the CPI grows. Over the past year or two, the CPI in the United States has been growing rapidly. And this holds true in Mexico and most countries around the world.

Currently, the inflation rate in the United States is over 9% – the highest rate since 1980. As consumer prices rise in conjunction with increasing costs for virtually every material and input for manufacturers, the Fed has entered crisis mode, raising the interest rate multiple times this year. And more rate hikes are expected during the remainder of the year. 

As a result, manufacturers are facing very tough times:

• Producer input prices rose by over 22% year-to-date in May of 2022. 
• Producer output prices rose by nearly 16% in the same year. 
• Manufacturers must grow by 8.1% just to break even.

And as inflation costs rise, many are preparing to weather a recession, which many consider inevitable at this point. 

Causes of Inflation

Inflation and the way it affects manufacturing is a complex process. One of the chief factors is disruptions and changes in supply and demand. 

As COVID regulations kept people from travelling, their spending habits changed. Consumption levels rose dramatically. This was only accelerated by the stimulus money the US government sent out. But manufacturers had recently reduced output in anticipation of an economic downturn due to market uncertainty. The market’s negative response to COVID had led many producers to slow down and even lay off workers. 

Because of this severe miscalculation, the mismatch of rising demand with reduced supply contributed significantly to price inflation. Companies were simply unable to meet the consumption levels they were faced with. 

Further disruptions from the war in Ukraine only exacerbated the supply-and-demand problem. With supply chains being strained and disrupted by war and economic retaliation, manufacturers were once again unable to adequately meet demand levels.

Labor is another factor contributing to the current levels of rising inflation. After many factories sent workers home, many of them never came back. In what has since become known as the Great Resignation, workers dissipated en masse. The US is now facing a critical labor shortage. As such, maintaining supply is problematic.

Rising fuel costs have also compounded the problem by multiplying manufacturing and transportation costs. With gasoline now around double the price from two years ago, trucks and heavy equipment are all much more costly to operate.

Undoubtedly, the most fundamental and pervasive factor contributing to inflation is expansion of the money supply. As governments print money and fund social programs with money yet to be created, the existing supply of money is diluted. The purchasing power of a given dollar is reduced by the amount of new money pumped into circulation. 

The Trickle-Down Effect

Inevitably, each supplier and vendor along the supply chain is forced to raise prices, which are in turn passed along to the manufacturer and ultimately the consumer. Inflation affects manufacturing in numerous ways. Here are some of the more notable ways inflation trickles down to every manufacturer, from raw materials to suppliers to financing to labor, etc:

• Replacing lower-prices inventory becomes more costly.
• The cost of service rises.
• Fuel and maintenance cost increases make transportation more expensive and problematic.
• Labor costs rise faster than wage increases, causing personnel shortages.
• Throughput is decreased, deliveries are delayed, and invoicing is lowered by higher labor turnover.
• Higher interest rates reduce borrowing and investment capacity.
• Customers purchase less in response to sticker shock.

How Manufacturers Can Mitigate Inflation Damage

Th strategic way in which a manufacturer heads into an inflationary period is decisive in how they weather the storm. Being too cautious can result in stagnation and reduced market share. But too much risk exposure can prove disastrous in an economic downturn. Here are some practical steps to minimize the effects of inflation for your business:

• Increase productivity without increasing labor to avoid or minimize price hikes.
• Reduce material costs by maximizing efficiencies without cutting quality.
• Avoid heavy lending during the boom cycle, as being overleveraged will prove disastrous when buying levels decrease in a recession.
• Repackage products to offer similar package sizing or smaller quantities without changing the familiar consumer price point.
• Increase prices gradually and consistently; price hikes are an inevitable way inflation affects manufacturing, and failing to raise prices will reduce market share and profitability in the long run.
• Consider automation or software upgrades for increased productivity.
• Invest in people and wages now to secure a loyal workforce in the future.

Inflation affects nearly every facet of manufacturing. But taking steps early to respond to the situation can enable a company to evolve with the changing times. Anticipate rising supplier and transportation costs, and keep price increases reasonable. Look for an inevitable reduction in demand. And begin building back now in preparation for the recovery before your competitors.