Friday, May 13, 2011

Inflation Watch: Are You Prepared?

Recently Clorox announced a drop in earnings due in part to the high cost of raw materials the company had to absorb. "As anticipated, we're seeing higher commodity costs and other inflationary pressures in the second half of our fiscal year, but at a higher rate than we had anticipated," said Chief Financial Officer Dan Heinrich. "The benefit of price increases and our successful cost saving initiatives helped mitigate this cost inflation."

A few months back, Procter & Gamble Co.'s Chief Marketing Officer Jon Moeller told the Consumer Analysts Group of New York that the company had decided to increase prices to make up an estimated $1.5 billion in increased commodity costs this year. Procter & Gamble has since announced a 9% increase in the price of some of its products.

Is this simply an aberration? Or is this the beginning of something nasty that lies ahead?

After long denials, Fed Chairman Bernanke has modified his tone. In the past, he brushed it off, saying, "I can kill inflation in 15 minutes." Now he acknowledges that inflation is likely to come. But while the Fed is aware of high commodity, food, and energy prices, it is not about to make major changes. In a recent speech in New York, the Fed's Vice Chairwoman Janet Yellen echoed Chairman Bernanke's view that inflation pressures from higher commodity prices will be "transitory."

"These developments seem unlikely to have persistent effects on consumer inflation or to derail the economic recovery and hence do not, in my view, warrant any substantial shift in the stance of monetary policy," Yellen said.

Like any leader, the Fed Chairman has a fine line to tread. He doesn't want to jeopardize the fragile job recovery. For the sake of employment, he is willing to allow inflation to come later, and he believes he has the tools to contain it.

But the Fed Chairman needs to come to terms with two facts: First, that the CPI is an unreliable indicator. The index doesn't show significant inflation, yet business people are contending with inflation every day. Why the gap? Hint: About 42% of the CPI is based on housing prices, which are under water. Second, that some important sources of inflation are outside the U.S. and therefore are beyond the Fed's control.

Governments of some foreign countries do not play by the same rules of free trade, free movement of currencies, and free movement of capital.

While business leaders have to pay attention to the Fed, they must also develop their own sense of whether inflation is coming, to what degree, and how soon. Missing a bend in the road can severely damage margins and cash flow. Increasing prices by 9% is not pretty for any company, especially one that was cutting prices the previous year.

The sooner you grasp inflation and take action, the better.

What Is Your View on Inflation?

How would you answer the following questions?

  1. Are you experiencing or anticipating significant increases in purchasing inputs for your company—energy, commodities, parts from overseas?
  2. If so, how are you incorporating those increases into your business model?
  3. How is your executive team dealing with the issue of passing the increases on to your customers? Are they taking action? What are the hesitations?
  4. Has inflation become the central item in your leadership team meetings and what approaches are you using to cope with it?
  5. Have you found ways to use inflation to your advantage?
  6. Are you so immersed in daily activities that you have difficulty seeing what is coming in the next two years?
Thanks to Ram Charan / Chief Executive Group, LLC

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