When input costs hit record highs and impact profitability, a common knee-jerk reaction is to cut costs or pass on costs to customers. But that may not be the best long-term solution.
Finance leaders say they are renegotiating terms with suppliers, diversifying sourcing, focusing on adding value to products, and expanding their markets to weather this high-inflation environment. Cost-cutting initiatives are also being introduced, but they are part of long-term strategic plans rather than ad hoc cuts in response to swings in input prices.
A widespread labour crunch due to COVID-19 and rising commodity and crude oil prices have been driving up costs in the past year. In a recent 2022 CEO Outlook Survey by EY, a staggering 87% of 2,000 global CEOs surveyed said that they are seeing "a significant increase" in input prices, and the war in Ukraine may lead to more increases.
Shipping prices for 40-foot containers remain at more than six times pre-pandemic rates, according to the Freightos Baltic Index that tracks global ocean freight prices. The Ukraine crisis is disrupting oil supplies and with countries avoiding Russian oil, demand for other oil sources will continue to skyrocket. Earlier this month, Brent passed the $100 per barrel mark for the first time since 2014. This Wednesday, it's almost at $125 per barrel after hovering as high as around $140 per barrel earlier in the week.
Andre Khor, FCMA, CGMA, the CFO of Chandra Asri — Indonesia's largest petrochemical company with a market capitalisation in excess of $10 billion — said the company took a critical look at its cost structure before passing on the increased costs to its customers.
"Before we pass on cost to the customer, we have to really keep our house in shape, because it's also about meeting our customers' needs and helping them," he said. "The advantage that my company has is that we're serving a fundamentally underserved market in Indonesia."
Chandra Asri produces petrochemical products such as polyethylene and polypropylene, and supplies to manufacturers in energy, automotive, construction, and consumer goods sectors. Aware of the impacts of its rise in prices to the whole supply chain, Khor said, the company absorbs the rising input price as much as possible before passing it on, especially for its long-term customers.
This is possible because the company implemented a cost programme that began a few years ago where it cut more than $25 million in annual costs and freed up $100 million in working capital, helping it to rake in $2.6 billion in revenue in 2021, Khor said.
The initiative reduced overheads through digital transformation, automation, and staff localisation (in place of expat workers); slashed real estate costs by accelerating work-from-home adoption; installed solar panels; and switched to electric forklifts to lower fuel costs. It also created digital twins of its factories' machinery to enable engineers to perform maintenance remotely.
The company's healthy balance sheet could take in the impact of sudden price hikes, since it's difficult to change contract terms in the short term, he said.
But to manage the current inflationary environment that may continue throughout this year, the company is renegotiating contract terms with customers.
"We take a holistic pricing strategy where it's not a one-size-fits-all for all customers," Khor said, adding that these negotiations include extending payment credit to help the company maintain a good relationship with loyal customers. What used to be a two-week payment term has now been extended to two months for select customers.
"We're cautious of any price increases because we grow with our customers," he said. "The finance team engages with the sales team daily to find win-win situations for us and our customers."
Khor said the company must also be aware of what its competitors are doing and balance the needs and obligations of the company to investors and banks, with maintaining good relationships with customers.
Valerie Lee, ACMA, CGMA, senior vice-president of Finance of the furniture division of Fung Group, has had to manage the enormous increase in shipping costs from the companies' factories in Asia to the US. This is in addition to a 25% US tariff the company has to pay if it sources from China.
"The global supply chain is badly tangled up, and globally, we are seeing shortages in labour and, as a result, lower production," she said.
She added that the company is looking to near-shore its suppliers to lower supply chain risks and decrease freight costs. Lee, who is based in California and looks after the US market, said the company has benefited from the work-from-home shift since the pandemic began where office chairs, gaming chairs, and sofas became its best-selling items. In the past year, retail prices of furniture and home furnishing went up by 8% to 10% due to the global shipping crisis and material shortages, she said.
"Raw material prices will continue to rise, but I think the bigger issue is still freight," she said. The company can save 20% to 30% in shipping costs if it prebooks shipping containers, Lee said. However, if there is a production delay due to COVID-19 outbreaks, the company has no other option but to pay the spot rate, which is much higher.
"With higher raw material prices, there's a lot that we can do — we can work with R&D to re-engineer and recalibrate our product portfolio and expand sourcing capabilities in different countries," she added.
Since a few years ago, the company has had to reconsider sourcing from China because of the US-China tariffs, even though the raw materials from the country may be cheaper.
"I think diversifying our sourcing base is a very important element in dealing with raw material and labour price increases," she added.
Adding value to products
The high-inflation environment has also helped Lee focus on the value that her company's products provide. These include improving product design and quality control and introducing innovations to justify price increases.
"We're more focused on companies we collaborate with, to leverage our licensed brands and design," she said. "This is so we're not just selling a chair produced in Vietnam or China; we're selling a branded item with quality, technology, and innovation."
Although her division sells furniture to retailers instead of end consumers, there has been a greater emphasis on customer experience. Her team works with retailers to expand selling platforms and channels. The company also started using computer-generated imagery (CGI) technology to create 3D models of its products, invested in a customer service contact centre to help customers with difficulty assembling the furniture, and paid greater attention to end-customer online reviews and feedback.
All these have helped to better position the company's brands, and end consumers are willing to fork out the premium for its products, she said.
Preparing for future inflation
In a blog last month, the World Bank economists wrote that inflation is now a global phenomenon, with 15 out of 34 advanced economies reporting inflation rates above 5% through December 2021. A similar trend is seen in 78 out of 109 emerging and developing economies.
IHS Markit in February predicted that inflation would remain elevated in the months ahead but may subside if demand cools and supply chain issues resolve later in the year. But the IHS Markit forecast was published before the start of Russia's invasion of Ukraine caused further chaos that experts say is likely to create more supply chain challenges and inflationary conditions.
Looking ahead, Khor said he will focus on creating value for customers and expanding Chandra Asri's market. With crude oil prices high, he still thinks that trying to lock in prices of raw materials is not the best strategy for the company because it's simply too difficult to predict where oil prices will head. Instead, he will focus on meeting the needs of its customers and sustain the company's financial resilience and operational excellence.
Lee echoed similar sentiments. Her focus will be on margin improvement by creating better products and expanding the business instead of introducing cost cuts. The company is also looking to introduce new product categories and break into new markets.
She stressed the importance of a dashboard reporting with real-time data to stay on the front foot of how the business is performing instead of relying on historical data. Her team tracks key indicators such as forward orders for every product category so that finance can help the sales team better price each item.
— Alexis See Tho is an FM magazine associate editor. To comment on this article or to suggest an idea for another article, contact Kenneth Tysiac at Kenneth.Tysiac@aicpa-cima.com