After many years of absence, cost and price inflation is returning as a risk factor for business performance. This has major implications for Demand Planners and supply chain professionals.
Central banks are re-assessing their monetary policies and programs to be ready to mitigate inflationary pressures in the economy. Financial markets are girding their loins for uncertainty in the bond and equity markets. Businesses are experiencing strong upward price pressures on energy, transportation, labor, supply, and materials costs.
Profit margins and ROI’s are at risk as businesses begin their financial mitigation efforts in this new and uncertain environment of post-Covid operations.
US inflation is 2-3 times the average annual rate experienced over the past 15 years
Currently, overall inflation in the U.S. is about 2-3 times the average annual inflation rate experienced over the past 15 years. Inflation for some key commodity categories like oil is much higher than that.
Supply chain management is experiencing rising costs due to commodity and factor prices along with delays and disruptions in shipping and transportation that are extending lead times and increasing inventory during this post-Covid adjustment period. Service and product pricing will need to be adjusted to reflect this to protect product margins and ROI.
Product costs are also rising due to materials and labor expenses, and other expenses which are essential to production. These too will contribute to adjustments in pricing to preserve margins. Higher inventories will result in higher interest, handling and warehousing costs, and other costs associated with holding stock. This will partially consume the free cash flow that would have been available in the pre-Covid world. And of course, there are also higher costs associated with Covid protocols essential to protecting employees, clients, and customers.
How Inflation Impacts Consumer Demand
Everyone working in supply chain has these same issues to deal with. There are inflationary pressures being experienced across and up-and-down the supply chain network. How is all this cost and pricing pressure going to affect the demand for products?
Enter the world in which Demand Planners are trying to understand the demand for products and services as household incomes change and as consumer behavior changes. Changing prices will affect demand patterns. The accuracy of demand forecasts directly affects the accuracy and mitigation activities of Supply Planners.
Inflation alters consumer behavior in ways that tend to increase demand volatility
Inflation also alters prices and consumer behavior in ways that tend to increase demand volatility and decrease demand forecast accuracy. So, the inflationary threats at hand are of critical concern to those who are doing the demand forecasting and demand planning as well as those who are using them in the supply planning and supply chain management.
Inflation Requires More Advanced Analytics
In times of low inflation and steady financial market conditions, it is easier for demand forecasters to accurately forecast demand with the many time series models available, which yields acceptable results with relatively simple methodologies. In current times, it is important to better understand consumer behavior and its reaction to changing household financial circumstances and economic conditions. This necessitates more complex analytics and more complex forecasting models such as regression.
Inflation necessitates more complex forecasting models such as regression
Now is the time for Demand Planners to focus more time and attention on gathering data and market intelligence from prior periods to better evaluate the factors that are currently driving demand. This can then be used with regression analysis and regression models to better explain the behavior of customers and consumers as their circumstances change. It provides an opportunity to simulate future outcomes and future scenarios of behavior instead of assuming relative stability of conditions as time series methods do.
This aids in gaining greater insight into likely product demand when prices and consumer income (in real terms) are changing. This can increase the reliability of projections used in supply management in periods of inflation.
Pricing Strategies Are Important In Inflationary Times
Since relative price is a key factor in purchase behavior, it will be important for Demand Planners to undertake analytics that test the price elasticity of demand and the associated pricing strategies to get the best financial results for the company.
It will be important for Demand Planners to undertake analytics that test the price elasticity of demand
Price strategies and market responsiveness to competitor actions are essential when competitors and inflation are simultaneously affecting the relative price of the company’s products. Marketing plans must be carefully considered when there are both company-controlled and market-controlled variables affecting demand.
Now is the time to increase collaboration across functions, increase use of qualitative methods to understand consumer behavior, and specifically focus attention on the multiple dimensions of inflationary effects that may influence product demand.
In Summary
Inflation is a condition which has been tempered for many years and is now a complicating consideration again. There is the question of whether it is a transitory condition due to the post-Covid transition, or if it may have a more long-term nature like it used to have in years gone by. Either way, its a reality that cannot be ignored by Demand Planners or supply chain professionals. Quality demand forecasts adapted to changing consumer behavior and thoughtful supply chain management will be essential to realizing the financial goals of your company and serving the needs of its customers.