Inflation slowed to 3% year-over-year in June, but commodity prices are still higher than they have been the last few years. As we learned during the pandemic, shipping delays and strong demand can send pricing soaring—and quickly. In order to mitigate risk when commodity prices increase, credit professionals must develop bulletproof pricing strategies for their customers. If businesses raise prices too aggressively, however, they risk getting stuck with built up inventory once prices regulate.
For example, the cost of lumber has increased significantly in the last month due to shortages as a result of ongoing Canadian wildfires. "… it is too soon to estimate how much of the affected area includes harvestable timber and how much will catch fire in the months to come," Marcy Nicholson, senior editor at Forest Economic Advisors, said in a news report. Increasing lumber prices affect U.S. businesses significantly as Canada supplies approximately 80% of U.S softwood lumber imports, according to Natural Resources Canada.
Rising fuel prices have made it more costly for the freight carriers to transport goods, increasing freight costs for shippers. The U.S. Energy and Information Administration reported that crude oil prices will reach about $80 billion in Q4 of 2023 and average about $84 billion in 2024 because global oil inventories are expected to decline over the next five quarters. Not only that, freight shortages due to disruptions caused by the pandemic, capacity constraints, increasing freight rates and severe driver shortages will continue to persist, per Smart Trucking.
Pricing Strategy Advice from Creditors
Price surges affect each business differently depending on the industry, but it's important that creditors are able to adjust prices accordingly and pass the cost onto customers. As a credit manager, you want to make as much profit as you can and raise your prices to avoid hurting margins, said Kevin Stinner, CCE, CCRA, credit manager at J.R. Simplot Company (Loveland, CO), who was directly affected by price increases for chemical products last year. "But if you price product too high, you're going to be stuck with inventory when prices decrease," he said. "Just keep in mind, prices will eventually decrease."
Credit professionals can protect their companies against price surges when accepting purchase orders (PO). "When you accept a PO from a customer, there may be price locks, which protect unit prices from being repriced," said Chris Ring of NACM Secured Transaction Services. "You can try to mitigate risk so that if the price increases a year later, you have the ability to increase the price you charge a customer. If it's your purchase order, make sure you have the ability to raise prices if you have to." Additional forms of protection in contracts include indexation, hedging and forward buying.
It is key to distinguish the difference between costing strategies and pricing strategies, said Shaun Papperman, CCE, CCRA, CICP, director of order fulfillment at Baltimore Aircoil Company, Inc. (Jessup, MD). "Inflationary pressures, which are far more predictable than commodity price surges, is a continuing issue," he said. "But it also comes down to your relationship with your customer. If they've given you a PO and the price is agreed upon, you've got to find a way to pay for it. And if your customer is living on margins that are thin, you must assess that risk before making a credit decision."
Even if price surges do not directly affect your customers, creating a pricing strategy can keep you ahead of the competition and protect you from future price surges. For example, Ty Knox, ICCE, director of credit and risk at EFCO Corp. (Des Moines, IA), says the rising cost of lumber is an advantage for his company since their product, steel, is a competitor of lumber. "But for our pricing strategy, we contend that we are the Lowest in Place Concrete Cost (LIPCC), meaning that you're going to save labor and reconditioning costs," he said. "In addition, we have continued to increase our prices to stay with the market but we hadn't done it as aggressively in hopes that we can garner more market share."
-Jamilex Gotay, NACM editorial associate