Icon (Close Menu)

Logout

Inflation: Costs, Supply Issues Put Squeeze on ManufacturersLock Icon

7 min read

It’s no secret that this year’s surge in prices and a global supply chain logjam initiated by the COVID-19 pandemic are squeezing Arkansas’ manufacturing industry, but company leaders weren’t itching to talk about the topic last week.

Raw materials, labor and fuel price increases are forcing producers to both economize and pass on the costs to customers, Arkansas Commerce Secretary Mike Preston told Arkansas Business. “We’ve definitely been hearing about rising costs since about March, when business started really opening back up and demand soared,” Preston said. “It’s causing a lot of issues for manufacturers across Arkansas.”

Most state manufacturing executives sought out to comment for this article declined; others cited hurdles with corporate communications departments preventing them from talking by press time.

But Donnie King, president and chief executive officer of the state’s largest manufacturing employer, Tyson Foods Inc. of Springdale, was frank about inflationary pressures in an Aug. 9 conference call on the meat company’s impressive third-quarter results.

He said Tyson had raised its prices to keep up with costs and will continue doing so.

“Inflation is up about 14% in our Q3 and 9% year-to-date,” King said in the call, according to a transcript by seekingalpha.com.

He added that Tyson has “increased prices to help offset significant raw material and supply chain cost inflation.”

‘Aggressive Pricing Going On’

The company raised its average prices in the quarter nearly 40% for pork, and 16% for chicken. Beef prices were up 12% in the quarter, with demand for both meat and poultry continuing to rise.

King said Tyson had already raised prices on its food-service line of products and will raise retail store prices on Sept. 5, all in response to “unprecedented” rising costs.

“Like other businesses, we’ve had labor [issues] and absenteeism and turnover in the business; we have a number of open positions, so that certainly has made us inefficient, and so we’ve got aggressive pricing going on. Aggressive revenue management and commercial spend management will help mitigate a portion of these inflationary impacts.”

Bottom line? “We will continue to [raise prices] to match the nature of the cost that’s coming to us,” King said.

The Institute for Supply Management, which tracks raw materials pricing in its ISM Prices Index, reports that costs to manufacturers have been going up for 14 straight months, and June’s index reflected the sharpest cost rise in 42 years.

July’s index tracked a slightly slowing momentum of inflation, but material prices were still up significantly.

A report by Timothy Fiore, who leads ISM’s manufacturing business survey committee, cited record raw-material lead times, rising commodity costs and shipping difficulties affecting all segments of manufacturing.

Michael Pakko, the state economic forecaster at the University of Arkansas at Little Rock, said manufacturers have “only so many ways” to respond to price pressures.

“In principle, firms will all try to some extent to pass on rising costs to customers,” Pakko told Arkansas Business. “Economic theory suggests that the circumstances of particular markets determine the extent to which a business can pass on its rising costs.”

For example, Pakko said, businesses that make easily substituted items could risk market-share losses if they raise prices. Long-term contracts in some industries restrict pricing options, he said, and some companies are likely to “value the protection of long-term customer relationships over short-term profit considerations.”

Steel and Timber Stand Out

David Peacock, CEO of Jonesboro’s Hytrol Conveyor Co., which recently installed a new manufacturing plant in Fort Smith, boiled down the pricing crunch to steel, timber and labor costs.

“Steel is our single largest cost component, and the price is up more than 300% in the last 12 months,” Peacock said in an email. “Wood was about as bad, but that cost has begun to come down over the past 30-60 days.”

To compete in the labor market, which human resources directors are calling the most competitive in years, Peacock said Hytrol had raised starting pay by 25%. “Labor costs are up,” he said. “We employ a pay progression, and in the past it might take someone 24-30 months to ‘top out.’ Now they get there in half that time.”

Preston, the commerce secretary, and Arkansas State Chamber of Commerce CEO Randy Zook also mentioned steel pricing as a focus of concern.

“I’d say steel prices are a particular worry,” Preston said, particularly for smaller and midsize manufacturers. “They are really less able to absorb or pass on the cost to customers. You see it across the board, but bigger companies have the ability to manage it better.”

Meanwhile, there’s debate about whether the cost crunch will far outlive the continuing COVID crisis, and about whether the recent cost spikes even fit the definition of inflation.

‘Just-in-Time Production’

Expectations about the future are crucial, said Pakko, the UA Little Rock economist.

“If prices are expected to be temporarily high and will recede once the supply-constraints ease, then a business might be more inclined to allow cost increases to temporarily erode profits, with the expectation that maintaining market share now will pay off in the future,” Pakko said.

On the other hand, if businesses expect the price increases to stick, “then the pressures to pass along the higher costs to customers are more persuasive,” he said. “In an emergent inflationary situation, where prices across the board are expected to continue to rise … the case for increasing output prices is even more compelling.”

One complication, Preston said, is that manufacturers have little lead or planning time, operating under “just-in-time production” conditions. “They’re trying to get the product out in an environment where there’s not a lot of storage, or existing supply to be stored, and that is difficult.”

Petroleum and gasoline prices have added to manufacturers’ headaches, soaring since a crash early in the pandemic. West Texas Intermediate crude oil, which was selling for $18 a barrel in April 2020, was at nearly $70 a barrel last week. Nationally, gasoline prices are up a dollar a gallon over the past year, and last week the Biden administration revealed that it is urging OPEC and other oil nations to increase production and offset demand-driven spikes.

Businesses obviously can’t operate at a loss indefinitely, Preston said. “At some point, prices are going to increase, and it’s going to be passed along to the consumer. You’re really seeing that in food prices now, and other goods and services.”

Initially, cost pressures were almost certainly driven by COVID, Preston said. “But as we’re going forward and continuing to see the labor market really tighten up, I think these conditions could stretch well beyond that. And then, you know, what happens in the next couple months to year two at the federal level could really impact that. We could see this get worse, unfortunately.”

Monetary Policy

Pressure is growing on the Federal Reserve to fight inflation by pulling back on easy-credit policies and quantitative easing, in which the central bank buys government bonds and other assets to increase the domestic money supply and invigorate the economy. The Fed announced a $700 billion quantitative easing plan in response to the pandemic in March 2020; in June 2020, it committed to buying $80 billion in treasury bonds and $40 billion in mortgage-backed securities.

Two months ago, the Fed indicated it was likely to look at raising interest rates in 2023 to combat inflation, but action is beginning to look likely next year.

“I don’t see how we avoid it,” Preston said. “At some point there’s going to have to be that reckoning.”

As an economist, Pakko took pains to distinguish between inflation, a situation he doesn’t think the nation is facing yet, and widespread rising costs. “The difference is subtle but important,” he said.

“Inflation is a persistent, sustained increase in the general level of prices. The current situation could develop into an inflationary spiral, but at this point the price increases are driven by a combination of strong demand and COVID-related disruptions on the supply side. The result is rapidly rising costs for manufacturers as the price of everything from raw commodities to transportation to labor costs are rising and putting a strain on profitability.”

Economists caution that year-over-year readings on price increases are distorted by the direct effects of the pandemic a year ago, particularly in regard to consumer prices. “Prices sagged in mid-2020, so if we measure price increases since then we are measuring from a distorted base, and it’s not surprising that we’ve seen sharp increases to offset the sharp declines,” Pakko said. “But there is no question that recent price increases have exceeded any reasonable bounce-back we might expect from the low-demand conditions of the lockdown period.”

In the Bureau of Labor Statistics’ Producer Price Index data for industrial commodities excluding fuels, “there was only a slight decline in prices during 2020, and prices have increased more than 17% over the past year,” Pakko said.

As a self-described “recovering monetary economist,” Pakko says monetary policy is a tremendous force in the inflation process. “Price pressures can emerge from the supply side or the demand side of the economy — or both, as is the situation today,” he said. But long-term inflation generally emerges only if those pressures are encouraged by “excessive” monetary growth.

“Recent Federal Reserve policy gives reason for concern,” he said. “The policy of low interest rates and massive asset purchases has flooded the economy with liquidity at the same time that these price pressures have emerged.”

The Federal Reserve holds the view that current price increases are temporary “and that inflation will not break out of control,” Pakko said. “We can hope that they are correct.”

Send this to a friend