Manufacturing And Inflation Explained

Consumers see jacked up prices at the gas pump, notice a rising bill for household items, or deal with the reality of an expensive housing market. But they may not understand the additional market forces churning beneath the surface, cutting into their paychecks.

The relationship between manufacturing and inflation is more complex and multi-faceted than most news reports give it credit for. So, here’s a look at how the two move hand-in-hand, the underlying causes of inflation along the supply chain, and what manufacturers can do to soften the blow.

First things first: How severe are the increases?

The Consumer Price Index was up to 8.5 percent in March, as high as it’s been since the early 1980s. The index—the country’s go-to metric for inflation—had been holding steady at or below the Fed’s target of two percent for more than a decade, but the measure started to rise in 2021.

In March, the Fed announced that it will raise interest rates a quarter of a percent, a step to curb buying and balance out supply and demand. Spending did dip in February from a strong month prior, but another interest rate hike could be on the way.

What factors along the supply chain contribute to price increases?

To help understand how manufacturing and inflation co-exist, it’s worth walking through the root causes of price increases along the supply chain. We are currently experiencing three key factors:

Supply chain disruption: This phrase has become a buzzword that many use but not all understand. By supply chain disruption, we’re talking about considerable events that make it more difficult or more expensive for manufacturers along the supply chain to obtain what they need. When it comes to the pandemic, a key factor was a change in buying behavior: after a quick but dramatic decrease in spending in the spring of 2020, some manufacturers downsized operations, only for stimulus money and social distancing to cause a surge in demand for goods (as, with social distancing measures in places, few people were spending money on travel or services). Not everyone along the supply chain could keep up, which is why we saw shortages of various items, like computer chips. The war in Ukraine is leading to further disruption, with some products produced in that area now in shorter supply.

The cost of labor: With the percentage of Americans entering the workforce on the decline, labor dynamics were already shifting when the pandemic struck, accelerating the change. Manufacturers have struggled to keep operations churning at maximum capacity with fully staffed floors. The ones that have are offering employees sometimes considerably higher wages—and rightfully so—than just a couple of years ago.

Gas prices: Oil and gas were likewise on the up and up when disruption struck the supply chain, with the U.S. imposing sanctions that have hampered Russia’s ability to sell crude oil. The average cost of a tank of gas reached record-breaking levels in March. Gas prices don’t just hit consumers, meaning we add yet another price increase to the pile for manufacturers.

How do these factors trickle down the line to consumers?

Most people understand that when raw goods are more expensive to procure or produce, they’ll have to pay more for the products they pick up at the store, as well. But how do these increases come to be? It’s helpful to imagine the scenario, starting at the top of the chain with supplier A.

Supplier A has to spend more on labor and gas, so they raise their prices. Supplier B, which purchases from supplier A, then has to swallow those price increases—plus account for the fact that labor and gas are costing them, too, more money on the balance sheet. Supplier C is in the same situation, now swallowing both the increases from suppliers A and B, as well as the higher prices of running their own shop. And on and on down the line until we come to supplier F, who sells directly to customers. Nominal price increases along the way have by this point added up, creating a noticeable spike for consumers.

There are also the simple dynamics of supply and demand at play. In times of disruption, when certain products are harder to find, manufacturers have only a couple of options: either find ways to produce their goods without certain supplies—or accept that they’ll have to pay more for them. More often than not, it’s the latter. Over time, manufacturers have learned to anticipate price increases before they happen and protect against being the “last company standing” in a strange game of rising-cost musical chairs.

These increases trickle down and out in every direction, from the clothes on your back to the food you eat. A pound of bacon now costs nearly $2 more than it did in March 2020. Long considered a yardstick for what’s happening in American pricing, a gallon of whole milk may well hit $4 very soon, up about 17 percent in the last two years. Gas, of course, is perhaps worst of all, rising from a U.S. average of $2.27 for a gallon of unleaded in March 2020 to $4.31 in March 2022. These price increases are also deeply impacting the housing market. Although lumber has deservedly grabbed headlines, wholesale prices of everything from windows to roofing tiles to steel have gone up since the start of the pandemic. When prices to build are prohibitive, builders put projects on pause, limiting market supply and shooting up real estate values.

How should manufacturers prepare for more inflation down the line?

With all the change, manufacturers may be tempted to sit tight and ride out the uncertainty. But if they’re smart, they’ll take the opposite approach. Becoming better equipped to handle inflation means becoming a more modern, more competitive manufacturer, one with a product strong enough to justify charging a premium. And on that point, companies that haven’t already should start raising their prices now, incrementally, so they’re not the last company standing when the music stops. From there, it’s a matter of managing for the long game by investing in people, wages, and smart technology—no matter what—in 2022. Manufacturers’ competitive advantage decades down the road is at stake, and those who can make out the forest through the trees will be the ones who grow and succeed.

At its core, inflation is a devaluing of the currency, often spurred on by an injection of more money into the economy. This instance is no different. Manufacturers, then, can’t control or avoid it. But by taking the opportunity to strengthen their foundation, they can lessen the impact on their individual companies while helping build a supply chain that is more resilient to the next round of disruption—whenever it may occur.