Managing Price Inflation in 2022: What Can Procurement Do?

Material shortages and inflation were two of the greatest challenges faced by procurement managers in 2021 and remain likely to follow us into the new year. Labour shortages, lower manufacturing capacity, energy cost rises, and delays at ports have become familiar fixtures in crisis headlines, having created a perfect storm across global supply chains. However, the UK still needs to build and construction will continue to be a crucial sector for the economy – it will simply cost more. Despite supply chain constraints, there is still plenty of demand to meet with construction output growth forecasted at 4.8% in 2022 by the Construction Products Association (CPA) [1]. Therefore, the pertinent question is how can procurement teams increase their efficiency to mitigate price inflation and save costs for their companies in the year ahead?

The Numbers

First, let’s look at some key UK inflation statistics from 2021 to contextualise today’s unprecedented construction market:

The Construction Output Indices (OPIs) reported ‘All Construction’ up 5.1% for the 12 months to September 2021 - the highest percentage change of any 12-month period in the dataset from January 2014 [2].
The material price index for ‘All Work’ increased by 24.5% in October 2021 compared to October 2020 – the largest 12-month change in the dataset again, this time from January 2017 [3].
Steel prices remained high with ‘fabricated structural steel’ and ‘concrete reinforcing bars’ experiencing the first and third greatest price increases year-on-year for October 2021’s statistics of materials and components published by BEIS, at 70.6% and 60.5% respectively [3].
In November 2021, the Retail Prices Index (RPI) reported a 27.8% annual rise in petrol and oil - reaching a historic high from over 34 years ago in January 1988 [4]. Increasing energy costs can have the knock-on effect of increasing inflation across a much wider range of construction materials, leaving industries involving energy-intensive manufacturing such as cement and concrete particularly exposed.
The UK unemployment rate was down to 4.2% in September 2021 from 5% in September 2020, meaning it is now only 0.2% higher than pre-pandemic levels recorded in March 2020 [5].

*Calculated from official releases by ONS and BEIS (see references at the end of the article)*

How Procurement Teams Can Protect Businesses

When profits are squeezed, operating models must respond to the challenge. In today’s market of high materials demand and rising prices, resilience is more critical than ever. The time is now to explore new savings levers. Procurement teams should look to implement a diverse set of tactics to maximise their chances of success in navigating this uncertain landscape:

1. Develop digital and analytics capabilities

Digital transformations, implementing enterprise resource planning (ERP) systems and dashboards are nothing new to procurement managers. It is not simply how you manage data but the ability to draw actionable insights from your data that wins in a volatile market, developing predictive capabilities to identify shortages and changing prices. Defensive moves against inflationary pressure, such as adjusting order volume, order frequency or inventory levels, all require data insights to optimise timing. A rapid response capability requires a flexible technology architecture and thus a core-light approach that minimises ERP software and maximises integrations should be pursued to enable a single source of truth for your organisation. This requires multiple modules to connect to a single ERP core through application programming interfaces (APIs), facilitating real-time data throughout the supply chain to feed seamlessly into pre-existing databases [6]. Ultimately, integration enables better adaptive response to price changes as the magnitude of changes are more easily compared against historical datasets for improved forecasting.

2. Smart indexation

Non-indexed contracts are now rare in long-term infrastructure projects, yet choosing the right index in contract negotiations is crucial to mitigating inflation risk. The key is to choose an index that measures the costs which most closely match the structure of project costs. Otherwise, one risks encountering differential inflation rates which can quickly turn an insignificant value activity into a dominant one if not adequately accounted for. Category managers can work closely with commercial teams to highlight market effects and their impact on purchase prices, ensuring the right arguments are advanced to aid negotiations with clients.

3. Inflation task forces

Data monitoring, predictive analytics and contract management require specialised resources, and more so than ever during periods of price increases which impact the bottom line. Companies that set up dedicated teams to monitor and implement an inflation response roadmap will be rewarded. The first task is to establish risk metrics and response actions against specific parameters. Perhaps most importantly, supply chain specialists can advance relationships with sellers through collaboration to minimise price increases. As highlighted elsewhere in this blog series, contemporary supply chains now rely as much on collaboration as on competition, with Deloitte’s Global Chief Procurement Officer survey finding enhanced supplier information sharing to be the top risk mitigation strategy (75%) [7]. Effective collaboration is proactive and structured, harnessing the soft skills of relationship-building to create clear incentive agreements and workflows built into partnership contracts.

4. Embrace a holistic view toward inflation

We must accept that to an extent, price increases are unavoidable and current inflation acceleration is likely temporary. Cross-functional initiatives can help ease the burden on procurement functions when prices are high, as the impact of any cost savings are amplified. Now is the time to explore new processes and models. For example, off-site manufacturing (whereby manufacturing occurs in a factory rather than building on-site) is increasingly being harnessed in smart construction. Due to a shorter construction period, off-site manufacturing can achieve financial net savings of around 7% by enabling buildings and infrastructure to come into service quicker [8].

Inflationary pressures will not let up any time soon, so procurement managers must acclimatise to a volatile market in which unexpected events can disrupt supply chains. That is why it is crucial that organisations take the time to develop effective, data-driven strategies to build resilience against inflation.

Words by James Chisnall

References