5 Key Cost Considerations as Oil and Other Input Prices Rise

March 11, 2022

Contributor: Jackie Wiles

Widespread input-price inflation hasn’t loomed this large for 40 years. How you manage costs in this environment can differentiate your growth trajectory from competitors.

In short:

  • The Russian invasion of Ukraine prompted organizations to take immediate action that prioritized human needs above all else, but the impact on business health is a growing concern.
  • Business leaders were already wary of input-price inflation due to supply-chain and revenue disruption tied to the pandemic. Russia’s invasion of Ukraine is worsening those trends.
  • Mismanaging costs in this environment could hobble your organization’s postpandemic ambitions. What’s needed now is a strategic approach to managing costs related to pricing, personnel, raw material supplies, IT contracts and demand planning.

For most organizations, Russia’s invasion of Ukraine prompted a crisis response that placed human needs above all other actions. But the economics of business are changing rapidly as input-price inflation rises. How your organization manages costs now could be critical to its future health. 

“It’s always a challenge for organizations to be strategic about cost management and retain capacity for growth, but many executive teams lack the muscle memory to tackle the type of inflation scenario we’re seeing today,” says Randeep Rathindran, VP at Gartner. “We haven’t seen broad-based input-price inflation like this for 40 years, and it takes agile and responsive strategy to allocate resources efficiently while tackling that pressure — and still achieve the organization’s desired outcomes.” 

Watch Gartner experts discuss: Top Inflation Concerns for 2022 and Beyond

What’s special about today’s input-price inflation?

News headlines typically focus on monetary inflation, because it relates to the higher prices that consumers pay for goods, services or assets. Think: surging housing or gas prices. Input-price inflation, by contrast, raises the cost of doing business by making the components required for producing or delivering products and services more expensive. It is typically the reason consumers end up paying higher prices. Whether and how those increases get managed — and passed on — directly impacts customers and shapes the organization’s ability to grow profitably.

Headed into 2022, many business leaders were already concerned that inflationary pressures and supply shortages could threaten their organizations’ post-pandemic ambitions. And then Russia invaded Ukraine. The impact on inflation is unknown, but persistent supply disruptions will continue to drive up the prices of raw materials like oil. 

Read more: Resources for Executives and Their Teams Amid Russia’s Invasion of Ukraine

On March 8th, 2022, the U.S. banned imports of Russian oil, liquefied natural gas and coal. The UK announced its own restrictions on buying Russian oil imports, and the EU has unveiled a plan to wean itself off of Russian fossil fuels. It’s too early to predict the ultimate impact on oil prices, but the cost of other inputs, such as wages, are also rising and show no sign of abating. 

Tackling the resulting margin pressure is especially tough on pandemic-reduced budgets. Many organizations used a range of tactics to preserve their balance sheets, especially in the early weeks and months of the COVID-19 pandemic. It became common to reduce or delay orders from suppliers or reduce raw-material stockpiles to eliminate waste. Planning horizons also shrunk amidst volatile conditions.

While warranted at the time, these initiatives meant that when demand began to recover, many organizations were forced to pay more for inputs to secure the supplies they needed to respond.

Bottom line: Since most organizations have already lowered budgets across business functions, there is limited room to offset input-price inflation through cost cutting in other areas. 

Download now: A Framework for Proactive and Strategic Cost Management

5 cost considerations during inflation

So what can organizations do to ensure they are managing costs now in a way that can still leave (or create) capacity to fuel their growth? Here are five key elements to remember.

No. 1: Pricing: Base your pricing changes on both competitor actions and customer profitability

It’s tempting but potentially short-sighted to pass price increases straight to customers. Price hikes may seem quicker and easier to execute than initiatives to improve productivity or create strategic cost savings, but remember that inflation will at some point turn into disinflation. At that point, you will likely need both to reverse the cycle of price increases and those productivity and innovation initiatives to preserve margins.

In evaluating price decisions in the short term, consider whether inflation is a temporary deviation, watch the competition, gauge the price sensitivity of customers and protect your most profitable customers. For example, even if inflation looks persistent and competitors are raising prices, you might be better served not passing on the costs to your most price-sensitive, big or profit-driving customers. 

No. 2: Personnel costs: Optimize hiring costs and recalibrate compensation packages

Try to contain hiring costs for critical skills. For example, source from a wider pool: the total skills market, which leverages untapped sources, adjacent skills and underrepresented profiles.

Also recalibrate compensation packages to reflect the new circumstances of remote work, relocation and costs of living — and note that as employees increasingly seek value and purpose at work, money is unlikely to fix your talent shortages in a vacuum. HR teams must deploy a range of tactics that aren’t just about money to attract and retain talent.

No. 3: Raw material supply: Widen your supply chain visibility and expand your options

Extend supply chain visibility from end to end, look for ways to diversify your supplier base and leverage partnerships with resellers and distributors.

In the case of semiconductors, for example, include the entire supply chain from chip fabrication to testing and packaging to better understand semiconductor dynamics. If you lack scale, try to partner with an entity that is a preferred volume buyer. Consider pre investment opportunities that could guarantee supply and track leading indicators, such as capital investments, inventory index and semiconductor industry revenue growth projections as early indicators of the supply situation. 

No. 4: IT Contracts: Renegotiate to remove waste in contract pricing

Reduce contract prices by negotiating to remove bundled support and unnecessary add-ons. For example, SaaS-related cost savings options include making a deal to terminate shelfware or add-ons (or secure a credit instead) or suspending unused functionality that you can do without for now. You might also explore free or usage-based licenses to respond to temporary peaks in demand.

To reduce software costs, consider discontinuing support and maintenance for licenses that are no longer in use If possible, move to third-party support to avoid wasteful support-bundling rules. Finally, reduce your support level from higher-tier to standard support.

No. 5: Planning: Manage one cycle ahead

Supply chain planning leaders need to build more flexibility into the sales and operations planning (S&OP) process to adapt to changing business conditions. To do so, embed a rolling, scenario-based planning approach to manage demand one cycle ahead. You’ll need to develop scenarios for the S&OP process and drive decisions for S&OP based on the risks, opportunities and business impact associated with those scenarios. Make sure to monitor these scenarios, retain the relevant ones for the S&OP cycle and confirm when and if you need to reevaluate decisions.

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