Inflation is raising its ugly head.

It has been quite a while since we were confronted by the grim prospect of inflation. The 1970s seemed to be the last serious time. Ever since Paul Volcker raised interest rates up to stratospheric ranges more than 20% for loans we have not had to think about it at all.

All that is changing—and it’s not a good change.

Like you, I have seen the struggles of the economy over the past three to four years. We have seen government intervention in the economy as never before and are experiencing deficits beyond belief. I don’t want this to be misunderstood as some political statement; I am just stating the facts.

There are doubts with Quantitative Easing (QE II) ending this month that the benefits intended were achieved. One thing that has certainly been achieved is a much lower dollar. That is contributing to our impending inflation.

Another item to consider is the world of commodities. Rarely have we had the confluence of an extremely large increase in demand such as what we see in the Asia Pacific region and China right now—or for that matter in Russia, Brazil, and India. Couple that with unemployment and a lethargic housing market at home, and you have quite a situation.

Inflation is a two-edged sword. On the one hand it will increase the value of assets like a home, but on the other, it will erode the value of your earnings by making those things you purchase more expensive.

This brings me to my focus this month. Prime product and parts prices will rise. Steel prices in 2009 and 2010 ranged between $575 and $754 a ton. The experts are saying we will be moving to $970 a ton in 2011. That is an increase of just under 70% in two years! Amazing! Just look around the grocery store and you will see the impact on your purchases.

Dealing With It

So how do we deal with inflation in our business? Many of you provide quotations to your customers for your products. Sometimes those quotes are outstanding for a while before they come to fruition.

“Prices are subject to change without notice” is an expression you will have to get used to again.

If you have the products on hand in inventory, you have a bit of a cushion. You know how much you paid for things. But you don’t know necessarily how much you will pay for replenishment of inventory. So the first thing: “Prices are subject to change without notice.”

The next thing is the frequency of price changes from your vendors. With the “just in time” inventory philosophy in place for most of our supply chains, the reaction time to price adjustments will be fast.

If we look back at the 1970s, we used to have an annual price adjustment from most vendors. Then it went to twice a year, then quarterly, and finally, as necessary. Many vendors today download over a communications network parts prices each night. This puts a large burden on the parts department or parts professional trying to understand what is happening so they can decide on their approach to the changes. It’s no easy task.

The administrative costs to managing the parts inventory and the prime product inventories are going to increase. There is just no way to be able to evaluate pricing without additional resources. By knowing this, however, you can make adjustments to compensate for these additional costs.

So let’s sit back a moment. For those of you who agree with my assessment of impending inflation greater than that which we have experienced over the past 20 years, you can prepare yourself with a 1% increase on all your parts’ retail prices and quotations.

Prime product is a different subject and can be approached from a different angle. Each unit you order will have a price attached to it. Thus, you can be able to price from a cost base if that was not your method already. It is less risky on the prime product side with price changes than it is on parts.

For those of you who either don’t agree or are unsure, please watch the Consumer Price Index (CPI) and the Producer Price Index (PPI) over the coming months. Remember though that the measures we use today were changed in 1983, so that the inflation perspective is less dramatic now than it was in the 1970s.

Having Inventory Ready

The final comment here relates to the inventory valuation method you use. We have replacement cost, average cost, first in first out, last in first out, and various other structures in use in American business. If we use a 6% inflation rate evenly spaced through the year and an inventory turnover of four times a year, we will have a 1.5% price change on 90 days of parts sales on hand in inventory each quarter. I think you should be protected against that.

My suggestion is the methods I used back in the late 1970s when inflation was between 12% and 18% annually on the products we were selling and stocking. I think you should push your prices up by the average increase in inflation on the products you carry, based on the inventory turnover. For example, if your turnover is two times a year and inflation is 6%, then an increase in price of 3% would be appropriately applied. Understand that this is not to make additional profit, but is about recovering the appropriate cost based on the inflationary price increases.

I am sure that you understand I am not rooting for inflation to be with us, but I am seeing too many signals that indicate it is coming on quickly. And in this case, being prepared is the best answer. Good luck.

by Ron Slee
June, 2011
Water Well Journal

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