The world has faced multiple exceptional and unexpected adverse events with a primarily human impact over the last two years and, before discussing anything else, we offer our sincerest sympathy and condolences to the victims affected.
A second impact has been on the global economy, with the tremendous loss of productivity exacerbating shortages of many critical materials and components and rapidly increasing commodity prices, with a sharp increase in costs and delivery times.
To name only a few of the unprecedented events that have occurred and are, in some cases, still occurring, all concentrated in these last 2 dramatic years:
- the Covid-19 pandemic and consequential global lockdowns;
- the Suez Canal blockage;
- singular weather conditions and mass blackouts which wiped out energy and petrochemical operations across the central U.S. in February 2021;
- the shutdown of the largest fuel pipeline in the U.S. by hackers;
- the congestion at Indian and South Chinese ports due to Covid-19;
- the ongoing tragic war in Ukraine and its evolving consequences;
- the earthquake that struck Fukushima Prefecture on 16 March 2022;
- the recent lockdown of main cities in China, like Shenzhen and Shanghai.
The prices of essential materials, products, and services have escalated at rates unheard of in more than a decade. The London Metal Exchange Index of six key industrial metals has doubled since the middle of the pandemic, reaching a level not seen since 2011. In Europe, natural gas spot prices ended 2021 at more than 12 times their pre-pandemic levels. In the runup to the end of year holiday season, maritime container freight rates were seven times higher than in 2019.
Consumers are already feeling the blowback of these price hikes. The US consumer price index increased by 8.6% in May from a year ago, the highest increase since December 1981. In Germany and the United Kingdom, the equivalent figures were 7.9% and 9.1%, respectively. That’s in addition to upward pressure on wages. Private sector labour costs in Romania increased by 15% in the last 2 years, while productivity declined because of the Covid-19 pandemic and component shortages in the production line.
Electrical energy prices are also becoming a grave concern across the EU, influenced by high global demand and mounting geopolitical tensions. After low electricity prices of around €35/MWh on average in 2020, electricity prices followed the rise in natural gas prices. On the back of the Russian invasion of Ukraine the daily average price peaked above €500/MWh at the beginning of March 2022.
According to recent long-term forecasts, gas and electricity prices will remain high and volatile until at least 2023. Compared to last year, the situation has deteriorated, and is likely to last longer. Sustained high energy prices are impacting the entire economy, driving inflation and severely affecting households, agriculture and industry.
Further to this, the transition from fossil fuels may mean that energy prices will remain on the higher end for many years to come. This, in turn, will also change the market dynamics for an entire host of materials required for batteries, electric motors, and generating equipment for renewable power.
The following table shows how all of these factors are influencing the market:
Electricity Energy Cost (1)
Labour Cost (2)
Material Cost (3)
Euro/Dollar Exchange Rate Impact (4)
(1) Data from www.ecb.europa.eu/pub/economic-bulletin
(2) Based on Romanian values
(3) Data from https://ec.europa.eu/eurostat
(4) October 2019 vs June 2022
How to calculate the price increase on a finished product
These data can be compared with a real case to derive the price increase impact on an industrial finished product.
First, it is necessary to establish a simple, though effective, model to properly calculate the exact amount of the price increase on the finished products or services. The variety of cases is evidently wide, but this shouldn’t prevent us to define a general rationale for our reasoning.
A case study was done by analysing an electronic industrial product, manufactured in Eastern Europe, comprising a metal chassis, a bill of materials whose value is about 50% purchased in US dollars and 50% in euro, with the metal parts acquired in Europe and the electronic parts bought (and thus shipped) from Asia to Europe.
In this case, the product price increase is about +26%.
This was based on the following list of impacting costs increases:
- Impact of average electronic material price increase in euro (BOM 2022 Vs 2019): +12% (a)
- Impact of average metal part price increase in euro: +5% (b)
- Impact of inbound and outbound transport cost increase: +5%
- Impact of energy cost increase: +3%
- Impact of labour cost increase: +1%
(a) including impact of Euro/US$ exchange rate
(b) Stainless steel price per kg rose from 0.45€/kg in 2019 to 1.326€/kg in 2022, Source: steelbenchmarker.com
What can industrial companies do to protect their margins?
For industrial companies, it is not so simple and straightforward to transfer the extra costs to the market and, for several months, some of them were forced to bear the increased costs, compromising their margins and the sustainability of their business. However, most of them can now no longer absorb said costs and clearly will have to transfer them to the market, causing a further impact on price inflation.
But for those companies with long term contracts in place, especially those deriving from a public tender, adjusting prices can be a very long and difficult path.
In any event, even though contractual obligations might make it seem impossible, there are some countries where the law can help both public and private contracts in this matter.
That said, simply increasing prices may be not enough on its own, as the aftermath of the aforementioned events is also affecting product lead time and manufacturability.
This is evidenced today by the fact that long-term bidding forecasts or non-cancellable purchase orders are becoming the standard if you need electronic components including, but not limited to, microchips and even metal parts.
What else can industrial companies do to handle shortage and price-hikes and make the best of this situation?
Industrial companies operating from a strong financial position and long-term view can limit margin erosion and even gain a competitive edge by substantially investing in some or all of the following:
- Redesigning production to leverage AI (Artificial Intelligence) and analytics. This helps to increase labour productivity while reducing manufacturing defects.
- Implementing automated manufacturing and warehouse operations. This can, in some cases, help to more than quadruple workforce productivity.
- Sourcing critical inputs from multiple suppliers in different regions can improve supply chain resilience, lead time and price stability.
- Re-evaluating nearshoring versus offshoring supply decisions can also help to reduce inbound shipment costs, by purchasing materials manufactured in the same country where the finished product will be sold.
- Establishing production plants in new emerging regions, to compensate the rapidly rising wage rates in some historically low-cost regions.
- Returning to vertical integration in some sectors in order to secure a reliable supply of critical inputs.
Are those solutions just theoretical or truly applicable ones?
Current scenarios provide us with cases that demonstrate their practicality.
GDS (Global Display Solutions) is considered a worldwide case of best practice in this for low-mid volume with a highly varied mix of industrial bespoke products.
Indeed, GDS’s priority has always been, and continues to be, the quality of its products and the relationship with its valued customers, who look to GDS for a reliable, flexible and competitive supply.
Consider: in 2020, during the first full pandemic period, one of GDS’s most important customers, a leading company in respiratory ventilators, so greatly increased its demand that it requested more than 5 times the quantities produced in the same period of previous year and GDS was able to hit the ground running and deliver, despite the intensely difficult situation and active lockdowns in various regions of the world.
GDS has invested substantially to mitigate the long-term impact of this global paradigm shift, with some of the important steps taken summarised as follows:
- GDS has analysed how to move part of its metalwork procurement process from Europe to India and the USA, reinforcing its procurement teams in said countries in order to ensure a positive impact on raw material availability.
- GDS has invested in a new SMD line with AI capabilities.
- GDS has automated and roboticised a new production line for the advanced optical enhancement of LCD panels ranging from 32” to 98″.
- GDS has opened a factory in Tunisia to mitigate labour cost increase and improve production capacity so as to better absorb production peaks.
- GDS is investing in more solar panels, leading its factories in Italy and Romania with the end goal of meeting its own annual energy demands.
Making the most of things, come what may
Based on a recent McKinsey analysis, if inflation and shortages are here for the medium term, companies that adapt their business operations quickly and decisively to reduce their exposure to rising costs will be in the best possible position to maintain margins and growth.
But what if most of today’s sharp price hikes do turn out to be temporary?
Without exception, the levers that help an organisation respond to rising costs also equip it with the tools and skills it needs to thrive when prices fall. In so doing, organisations can secure their fair share of savings from suppliers when their input costs dip and establish a platform for the continuous improvement of cost, quality, and flexibility regardless of changes in price and availability of labour, energy, or other inputs.