BrainTrust Query: How Will Retailers Manage the Impact of Rising Commodity Costs?
Commentary by Bill Bittner, president, BWH Consulting
The big cry again in
last Tuesday’s election was "It’s the Economy Stupid." But
with the word "stimulus" turned into a pejorative, the only tool
left to the government is now monetary policy. The Fed announced their $600
billion buy-back plan for treasuries on Wednesday. The goal is to lower the
cost of borrowing for businesses and consumers. The unfortunate side effect
will be a continued rise in commodity costs. The Wall Street Journal described
how a few retailers are responding to the pressure to date. Some are passing
on a portion of the increases, some are reducing costs in other areas, and
some are just letting the increases go through and taking their lumps.
We have
already seen the huge impact the economy has had on consumer behavior. Discount
retailers have seen their revenues increase, private label has taken sales
away from national brands, and consumers are saving more — i.e., spending
less — exactly the opposite of what is needed to increase demand in a sluggish
economy.
The challenge with the current round of commodity price increases is
that it is not driven by an increase in demand, but rather the monetary decline
of the dollar. As Asia raises interest rates while the U.S. continues to lower
them, commodity prices are going to rise even more while demand remains tepid.
I believe this should really take the price increase option off the table.
Margins will decline, having a huge impact on various business models and the
way successful retailers conduct business.
I believe retailers will increase
forward (investment) buying. Self-distributing retailers will have greater
advantage over others because of diverting income and lower storage costs.
Labor costs will get greater scrutiny with retailers focusing more closely
on operating costs. Freestanding retailers will see advantages from their investment
in energy savings. Rising fuel prices will be a double-edged sword, leading
to increased delivery costs for online retailers but also decreasing consumer
trips to the brick and mortar locations. Online retailers may get hit by a
double whammy if mandatory sales tax collections go into effect. With real
estate prices so low and interest rates declining, maybe more retailers will
purchase their properties rather than pay rent.
Discussion Questions: Do you think retailers can afford to pass on the full
impact of commodity cost increases? Should retailers hold the ground on prices
even if it means putting growth and investment plans on hold? What other changes
could a retailer make to survive reduced margins?
If the consumer is the rock, the cost of oil is the hard-place. The impact of higher oil on major retailers is massive and given consumer sentiment, there’s no room to pass on the pain.
The irony here is that the only place to salvage profit is below the line… in operating costs. That usually leads to staffing reductions. So the very thing the stimulus effort is designed to bolster, employment, will be one of the primary victims.
The Fed needs to do whatever it can to spur investment and job creation. Without more jobs it doesn’t matter what retailers do, consumers won’t be buying. Americans have seen higher gas prices and have made adjustments. Each retailer will have to set its own course to deal with this. Retail has done this before. Some will come out ahead, others will close. Let’s hope this is a better holiday season than last.
Manufacturers should take their prices up to reflect the rise in commodity prices and retailers should follow suit. Welcome to capitalism.
Most of them don’t have any choice but to pass them on. The operating margins are as thin as most of them can survive with.
Retailers can and should make online comparison shopping easier for shoppers, given that the expected rise in commodity prices will force prices up in the grocery stores. If retailers plan to hold the line on prices, they should make it easy for shoppers to know it!
Let’s talk turkey. Mr. Lempert suggests our Thanksgiving “tom” will cost more this year. I conducted a quick experiment online among four big grocery retailers, one of whom will get my turkey purchase in a few weeks. Read what I found on my blog at www.shopperannie.com.
Given a jolt at the fuel pump yesterday as well, I’d say many retailers have work to do to help shoppers avoid putting their wallets back in their pockets this Thanksgiving.
This is not a new topic for retailers. Overbuilding, along with the growth of Walmart and Target moved full-line retailers to compete primarily on price. This squeezed margins and led to, first, expense reduction (read service levels) and, secondly to a reduction in product costs by lowering the quality and make of the products. This created a downward spiral that became largely self-fulfilling. Lower quality required more promotion, lower prices, and so on and so on. Increasing commodity prices obviously increases the squeeze, but, like I said, this is not new.
The answer to this is, at a high level, remarkably easy. Take a look at the Kindle, or any of the Apple products. Customers will pay full price (in some cases very high prices) for new and exciting products. They will also respond to retailers that localize their offerings, as Bed, Bath, & Beyond has demonstrated along with the early success of My Macy’s.
In the end, however, the fact remains that there is simply too much retail out there chasing too little demand. Rising commodity prices will simply hasten the demise of the marginal players.
The absorption sponges of manufacturers and retailers are saturated. Prices will rise, consumers will pay more and life will go on.
The first battle in rising commodity prices is at the manufacturing level. With retailers not willing to take price increases due to their real need to maintain competitive pricing manufacturers, particularly those private label suppliers, are really feeling the pinch. Store brands are a way for retailers to increase profits as brand manufacturers with clout pass on increases. This puts more pressure on those store brand suppliers and they are struggling to adapt.
In the end, prices will have to rise as cost cutting has been going on for several years.
Retailers probably have no choice but to pass most or all of the cost onto consumers, although since higher gas will pinch consumer wallets, they will need to be careful about overdoing it.
Of course the increased costs will be passed on. It has to be. The only question is how many players (i.e., manufacturers and retailers) will need to suffer or go bankrupt before they gain that pricing power. It’s time to double-down on Walmart, which knows how to handle this situation more than any other company in the world.
These costs will have to be accounted for somewhere. The idea that they can be passed on from manufacturer to retailer without a concomitant increase to consumers is fallacious.
With real demand declines and rising prices there are few options to “absorb” these costs successfully. I believe we are in for another round of retail and manufacturing/trading consolidations.
Oversupply will not weather this storm and a reduction in supply is inevitable and is the only solution to balance the economy.
Not a completely unrelated question: Do you think it would be a good time to get serious about alternative energies? It would reduce volatility of our energy, commodity, and retail prices…and as far as stimulus spending, here’s an investment with a great potential return, instead of the “shovel ready” pot hole filling jobs we’ve been spending most of the stimulus funds on.
The retailer should never be the keeper of the pricing in terms of the consumer. The retailer should continue good practices with regard to their margins. If the cost of goods goes up, then the price goes up. And, the shopper pays more!!!
There is only one place where pricing is not related to costs. That is what competition is doing. If MY unique competition is holding prices, then it is likely wise that I do the same. If MY competition is raising prices, do I hold mine just to be a good guy? Not unless it brings me more business and more bottom line.
While many of the comments concerning product innovation and distinctive competition are valid, they are not short- or near-term answers…and often require competency not yet demonstrated. However: one of the elements mentioned in the article can and should be considered immediately. Forward buying.
Across every retail enterprise are commodities for which demand/need can be forecast. The greater the degree of vertical integration, the longer the list of those commodities. In the past we have seen progressive retailers act in this way through purchasing exchanges, long-term contracts on commodity materials and similar efforts. If in fact (and I am no economist) the impact of the Fed re-buy program will be as suggested, it is imperative to lock in the cost of as many commodities as possible.
If you want one quick example of how important this is, look at the history of Southwest Airlines. The long-term aviation fuel contract Southwest entered into, more than any other single element, contributed to sustainable profitability and generated the cash flow needed for expansion.
Will price increases be passed along? By many, the answer will be yes. I think the lesson is to try to be the Southwest of this scenario who did NOT have to pass along increases.
Commodity costs are what commodity costs are. The prices will pass to the consumer in some form. Retailers can remain competitive on “needs” if they rethink their pricing and strategy on “traffic” items. Here lies an enormous leak of margin, most unnecessarily. First, does this item REALLY generate traffic, or are we selling a lot of low margin product to customers who are already here? Are we carefully analyzing traffic generators for effect, or are we doing it because we always have and so is everyone else?
Everything we do needs to be revisited in order to balance margin as prices climb.
After two years of lowering prices–and suffering the margin hit–retailers will now be forced to raise them. Few can afford not to, as they’ve spent all they had and then some.
This is one more example of how making the conversation only about price is a lose-lose proposition for retailers. They invest in price alone, and cut everywhere else. The resulting lack of differentiation means that they have to be lowest, every week, or lose that customer.
Shoppers see no reason to remain loyal because it’s all the same and no one offers anything but price. And down we go.
Everybody will pay for this. But the real loser is the economy. What this will do to the economy in the short term, as well as the mid-term is anyone’s guess. However, it is a mediocre decision that will demand that retailers become more efficient and better responsive to global rates and charges.