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Rising inflation, energy costs and shrinking manufacturers’ margins

By Femi Adekoya
24 August 2022   |   4:11 am
Manufacturers have had to contend with more difficult problems in recent years as they try to keep up with rising demands, shifting consumer trends, and operational expenses.

A garment factory.

Manufacturers have had to contend with more difficult problems in recent years as they try to keep up with rising demands, shifting consumer trends, and operational expenses. Companies and consumers are currently having trouble keeping up with high prices of everyday items and commodities as inflation remains on the increase. The situation is dire for everyone and there seems to be no end in sight. FEMI ADEKOYA writes on how energy costs and inflation remain a challenge for local production.

Globally, the concerns about inflation have led many countries to consider an aggressive approach towards slowing down the economy. Consumers are also beginning to think twice about spending on goods and some services.

While a forced recession appears to have worked for some economies, the situation is not the same in many African countries, especially in Nigeria, where a higher interest rate regime spells doom for a productive sector that is barely struggling to stay afloat.

With the crisis between Russia and Ukraine, the rising cost of energy around the world has translated to a significant uptrend being witnessed in most economies as prices of goods and services have reached unprecedented levels.

The International Monetary Fund has also projected that the present inflationary pressure will continue until 2023, leading to further concerns over a consequent global economic recession. In the same vein, the IMF increased the inflation projection for advanced economies to 5.7% and 8.7% for emerging market and developing economies.

The managing director of the IMF has encouraged Central banks from each country to clamp down on the rising inflation rate. According to her, “Even now, the prices are creeping up. We need to dampen it down,” she stated. “Central banks from each country must take decisive steps to suppress inflation until it becomes clear that the inflation rate is moving within a specific range.”

For many manufacturers, the present situation, having been compounded by lack of foreign exchange for critical raw materials, may signal the beginning of a period of increasing pass-through costs leading to hiked product prices and service fees. Albeit rational, producers are equally moving on the side of caution considering that many households are barely striving to get by and a hike in price could mean substitution for cheaper imports and other alternatives.

The industrial sector must be able to act quickly to counter inflation and preserve profitability as the cost of materials continues to climb. What steps manufacturers need to take to reduce the financial consequences on the industry as a whole and how precisely does inflation influence manufacturing, are questions that need answers.

Input cost pressures are not expected to ease soon. According to a January 2022 PwC Pulse Survey, 68% of manufacturers agree that inflation is likely to remain elevated at the end of 2022. To offset increasing input costs—of everything from raw materials to parts and components to energy—nearly three-quarters (73%) of industry leaders expect they’ll need to increase prices of their goods and services through 2022, presumably to protect both gross and profit margins.

With manufacturers hit on multiple fronts, they’re looking well beyond the traditional cost-containment playbook to preserve margins. Pricing that perfectly aligns with cost of goods or just-in-time inventory management approaches seem like quaint and distant memories. Most industry leaders now realise that they will need to find ways to inject agility and resilience into their organisations. And fast. Sixty percent agree that increasing agility to better operate in a turbulent business environment will be important to their growth this year, PwC survey finds.

Already, local manufacturers in the country have urged the Federal Government to develop sustainable national anticipatory policy measures against external influences, to mitigate the impact of global activities on the economy.

According to the Manufacturers Association of Nigeria (MAN), the prevailing local challenges were compounded by the lingering backlashes of COVID-19 pandemic and the ongoing Russian-Ukrainian war.

They noted that apart from the need for ardent management of global peace, the series of global occurrences and the lessons learnt demand that national governments should begin to take drastic measures to manage these phenomena proactively going forward.

The local operators in the latest Manufacturers CEO’s Confidence Index (MCCI) for the second quarter of 2022, noted that though the operating environment in the quarter under review was fairly better than the condition in the preceding quarter due to compelling adjustments made by the government, manufacturers and households in response to general increase in price, forex shortage, increasing cost of energy, scarcity of raw materials and many more, thrown up by the war in Europe.

With an aggregate MCCI score that increased to 54.6 points during the quarter from 53.9 points of the first quarter of the year, MAN stated that the improvement in index score was attributed to the feedback on the anticipated improvement in business condition, employment condition and production level in the third quarter of the year.

The Lagos Chamber of Commerce & Industry (LCCI), has also called for targeted financing of critical sectors like agriculture, food processing, aviation fuels, transport and foreign exchange availability for manufacturing inputs.

The chamber noted that it was obvious that the government’s intervention so far has not impacted the inflationary pressures that keep rising .

The Director General, Dr. Chinyere Almona, who spoke on the July 2022 inflation, said Nigerians paid more for goods and services than they did exactly a year earlier in July 2021 by a relatively high rate of 19.64 per cent.

Almona said without concrete and quick steps to intervene, the rising tide of the inflation rate may continue into the end of the year.

“A major worry is about the inflation scourge constraining production, causing job losses, and courting an imminent recession. The inflation rate may ease in the near term driven by constrained consumer demand, harvests maturing in quarter three and the resumption of wheat exports from Ukraine to Africa. However, there are fears of falling growth due to constrained production in the past months.”

Citing the states’ inflation rates, she said the three lowest rates were recorded in Borno, Jigawa, and Kaduna, while the highest rates were found in Akwa Ibom, Ebonyi, and Kogi States.

She therefore suggested that the government should offer a targeted intervention for the movement of food items from production areas to high-demand areas to cushion inflationary pressures.

“Specifically, for manufacturers, input prices have spiked. Items such as diesel, which most firms depend on for powering their factories have continued to rise in price causing an unbearable cost of production which also translates to higher consumer prices.

“Nigeria’s energy crisis is worsened by the poor supply of electricity and a bumpy road to renewable energy deployment.”

Almona emphasised the need for a mix of fiscal and monetary policies to tackle the core drivers of the inflation scourge in Nigeria.

Also, the Chief Executive Officer of the Centre for the Promotion of Private Enterprise (CPPE) and former Director-General of the Lagos Chamber of Commerce and Industry (LCCI), Dr. Muda Yusuf, lamented that the heightened inflationary pressure remained troubling, with drivers abating.

He said: “In many cases, increases in production costs cannot be transferred to consumers. The implication is that producers are also taking a hit. This is more pronounced where the demand for the product is elastic. These are products that consumers can readily do without.

“The accelerated fiscal deficit financing by the CBN is a significant inflation driver. The financing of the fiscal deficit has been elevated to disturbing levels with huge implications for the money supply and the effect on inflation. CBN financing of the deficit is high-powered money and very inflationary. It is an inflation tax.

“The key drivers of inflation include high and increasing energy cost; worsening currency depreciation, escalating transportation cost, high import duty on manufacturing inputs, illiquidity in the forex market, bottlenecks in the logistics chain, security concerns and low productivity resulting from structural challenges and weak application of technology. Central bank financing of the fiscal deficit is also a major driver of inflation”.

“To tackle inflation, all forms of taxes and levies on the importation of petroleum products should be suspended to give a respite on the spiking energy cost. There should also be deeper stakeholder engagements across sectors to develop an enduring strategy on the way forward”, he emphasised.

Analysts at PwC note that as manufacturers get a clearer idea of how input costs are affecting their margins, they will get a clearer understanding of any price increase of their product and service that they may need to pass through to customers.

“As the prices of energy, raw materials and other commodities rise, manufacturers need to find ways to cushion the impact on costs of goods sold. Numerous levers can be pulled, such as reassessing all contracts. Which indexed contracts for commodities need to be reconsidered? Which contracts should be fixed-priced? Has every contract renewal been scrutinized for renegotiation? Is your trading strategy aligned with today’s price volatility? It could also mean being more aggressive in finding alternative suppliers that offer more attractive pricing, or suppliers that are closer to your operations to trim delivery costs.

“While future cost swings are unpredictable, it’s nevertheless crucial to keep a transparent and open dialogue with customers to manage expectations and provide visibility. Any price increases ought to be explained—preferably well before they are made. You may also want to come up with ways to ameliorate the pain of such increases, perhaps by discounting service fees or spare-parts prices”, they added.

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