Everyday higher prices.
Manufacturers and retailers are desperate to pass on higher commodity prices to their customers.
Business and commodity prices
Feb 24th 2011 .
No one will be laughing on April 1st when Whirlpool and Electrolux raise the prices of their washing machines by a whopping 8-10%. The firms want to pass on the higher cost of inputs such as steel, which has risen by 20% in the past year. So far, American manufacturers have had to suck up most of the increase in the prices of their raw materials, with predictable consequences. Whirlpool’s profits have disappointed, and its share price has tumbled by nearly a third since April.
So its promised price rise will be watched closely by retailers and manufacturers everywhere. Can consumers be made to pay more? Perhaps not yet: the downturn has made frugality fashionable. Even the well-off can be seen mingling with the masses in Walmart or Tesco.
Well before the recession, retailers and manufacturers already worried that they were losing their “pricing power”. That did not matter much in good times, when margins rose even when prices fell, thanks to the rapid increase of manufacturing in low-cost countries such as China. But now the surge in commodity prices—The Economist’s commodity-price index has risen by 49% in the past year—is forcing desperate manufacturers to find out whether they have any pricing power left.
Passing on higher commodity costs used to be relatively uncontroversial. Higher input costs hit all manufacturers alike, so they all wanted higher prices. And it was easy to explain to consumers why prices had to go up.
Yet many doubt that Whirlpool and Electrolux will be able to persuade customers to pay their higher prices. If so, the price rises will swiftly be reversed and the bosses responsible. A particular worry for him is that two South Korean rivals, Samsung and LG, are said to be keen to use their rivals’ price increases as a chance to steal market share.
Retailers once simply accepted it when a manufacturer said it would raise prices because of higher input costs, says Sandeep Chugani of BCG, a consultancy. Now they want to know the exact formula for how much a particular commodity affects the price of a good. This makes for tough negotiations. Big retailers, with their greater muscle, may gain an edge at the expense of manufacturers’ margins.
When retailers decide to pass on higher costs to consumers, they are increasingly trying to do so in ways that hint that they still offer value for money. One way is to offer a wider range of products in a particular category, including a no-frills version that will remain cheap and higher-quality ones that grow more costly. Another is to raise prices discreetly by offering smaller products. But this can backfire: customers noticed when Kimberly-Clark sold them smaller sheets of toilet paper.
Retailers are starting to reverse the trend towards handing over control of parts of their stores to manufacturers: eg, by letting PepsiCo run the soft-drinks shelves and Procter & Gamble rule the nappies. Now, retailers don’t want anyone to get between them and their customers.
This new attitude will hurt manufacturers’ margins. So will the growing investment in private-label goods, especially in America, where they have been rarer than in Europe. Sears, for example, could squeeze its branded suppliers by marketing its own Kenmore brand properly, says Mr Chugani.
Some retailers are looking for opportunities to reintegrate their supply chains, which had been increasingly outsourced in recent years. A senior retail executive says that in negotiations with suppliers he is now ready to offer to buy their shares. The coming year will tell retailers and manufacturers a lot about whether the price elasticities of goods sold in shops have really changed. Analysts predict that this will vary widely, depending among other things on how rich the shoppers are and what they are buying.
It will be easier to pass on higher costs to the wealthy. Soaring cotton prices will probably push up clothes prices sharply. Ralph Lauren’s customers will probably pay more for their threads without much grumbling, but Walmart’s may not. Food companies are in a stronger position than clothes makers. Clothes can be mended or reused; baked beans can’t.
Some firms boast that they will absorb all the pain themselves. Wegmans, a regional American supermarket chain, pledged this week not to raise prices this year on 40 staples, from fruit to coffee. It says this will cost it at least $10m. In contrast, Hanes, a mass-market clothes maker, is talking of raising prices by up to 30%. It will surely lose market share.
Historically, the margins of retailers and manufacturers have been remarkably stable, says Carsten Stendevad of Citigroup’s corporate-advisory arm.
If commodity prices continue to rise, they will eventually be passed on to consumers one way or another. After years of goods getting cheaper, consumers may have to start getting used to everyday higher prices.