Output up, but profit margins down?

Posted on 23 Apr 2012

Dr Peter Colman, senior director and Richard Greenwood, senior consultant, at Simon-Kucher & Partners discuss how manufacturers can manage the ‘margin squeeze’ through better pricing.

“Data from purchasing managers showing that the UK manufacturing continued its expansion in March is welcome news and implies that confidence is tentatively returning to a sector which suffered a difficult second half of 2011.

However, the survey also reveals that input costs are now sharply on the rise and manufacturers will have to think carefully about how to pass them through to their customers if they are to sustain or improve their profit performance.

The Markit/CIPS UK manufacturing purchasing managers index (PMI) rose to 52.1 in March, up from 51.5 in February, with any score above 50 indicating an expansion. However, as well as reporting an improving outlook for output, respondents also saw cost pressures building, recording one of the steepest monthly rise in input costs in the survey’s history.

Peter Colman, senior director at Simon-Kucher
Peter Colman, senior director at Simon-Kucher

These findings are supported by the official Producer Price Indices. Manufacturer’s input costs were 5.8% higher year-on-year according to the most recent data, having risen on a monthly basis during February and March by 2.5% and 1.9% respectively.

One of the fastest rising cost components was fuel, with manufacturers paying 9.1 percent more than 12 months ago, as geopolitical concerns have kept the price of oil elevated.

While input prices are rising fast, the prices charged by manufacturers are failing to match this. Across the UK manufacturing base, average prices charged grew at an annual rate of just 3.6% in March – a slower rate than that seen since the start of 2010.

With selling prices failing to keep up, manufacturers will see margins squeezed and their profit position threatened, in spite of the slowly improving outlook for output.

The companies that deal best with the uncertainty of managing volatile input costs without damaging their bottom line are those that maintain a regular and formalised pricing process.

Richard Greenwood, senior consultant at Simon Kucher
Richard Greenwood, senior consultant at Simon Kucher

These high performing companies exhibit three similar characteristics: they “train” their customer to expect price rises by doing so regularly; they plan well and agree in advance about how to react to different groups of customers; they communicate effectively with their clients about the merits of their price rise and the value of their product. In short:

  1. Practice makes perfect. By executing price raises at regular intervals, customers become more accustomed to price changes, which greatly facilitate the process. Firms that raise prices infrequently typically face greater resistance.
  2. Have the courage of your convictions to realise the pricing change. Announcing price rises and then retracting them causes untold headaches; extensive prior preparation involving knowing your customer and planning how you will react to their response in advance is paramount.
  3. Finally, successful companies understand that communication is vital to implement price rises. Customer perceptions of “fairness” need to be managed whilst reminding them of the value delivered by the product.

Despite the uncertain economic outlook, one thing is certain – those manufacturers that fail to take pricing seriously will always underperform compared with those who give it the due attention it deserves.”