Forty-year inflation peaks, labor shortages, Covid-19 issues, and workers retiring at an all-time high it’s no surprise that companies are feeling the effects – and the construction industry hasn’t escaped these damaging effects.
Construction companies are reporting 10%-30% increases in material costs from the time the bid is accepted to the time material orders are placed.
The shift in inflation is a challenge for many construction companies to calculate but is extremely important to be paying attention to.
Companies that aren’t proactive with facing rising inflation are likely to disrupt more than their customer’s pockets. Without the proper knowledge, companies are likely to underbid projects, resulting in lost revenue and strained financial planning.
In this article, we will address what inflation is, what causes inflation, how inflation is affecting our marketplace, and what you can do to protect your business from rising inflation.
This article will also explore the role of inflation and how it affects the construction industry.
What is inflation?
The Federal Reserve describes inflation as “The increase in the prices of goods and services over time.”
Simply put, inflation is the effect of goods and services becoming more expensive, often resulting in people spending less money. For many, the increase in inflation is a key identifier for a struggling economy. However, inflation is also inevitable.
Rising inflation can only be true, or core inflation when a rise across many goods and services, increases. However, due to the nature of food and gas, these items are excluded as they can affect inflation by themselves.
A common resource used to identify inflation is the consumer price index.
The Consumer Price Index (CPI) is a measure of the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services.
CPI allows businesses to have an idea of the changing market in regards to pricing increases and provides enough detailed information for companies to make informed decisions about product and service pricing.
Based on historical information from previous CPI information a desirable rate of inflation does not exceed 2% within a year.
With inflation increasing by 8.5% in the last 12 months, we could describe our current state of the economy as less than desirable.
Inflation and Intrest Rates
Rising inflation is the number one concern of small business owners, according to a recent survey conducted by the U.S. Chamber of Commerce.
As inflation rises, the potential for banks to increase borrowing costs for businesses is high.
These are not only for new businesses borrowing money to worry about, current businesses with existing loans should worry as many lenders have floating or variable rate financing sending their current rate of borrowing well above where they currently sit.
As of 2018, pre-pandemic interest rates for small businesses sat at nearly zero, today we are seeing interest rates around 9% and in some cases even higher.
What Causes Inflation?
A variety of factors are the cause of increasing inflation – and right now companies are facing the perfect storm.
High demand, low supply, extended delays, labor shortages, and a global pandemic are proving to be the perfect combination for record-breaking inflation.
With the pandemic hitting China weeks before spreading to the United States, problems within the supply chain began early. Due to Covid restrictions, many factories shut down for weeks, even months at a time, creating a shortage in supply. As Covid-19 spread and we faced a worldwide shut down our global economy began to take a catastrophic hit.
In an attempt to save our economy, the government issued stimulus checks resulting in heightened spending and an increase in demand for products.
With demand at an all-time high and supply at an all-time low, it was only time before inflation.
Supply Chain Issues
As a result of pandemic closures, construction material supply greatly decreased in the United States making them hard to come by, if they were available at all. Stocked inventory rapidly decreased and could not be replenished at the speed at which demand was needed.
As if a global pandemic wasn’t enough, multiple natural disasters caused even more havoc on the construction industry.
The plastics industry was greatly affected by the winter storm that swept through Texas and hurricane IDA that came through in September of 2021.
Lumber production slowed due to wildfires across the country and of course the blockage of the Suez Canal – all disrupting the supply chain.
Deliveries of construction materials and equipment were disrupted due to severe labor shortages in factories and shipping facilities.
While some products were being manufactured, often they were waiting to be shipped for months at a time.
With such low supply and high demand, construction material cost dramatically increased.
Effects of inflation on Companies:
Rising inflation results in rising costs for companies. With a dramatic increase in costs in such a short amount of time, many companies are struggling to keep up. Such steep increases have resulted in greatly decreased profit margins and even losses.
There are two direct ways in which companies are affected by increasing inflation
- As inflation increases, the purchasing power of consumers decreases leaving them with less ability to purchase as many goods and services as they once did. Fewer products and services being purchased equals less total revenue for companies.
- As inflation increases, most overhead costs such as raw materials, manufacturing, and labor increase requiring businesses to absorb some of the cost instead of transferring all additional costs onto customers – avoiding the loss of loyal customers.
Are all businesses affected by inflation the same way?
Not all businesses are affected by rising inflation costs the same way.
The impacts of rising inflation on businesses depend on what market they are in, the variety of products and services they offer, and if the company is proactively prepared.
Essential goods and services are unavoidable therefore companies who manufacture or sell essential goods are likely to feel less of an impact as consumers have no choice but to purchase essential goods.
Companies that sell non-essential goods are likely to feel the effects of inflation more as consumers typically decrease consumption of these when prices rise.
How is the construction industry affected by increasing inflation?
“The construction industry is in the midst of a period of exceptionally steep and fast-rising costs for a variety of materials, compounded by major supply-chain disruptions and difficulty finding enough workers—a combination that threatens the financial health of many contractors. No single solution will resolve the situation.” As reported by the Associated General Contractor 2022 report.
U.S Single Family house construction cost index is up from 12% to 17% causing major impacts across the industry.
As inflation continues rising, construction companies are often left delaying project bids until closer to project start dates to prevent cost overruns due to inflation.
Due to the duration of time between construction project bids being accepted to the time project materials are being purchased, companies are forced to revise their bid offers due to the many price increases for materials, labor, and shipping.
In doing so, frustration among customers is on the rise.
To prevent disputes with customers, construction companies are often left delaying project bids until closer to project start dates to prevent underbidding projects and conflicts among clients.
How should companies prepare and manage rising inflation?
If you feel like your money is not taking you as far as it once did, you aren’t wrong. Inflation among small to medium businesses is quick to impact the way organization is run.
While companies should always be proactive it is even more important to do so in an ever-changing economy.
To prepare for rising inflation, companies should:
- Analyze the market position and identify what prices should increase to align with competitors’ pricing
- Analyze product and service offerings identifying highest those with the lowest revenue potential and highest margins
- Minimize supply chain risk by diversifying where supply is imported from.
- Research and identify products that have long lead times and strategize best practices to prevent products from being unavailable
- Example: Stock up on products with low cost to hold
Post pandemic inflation is here and while it came on quickly, it will be slow to resolve.
With inflation at an all-time high, companies are feeling their bottom lines take a hit. Regardless of the industry, companies need to be analyzing the market, streamlining their business, and creating a strong financial and operational strategy to minimize the effects of our post-pandemic economy.