Dive Brief:

• More than half of organizations said they've experienced inflation in raw materials, commodities and freight in the second quarter of this year, according to a Gartner global survey of 111 CFOs. Meanwhile, around three in five organizations reported wage inflation, nearly double the amount during the first quarter.
• Due to continued input price inflation increases, nearly three in four (74%) of CFO respondents cited the risk of lower profitability as their top concern. The survey was conducted in July 2021.
• "Most CFOs today have not experienced this level of sustained and broad-based input price inflation," Randeep Rathindran, vice president of research of Gartner Finance, said. "The risks are doing too little and taking a hit to profitability, or if inflation turns out to be transitory, overcorrecting by excessively raising prices or wages."

Dive Insight:

When the pandemic struck, companies conserved cash but did not adequately plan for a jump in demand, Rathindran told CFO Dive in an interview.

"When the production of $50,000 cars are held up by production of a 50 cent chip, that's the idea of just-in-time manufacturing being carried too far and making inflation worse," he added.

During the worst of the pandemic, most companies took cost-cutting measures, and, once the fog lifted, focused squarely on returning to pre-pandemic levels of growth. Now, Rathindran said, inflation is moving the focus back to costs.

"Usually this happens in waves," he said. "You worry about costs during a slowdown, and you let your foot off the gas when growth picks up. But now, CFOs are in a position of having to do both."

The main types of input price inflation CFOs said their organizations are grappling with are wages, raw materials and commodities, freight costs and salaries.

In the early days of the pandemic, many CFOs enacted what they thought would be temporary cost-cutting moves geared towards company survival. Organizations curtailed their planning time horizons, Gartner said, and "carried the idea of just-in-time manufacturing too far to preserve cash flow."

This has created some of their current headaches, as most CFOs are now concerned by the prospect of lower profitability stemming from margin pressures.

“Many CFOs responded to early input price inflation by passing on costs to customers, and failed to make long-term structural changes, like investing in suppliers to increase capacity and improve costs,” Rathindran said.

As a result, they're now staring down eroding margins and are faced with paying more for materials and services amid surging demand. The primary method of responding to the issue of higher costs is to pass those costs onto customers, which just over three in five (61%) report doing.

On the other hand, fewer than a quarter of the respondents reported turning towards product line innovation to mitigate rising costs, while just 8% reported making long-term capital investments in suppliers to improve capacity.

Based on results from the survey, Gartner recommends CFOs focus their efforts in three areas as they face margin pressures:

1. Making more principled price-setting decisions

It would be bad practice to reflexively pass costs onto customers without first assessing whether input price inflation is transitory, Gartner said, and whether their competitors are raising prices.

CFOs must understand their customers’ price sensitivity and profitability to avoid further eroding margin profitability.

"Many companies can't offset higher input costs through cost savings, because they're already running so lean after pandemic-induced cost cuts," Rathindran told CFO Dive. "But this can cut both ways. On one hand, people have saved a lot during the pandemic, so companies can raise prices, but on the other hand, depending on the industry, price-sensitive people could write you off as a luxury product."

2. Rethink recruitment and retention

Companies can reduce the impact of salary inflation for their most vital talent by tapping the "total skills market" and looking beyond traditional talent pools, Gartner said. CFOs specifically may consider reassessing salaries for remote and hybrid workers who choose to relocate to less expensive areas.

Because the respondents' two biggest sources of inflation were wage and salary, it's incumbent upon CFOs to ensure personnel costs aren't completely out of line, Rathindran told CFO Dive.

3. Improve insight into supply chain dynamics

When supply chain issues arise, the most progressive CFOs don’t just diversify their partners or study the data to try identifying and alleviating bottlenecks. Often, forming strategic partnerships and making capital investments in suppliers can significantly decrease longer-term margin pressures, Gartner found.