The Price of Uncertainty

Just as we appear to be climbing out of the 2008-2010 recession, surging commodity prices may put the brakes on business growth and corporate spending. The March Producer Price Index spiked 1.6% in March after increases of 0.8% in January and 0.9% in February. Businesses already worried about cost management are forcing to sharpen their pencils even more to maintain their margins as consumers remain hesitant in an uncertain environment.

The recent economic recovery has occurred because of increased consumer spending, but the Economist recently showed spending staying below pre-2008 forecasts. This means many businesses need increased business spending to make up for the shortfall in spending, but increasing commodity prices will likely dampen the enthusiasm to invest.

Once again, the corporate finance profession will be at the forefront of decision making during this volatile and uncertain time. In a recent CFO Magazine article, Hawaiian Airlines CFO Peter Ingram cautioned businesses to prepare for higher uncertainty as consumers and businesses keep a very close eye on expenses. CFOs and controllers must balance the need for top-line revenue growth with the probability of rising costs impacting cost management and sales forecasts. Here are some tips for preparing for another round of inflationary pressure.

* Focus on quality of costs. Since resources are still tight, understand which areas of your cost structure are of high quality. Review supplier agreements and long-term contracts to identify which costs are fixed in the short term, and concentrate your efforts on costs that are uncertain or open to negotiation. A good cost management system should allow you to identify these costs rather easily.

* Be smart about hedging. Locking prices is normally a smart strategy, especially for businesses with long operating cycles. However, this commodity price surge is still tempered by a very uncertain macroeconomic environment. If consumer spending and business investment fall quickly, prices may decrease. Hedge only as long as you feel uncertainty warrants.

* Incorporate more probability and scenarios into your short- and medium-term plans. Identify a small number of key variables in your cost structures and develop plans assuming a range of potential outcomes. You will not be able to predict the future, but you can anticipate what may happen and quickly alter plans.

Will this pricing surge be similar to the 2008 commodities boom and subsequent bust? I do not believe so, but I have also learned to expect rapid change and continued uncertainty. Our roles as the objective, fact-based advisors to our management teams demand us to think quickly and identify what risks could impact our companies during this new pricing surge.