Dave Baiocchi

Inflation Strategy—Part Three

Posted on May 20, 2022 in Featured, Features

As 2022 grinds toward the midway point conditions have not really been improving. The climate continues to be driven by high demand, dwindling supply, rising prices, and an uninspired workforce.  The Federal Reserve has been slow to take its medicine and tighten credit to try to halt what some would categorize as “runaway” inflation.  Add to that, the disruption to the energy sector caused in great part by Russia doubling down on war, that by the day is looking more and more like a stalemate.  In my last two columns (April and May), I laid out a series of strategies that could be employed in order to reshape and align dealership goals moving forward in light of a post-pandemic, but the sluggish and unbalanced economy.

This month I want to turn my attention to how these factors affect our efforts in parts.   Inflationary pressures, as well as shortages from suppliers, will force us all to think differently about our vendor choices, our stock order time frames, our cost calculations, and our pricing policies.

Parts Vendor Decisions

I’ve been in this business for 40 years and I have never seen a time when so many consumable parts were on backorder.  The word “delay” doesn’t even begin to cover what we are facing.  Many of you have long-standing relationships with your current parts suppliers.  These suppliers can no longer deliver the parts you need, and in many cases cannot even provide you with an estimated delivery date.  These are not 1-off esoteric parts.  I’m talking about oil, coolant, filters, hoses, and belts.  Inventory that we have counted on for years; inventory that will immediately affect our ability to service our customers.

In these conditions, many are quick to abandon their current supplier and find another alternative.  I understand the “any port in a storm” logic.  There should however be some considerations given to qualifying a vendor before starting a new relationship.  Throwing a PO at a new vendor just because they can deliver parts tomorrow morning, may not be a smart idea.  It pays to ask WHY they have stock on hand when your current supplier doesn’t.

• What is THEIR source for these materials?
• What assurances do they provide that the quality of their parts will meet our customer’s needs?
• Does their oil have the proper API rating for the equipment you are caring for?
• What is the micron rating of the filters?
• Is their coolant the correct type for the equipment (IAT, OAT, Hybrid)? Just because it’s the right color doesn’t mean it meets the standards.

Suffice it to say that quality matters.  I’d rather try to explain why I have to reschedule the customer’s service than I would try to explain why my new oil is making their units overheat. As an aftermarket organization, your reputation is riding on the quality of the parts you choose, and the capability of your suppliers to stand behind their products if they fail.

Price increases – current price or average price

Right now, you are most likely seeing price increases affecting every stock order you place.  One dealer reported to me that the last four oil deliveries all came in with different net costs.  How do you manage the pricing policy when the costs are changing every 10 days?

Usually, there is an ebb and flow to the way price increases are effectuated in the industrial marketplace.  The regulating factors are easy to identify.  In short, prices increase because costs become unmanageable.  Your supplier raises their price. Your employees demand higher wages. Increases in health care, interest rates, insurance, taxes, and regulations give you no choice but to feed the inflationary monster.

In the last 30 years, price increases have moderated year over year.  Increases in efficiency and healthy competition at the wholesale level have provided price stability in the marketplace.  Annual price increases have ranged between 2%-5% per year, and are mostly on the lower end of that scale.

What we are facing now however is more than anomalous, it’s downright frightening.  Labor shortages, supply chain interruptions, and geopolitical circumstances are affecting every market, not just ours.  Retail prices can’t seem to find a resting place, as consumer products from fast food to used cars quickly become unaffordable.

My point here is that if we are going to survive this disruption, we need to understand that as a supplier, there can actually be an UPSIDE to inflation. That upside is called INVENTORY.  When wholesale prices increase, all the stock on your shelf becomes more valuable.  There are dealers who manage their retail prices based on “average cost”.  Prices are marked up based on the median “per unit” cost of the item.   If I own 10 at a cost of $1.00 each, and this month I buy 10 more at a cost of $2.00 each, I now own 20 at an average cost of $1.50.  If my markup is 1.55 (35% GP), then my retail price would be $ 2.33.

This is a dangerous pricing strategy in an inflationary environment.  It blunts the effect of rising prices by using existing inventory to dilute the net inventory value.  If this is the way your ERP system is calculating parts pricing, you may want to rethink your practices.  Our existing inventory value actually needs to be adjusted every time prices increase!  To do this we need to design our markups based on LIST PRICE, or LAST COST ENTERED.  Using this practice, a price increase automatically affects the net value of every item we currently own.

My example above would now calculate differently.  If the system uses the “last cost entered” as the basis for a markup my retail pricing on the item would go from $2.33 to $3.10.  Extending price increases to your entire inventory is imperative in times like these.  Your ability to pay your own rising expenses will be predicated on your willingness to leverage existing inventory to your advantage.

Collect ALL your freight costs – by weight or by item

Another rising cost we cannot afford to overlook is the cost of freight.  Fuel prices are the locomotive of the inflationary train, and the cost of getting parts to your receiving door will swallow your hard-fought profitability if you don’t pay attention to it.

Do you markup freight?  Why not?  Does the shipping and receiving crew work for free?  We tend to think of freight as an expense to be “recovered”, but we seldom include the costs of handling as part of that expense.  As these costs increase, now is the time to either institute or adjust your freight markups to recover all the costs.

How do you “apportion” freight costs?   By weight?  By piece?  By flat rate?   The truth is, it doesn’t matter as long as you have a policy.  I tend to favor splitting the cost by weight.  If you have 5 pieces shipped in the same box for 3 different customers, estimate the weight distribution of the shipment for each customer, mark up the entire freight cost, and then divide the total by the apportioned percentages.

Inflation will be an issue we have to contend with for at least the short term.  Having policies and practices in place that leverage our inventory, and recover our true costs will help us to be profitable in a difficult and changing marketplace.

About the Author:

Dave Baiocchi is the president of Resonant Dealer Services LLC.  He has spent 40 years in the equipment business as a sales manager, aftermarket director, and dealer principal.  Dave now consults with dealerships nationwide to establish and enhance best practices, especially in the area of aftermarket development and performance.  E-mail [email protected] to contact Dave.