“Although interest rates are still very low, there is discussion about the possibility of inflationary business conditions in the next 2-3 years. Younger employees may not have the experience of working through an inflationary environment. What advice would you give to members who may be facing this economic condition?”
– Steven Kletzien, CFO of Wisconsin Lift Truck Corp in Brookfield, Wisconsin
President Wisconsin Lift Truck Corp.
There are three major impacts that inflation has on our business; the cost of money, the cost of goods we purchase for resale, and the goods and labor for operating our business.
• Cost of Money – Dealership. Interest rates are highly correlated to the rate of inflation. As inflation rises, so does the cost of money. As a dealership we have a line of credit to finance operations, we finance rental equipment purchases, and we finance equipment & real estate for our operations.
o Lines of Credit. The interest rate on the line of credit rises as short term interest rates rise. During periods of higher interest rates it is beneficial to shorten the credit and collection cycle, minimize inventories of new and used equipment, and to minimize parts inventories. Lower inventories will result in lower interest costs.
o Term debt. It is best to finance long term assets during periods of lower interest rates. To the extent a dealership is aware of the trend of rising interest rates and there is a need for rental equipment, service vehicles, cartage vehicles, tools and equipment in the upcoming several years, it is beneficial to acquire long term assets during periods of low interest.
o Mortgage debt. In periods of high inflation mortgage interest rates will rise. Funding expansion of a dealership’s facilities or acquiring new ones during periods of low interest is beneficial.
o Acquisition debt. If a dealership is looking to expand through acquisitions, doing so during periods of low interest is generally more cost effective. Any acquisition involves accounts receivable, inventories of equipment and parts, and vehicles/ tools and equipment. The payback on an acquisition is faster the lower the rate of interest on debt used to fund an acquisition.
• Cost of Goods for Resale.
o New Equipment. A dealership that sells capital equipment will see the cost of such equipment from their suppliers rise during periods of inflation. In a period of rapid inflation, price increases may be more frequent than annual. There is an argument for increasing inventory orders prior to price increases. As such, sales occurring after price increases will provide higher margins on the inventory purchased prior to the price increase. Caution must be taken not to over order as the interest rate on floor plan or line of credit indebtedness will erode the benefit of forward purchases.
o Used Equipment. During periods of high inflation the value of used equipment generally rises at a rate similar to the increases in new equipment pricing. Equipment coming off of lease or out of the rental fleet in high inflation periods will command a higher retail price than was contemplated when they were leased to a customer or added to the rental fleet. This higher value creates an opportunity to wholesale fewer pieces of equipment and recondition equipment for the retail market. Entering into leasing arrangements that allow you to purchase customer leased equipment at the end of the lease at a fixed price from the lessor can provide a significant margin opportunity when the equipment is resold.
o Parts. Generally parts pricing is transactional, such that pricing adjusts throughout the year based on supplier pricing notifications. The primary task as it relates to parts is effective management of parts inventory.
o Storage rack and storage & handling equipment. Our suppliers charge a surcharge based on the price of steel they put into their products. During periods of high inflation this surcharge changes frequently. It is important to have terms limiting the validity period of quotes to correspond with the pricing commitments from your suppliers. It is also beneficial to incorporate similar language for surcharges on customer quotes so that the pricing adjustments correlate.
o In general, pricing policy should be reviewed to make sure the prices to customers properly reflect current costs of equipment. Equipment purchased before price increases should be offered to customers at current pricing.
• Contract Maintenance.
o For those dealers that provide long term, fixed price, maintenance agreements to their customers, it is important to add a “cost-of-living” adjustment clause to these contracts now before inflation increases at a high rate.
• Cost of labor.
o As inflation rises, employee wage expectations rise with it. It is very important during inflationary times to understand the impact inflation is having on wages. Wage surveys should be reviewed on an ongoing basis to determine how much of the inflation is being reflected in wages by position. There can be different levels of wage inflation for different classes of employees. For example, if technicians are in short supply, the rate that technician wages inflate may be more rapid than the wages of other employees. Keeping wage scales competitive prevents the unnecessary loss of tenured or even newly hired employees.
• Cost of Fuel
o The price of fuel has been volatile over the past decades. Most of us have implemented pricing mechanisms into our customer billing practices to adjust for the price of fuel. It is important to have a pricing mechanism that allows you to pass along to the customer the price of fuel. These pricing adjustments can be up or down, but should be reflective of the costs for fuel.
We are emerging from a period of very stable, low interest rates and low inflation. When inflation begins to rise, interest rates will follow. It is important to communicate the potential impacts of inflation and rising interest to your managers so that they will take the appropriate actions at the appropriate times to optimize the return to your company when inflation comes.
Great question – A lot of economists are predicting a return to inflationary pressures in the near future. In fact, a lot of people are surprised that we have not experienced inflation yet. The last recession brought on a prolonged period of low interest rates and most people feel that this trend will not continue. Along with higher interest rates, an inflationary environment will also bring with it widespread price increases. For the independent dealer, I believe the best thing that can be done would be to keep a watchful eye on margins and be prepared to do whatever is necessary to protect those margins. This may mean having the courage to raise prices more frequently than has been done in the past. An inflationary environment is something that is foreign to a lot of the younger workforce. Many of them are not old enough to remember the severe inflation that the country experienced in the 70’s and 80’s. Should that happen again, it will take a different strategy and skill set to be successful.
President, Springer Equipment,
As your company’s CFO you can easily run your inventory finance costs at say three-quarter’s of one percent over prime and compare those costs to what we know inflationary business conditions will ultimately drive rates to in the coming years. As an example to younger employees who have never seen the effect of high interest rates on your company’s bottom line use a 4% rate then show a few examples using 5%, 6% and even 7% rates of interest. As we all know a few additional points on several hundred units erodes a great deal of hard earned profits.
To drive the point further take a 20% interest rate that some of us experienced years ago and show the younger employees what happens when rates were five time higher than they are today! Remind them that history has a way of repeating itself and being in a position of carrying high inventory levels during high inflationary business conditions is a formula for disaster!
President, Container Systems Inc.
The advice I would give to younger materials handling professionals that have yet to experience this industry during inflationary times is that it can be an excellent time to close the sale on pending projects. Companies facing the prospect of their projects being 10 or 15% more costly because they delayed their decision can be very motivated customers. Another important item to remember is to always list an expiration date on your proposals. In times of rapid inflation your quotes can become outdated very quickly. Lastly, communicate regularly with your suppliers so you know when they plan to increase their pricing to keep pace with inflation.
President, Advanced Equipment Company
Charlotte, North Carolina
Our economic conditions always follow cycles. We have been in a long period of low interest rates and low inflation. This cannot last. Government actions to contain interest rates and inflation will only go so far. We are already seeing rising food and commodity prices and soon we may see a spike in the consumer price index which will start to change people’s behavior. Based on your business strategy, now may be the time to acquire assets which will retain their value as the purchasing value of the dollar declines. Now may be the time to take on some extra debt at a low fixed rate knowing that you will be paying the debt back with cheaper dollars.
Now may also be the time for your company to lock in a desired line of credit at a low fixed rate. You must constantly gauge the effect of inflation on your business performance. Higher prices from your suppliers mean less profit for your company unless you are able to raise price without losing business. You need to work on two fronts; first to limit as best you can price increases from your suppliers, second to wisely raise prices to your customers. You also must be very careful about getting into any long term fixed price contracts with your customers. On the other hand, you may want to negotiate fixed contract prices with key suppliers as a hedge against inflation. Customer loyalty will be the key ingredient to your success when we move into a time of rising prices. Customers will be tempted to change suppliers if they can to get a better price. Loyalty due to unsurpassed customer service will be the anchor that retains your customers.
President Conveyor Solutions, Inc.
After World War II, rates trended upward for approximately 35 years. After their peak, they’ve progressively declined to where we are today.
I’ve owned my business almost twenty years. While I’ve seen rates much higher than today, I can’t imagine trying to invest in the growth of my business when they were peaking in the early 80’s.
Business owners (and those responsible for the company’s money) will need to be aware of their borrowing power and associated costs moving forward. With that being said, I’m going to take a look at the other side of the coin as well. When rates are as low as they are today, it doesn’t leave you with a lot of options. If you’re moving into the later years of owning your business (or responsible for managing the funds), higher rates in the future will open some doors providing options for investments to diversify which don’t exist today.
America became one of the strongest countries in the world during those challenging times. I believe we’ll make the best of any situation and react positive to the change in rates. The most important part is to be aware of the situation and understanding how to use the exiting/future conditions to your advantage.
Mark K. Nelson,
President, Nelson Equipment
Increase your communication with your customer on projects that are under development. Find out their time table for implementation early in the process and then discuss how to communicate potential price increases that come rapidly during inflationary periods. Manufacturers don’t enjoy this business climate any more than you. They are very good at communicating with Distributors early so they have time to react. This allows everyone to develop a plan that can save valuable dollars by adjusting the time table of project implementation. By doing this, you once again reinforce your value to the customer as a supplier.
Executive Vice President, Gregory Poole Equipment Company,
In response to our question for advice to the younger generation who may have not experienced inflation I would first identify indexes you would want to track to measure inflation. We watch Consumer Price Index, interest rates, housing prices, average wage increases and others. If you see these indexes going up then I think you need to develop plans for two key areas. You need look internal and see where you can reduce cost and improve processes. Look for the waste in the organization and take it out. During growth periods, companies have a tendency to add unnecessary expenses. The key is having a plan so you are ready when you start to see inflation. The second area is to identify products and services your can increase to past these raising cost to the customers. Examples are increasing service rates as you raise technician wages. Raise rental rates as you replace your rental fleet with higher price trucks. Review you parts pricing to see if you can strategically raise prices to different customers. Try to raise margins on new and used products, but this could be challenging. Lock in some long term interest rates on borrowed money. These are a few examples. Again, the key is to have a plan what actions the company is going to take when inflation occurs. This should be communicated to your entire management group.
VP – Marketing & Sales, Fallsway Equipment Company,
Great question, Steve. Although I am as concerned about a possible deflationary environment before an inflationary environment kicks in, and judging by the world’s central banks’ monetary easing, this is one of their primary concerns as well. There are a number of people still in the workforce that lived through the high inflation of the 80’s, but you have to go back to the 1930’s for 10% annual deflation.
In an inflationary environment you essentially want to lock in long term costs that benefit your company and shorten your expenses related to the products you’re selling.
• Anticipate now any long term debt financing requirements and lock in today’s low rates well before inflation takes off. Not only are you minimizing your interest expense, but you will be paying off debt with lower valued dollars.
• Acquire any long-life assets your company will need in the future at today’s relatively low prices.
• If you have leases or long term supply contracts lock them in for an extended term.
• Working capital requirements can increase dramatically. Lock in your banking relationships and lines of credit and ensure any covenants you’re entering can be fulfilled in an inflation-stressed environment.
• Be very conscious of selling long term agreements for a fixed price – especially long term maintenance contracts that are very susceptible to increases in labor and parts pricing.
• Ensure your marketing/sales departments are constantly monitoring their sales prices vs. competition. Don’t allow yourself to be caught flat-footed by inflation while you’re feeling really good about winning new business!
• Take advantage of extended term opportunities with major suppliers and any special bulk buying discounts.
• Look for overexposure to industry segments or a handful of customers that could dramatically affect your operating viability if their businesses went south.
• Be prepared to pivot quickly and tighten your belt for both operating expenses and human resources.