The Price of Uncertainty

Finance chiefs are contending with increasingly unpredictable prices for raw materials.
Sarah JohnsonApril 1, 2011

When Catherine D’Amico, CFO of Monro Muffler, sought relief from volatile commodity prices, she found it in the form of tires — some $8 million worth.

The automotive-services firm upped its total inventory by 11% between March and December of 2010, to almost $100 million. Two-thirds of that increase was devoted to tires, which can fluctuate in price depending on oil and rubber prices.

Many CFOs are in similar circumstances, taking whatever steps they can to ensure that rising commodity prices don’t undermine a fragile recovery. D’Amico says that the inventory buildup, along with temporary price guarantees from vendors, will help her company keep prices in check. “It’s still a tight economy,” she says. “If we’re not competitive, people can go somewhere else, or they can defer [car repairs].”

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Since last summer, prices for oil, steel, wheat, cotton, and other raw materials have risen, for reasons ranging from increased demand to extreme weather conditions to political instability. Last month, the Thomson Reuters/Jefferies CRB Index, which tracks the prices of 19 commodities, hit its highest level since September 2008.

Such jumps are challenging for CFOs in many industries, despite their best efforts to hedge, negotiate with vendors, and keep costs low. “If you’ve already gone through an aggressive [cost-cutting] program to raise margins, there are questions as to how much fat is left to cut,” says Mark Sadeghian, a Fitch Ratings analyst.

Commodity price spikes will almost certainly affect companies that aren’t direct purchasers of such materials. For example, when consumers get hit with higher gasoline prices and experience other pass-through costs, such as those influencing food prices, “they consume less, and that means a lot of companies may need to readjust their internal forecasts and plan for lower growth,” says Sadeghian.

An index of 19 commodities reaches a two-year high.

Indeed, some CFOs have already changed their public predictions. During a recent call with investors, Procter & Gamble CFO Jon Moeller said the impact of commodity costs was double what the company expected at the beginning of the year, creating an “earnings headwind” of about $1 billion after tax. To compensate, P&G plans to raise prices on some products, substitute cheaper materials in others, and work on reducing its selling, general, and administrative costs.

Another solution to the price pressure: redirect consumers to less-expensive products. For example, Darden Restaurants makes quick changes to its advertising when certain foods are suffering from sudden price hikes. “We can influence what consumers are craving, and their reason for coming in to the restaurant,” says CFO Brad Richmond.

Other industries have less control over their customers’ behavior. Hawaiian Airlines, for example, is at the mercy of its “leisure-oriented” consumers, says Peter Ingram, CFO of the airline’s parent company. “What we are able to charge has very little to do with the cost of producing our product,” he says, and much more with ticket demand and seat availability.

In fact, Ingram doesn’t mind the high price of oil per se. What really bothers him, he says, is the overall level of uncertainty: “Volatility, to me, is even more of a problem than the high level of cost.”