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Home / Blogs / EU inflation hits multiple manufacturing sectors

Home / EU inflation hits multiple manufacturing sectors

RESILINC BLOGS
Resilinc’s Special Report: European Inflation Update: Impacts On Your Supply Chain

EU inflation hits multiple manufacturing sectors

Dec 07, 2022

Resilinc Editorial Team

Automotive, Energy, Supplier relations

Europe is suffering through a period of extraordinary inflation that will negatively impact the health and well-being of its people and drive disruptions and uncertainty in global supply chains. After averaging 1.6% annual inflation from 1999 through 2021, the annualized rate exceeded 10% in the Eurozone in October 2022. The UK, the Netherlands, Belgium, and Germany are suffering higher rates—and Baltic and Eastern Europe nations such as Hungary and Ukraine are seeing prices rise at over 20% on an annualized basis.

While energy price hikes resulting from cutbacks in Russian gas deliveries get most of the blame, analysts see a broader range of causes. “There are five main factors contributing to inflation today,” wrote McKinsey consumer-packaged-goods (CPG) and retail expert Roman Steiner in a September report. “Labor costs and the availability of talent, as well as rising prices in agriculture, hard commodities, freight, and energy. … These factors together add up to a perfect storm.”

In early November, the European Commission (EC) declared the EU economy in a recession which it forecast would last at least through the first quarter. The EC also projected an average inflation rate of 6.1% through 2023. While much depends on the severity of Europe’s winter and the consequent demand for energy, it’s clear that Europe is in for a prolonged economic downturn.

Supply chain impact to suppliers and OEMs

This will have widespread ramifications for supply chains—both on the supplier side and for OEMs with European supply chains. In the automotive sector, where BASF, Robert Bosch, Continental, and other suppliers in the EU top 10 generated more than $400 billion in 2021, Europe’s inflation is cutting deeply into profits and upending traditional pricing models, according to Roland Berger automotive specialist Florian Deichmueller.

OEM customers in the automotive space typically “demand annual price reductions” based on the assumption that their suppliers’ costs decline with improved manufacturing efficiency. Because such efficiency gains are modest, suppliers typically front-load their initial pricing to “break even over the course of a contract” which can last six to eight years.

Contracts generally allow suppliers to pass steel and copper price hikes on to OEMs, but not cost increases for other inputs, including labor. Writing in July 2022, Deichmueller opined that suppliers’ only option was to quickly “raise prices for OEMs” and renegotiate contracts “to automatically cover future price rises across a range of areas, not just” steel and copper. He advised managers at automotive suppliers to prepare for resistance from their sales teams, who are typically “reluctant to even start discussing price changes, which have mostly been unnecessary for the past 20-30 years.”

It almost goes without saying that automotive OEMs—still taking hits to production from the semiconductor shortage—will not respond with enthusiasm to the kinds of price hikes and contract adjustments that Deichmueller recommends.

Energy-intensive industries in Europe are suffering even more than automotive suppliers. According to Resilinc’s recent Special Report – European Inflation Update: Impacts on your Supply Chain, “the majority of European fertilizer, glass, paper, and metal manufacturing is ceasing or has already ceased.”

Aluminum smelters are particularly susceptible to the energy cost inflation plaguing Europe. Rabobank has reported that the shortages of aluminum cans that troubled American beverage companies in 2021 will continue. “Not only do we expect higher prices … but we also expect small beverage producers to face continued risk of aluminum can supply shortage.”

Similarly with glass packaging: “As the largest importer of glass bottles, U.S. glass bottle supply is more closely linked to the global market, and the impact of the EU energy crisis may be more pronounced,” reports OEM Magazine. “Tight supply, especially for wineries, distilleries, and craft brewers, as well as higher cost, are expected for the next 12 months.”

Some analysts advocate that the Biden Administration renew U.S.-EU free trade negotiations, which stalled under the Trump Administration. An EU-U.S. free trade agreement would “ease existing supply chain woes and reduce inflation in the medium-term but also increase economic growth on both sides of the Atlantic, thereby reducing the risk of a prolonged recession in the U.S. and the EU,” writes James Kunhardt of the Brookings Institution.

Kunhardt doesn’t address how the Biden Administration would get such an FTA through a divided Congress. And even with bipartisan support, negotiating such an FTA would take years. In the meantime, Europe-based suppliers and their customers should brace for a rocky year—or years.

“Nuanced, portfolio-oriented, multilever, paradigm-shifting creativity is required,” writes Kevin Bright in the McKinsey CPG report. “We need to be thinking about this as a new normal. While we may all hope that inflation is going to persist for only another few months or a year, we have to prepare for it to persist for five, six, or seven years. Companies should be thinking through a longer-term solution around resilience, agility, and strategy [and asking themselves if they] have the right resources, the right data, and the right technology to be able to do this at pace and with rapid iteration?”

Add Bright’s colleague Pieter Reynders: “Companies that make strategic bets in the places where they want to gain market share—where they feel they already have a competitive edge and are therefore investing consciously—are going to be the long-term winners coming out of this. The more strategic you can be about where you want to invest (versus where you’re looking to recover margin losses), the better off you’ll be.”

Resilinc’s Special Report: European Inflation Update: Impacts On Your Supply Chain

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