Insights from the ISM Meeting…..Inflation is on the rise (despite our Fed Chairman's views otherwise)…

I attended a session led by four procurement leaders at Alcoa, Manpower, Merck and Kraft who spent time discussing some of the current challenges on the environment, including most notably the rise of increasing commodity prices. These companies are focused on how to offset pricing increases through long-term relationships, using substitutes, or using less of a material, but are challenged. All believe that there will definitely be inflation due to rising commodities. This is true also of labor costs, where labor in all parts of the world is rising.

Manpower noted that there is a critical shortage of labor, not because there aren’t lots of jobs – but people aren’t close to the jobs, or aren’t qualified! Importance of building individual and managing talent. Currently 3.5M people on payroll at Manpower, but there is a huge imbalance between supply and demand of labor. Lots of jobs available, but people are in the wrong place. There are lots of people looking for jobs – and there are 1M jobs in Europe but can’t find jobs for them. The result….labor inflation. It means having to pay more for fewer qualified people (my words, not his).

Alcoa is particularly hard hit with commodities and basic materials. There are shortages and increasing pricing pressure in many commodities. To counter this, Alcoa is applying arbitrage, which begins by driving a global footprint to identify and execute regional leverage-arbitrage-opportunities around the world. In the longer-term, they expect to begin market restructuring, and are actively looking at vertical (backward) integration into strategic parts of the supply chain to reduce market risk and improve market transparency. They believe demand fundamentals are there despite the drop and that commodities will continue to increase.

Kraft is experiencing significant challenges as increasing prices of not just agricultural goods, but oil for transportation, is provingdifficult. But they are also focused on benchmarking competitors to find tactical advantages.

At Merck, pressures in healthcare are second to none, even though margins are higher. Biggest on the list is healthcare reform in the US, pricing pressures in Western Europe where governments buy most of the pharma products. These countries are having financial trouble, so it is increasingly difficult for them to buy and provide it to people. Competition from generics is significant and immediate competition that begins by companies that didn’t invest in R&D and fast-follow, reverse engineer and begin to supply. The price for a product will decrease exponentially overnight – and sales might drop by 50-80% overnight. For a multi-billion dollar product – a big issue! They believe Pharma M&A activity will continue to grow in the next 5 years. Although pricing pressure is downward on the revenue end, the cost of producing and distributing drugs and biologics is going up, particularly in biopharma where cold chain requirements is driving up costs…

Another session by the Economist Business Intelligence Unit said the same thing….despite the lull in commodities, the forecast is for commodities and oil to stay high and continue to increase next year….

So despite what Ben Bernanke says when he chooses to ignore these trends, the fact is that we are all part of a value chain where the ultimate payor is the consumer….so expect inflation to occur sooner, not later.