Is it sustainable for companies to pass on rising costs?

Businesses are passing on rising costs to their customers, according to a slew of data released this week, but is there a limit to consumers’ spending power?

Service providers raised charges at a record rate in April, according to Thursday’s headline reporting the latest AIB Purchasing Managers’ Index for the sector, which showed that one in three companies raised their prices last month.

It was remarkable given that the services sector accounts for more than half of the economy’s activity and covers areas as diverse as tourism and travel, financial and business services, and media and telecommunications.

On the same day, the chief executive of the Irish Restaurant Association spoke to Claire Byrne on Today about rising restaurant costs and called on the Government to keep the VAT rate for the sector at 9%.

“The price of chicken in restaurants is now 35% higher than when the minister made his statement (about raising the rate to 13.5% from September),” said Adrian Cummins.

“We thought we were going to have an economic rebound after Covid. We haven’t seen it because of the Ukraine war,” he said. “Our input costs are increasing day by day.”

“There is no magic number that consumers can consider an ‘acceptable’ scale of price increases,” said Austin Hughes, chief economist at KBC Ireland.

“With many household budgets under severe pressure this year, it is certainly the case that any double-digit increase in all but the most basic necessities is likely to see demand reduced by more than price increases, meaning that consumers will spend less in these areas, and revenues will fall for those companies.”

Another Purchasing Managers’ Index published on Tuesday, this time on Irish manufacturing, showed rising energy and raw material costs are forcing most manufacturers to continue raising their own prices, passing them on to customers.

One industry forced to absorb rising costs is construction and companies working on public projects. Input costs have risen since May 2020, mainly driven by Brexit, Covid, public health measures and now the war in Ukraine.

“All of these events were beyond the contractor’s control and could not have been reasonably foreseen when the projects were priced,” said Paul Sheridan, CIF’s Principal Contracting Director.

“Because Ireland does not use standard international contract forms, the contractor has been forced to absorb all these cost increases.

“Contractors are now subsidizing the delivery of public projects using their own balances,” Sheridan said.

Although the taxpayer has not had to pay the rising costs of these public projects, society could end up paying a much higher price.

“This is unsustainable and is causing systematic long-term damage to the industry, which will most likely have a negative impact on the delivery of the National Development Plan, housing for all jobs in the sector,” Sheridan warned.

The average household faces a €330 increase in the price of their annual grocery bill, according to figures from consultancy Kantar, published on Tuesday.

It found that 23% of households are now struggling to make ends meet when it comes to their weekly grocery store.

Grocery price inflation reached 4.7% in the 12 weeks to April 17, its highest level since September 2013.

Foods like cooked poultry, bread, pasta and butter have seen some of the biggest jumps in recent months.

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Is it sustainable for companies to continue to pass on rising costs to consumers? Or will companies encounter price resistance from customers?

“Retailers were absorbing costs before,” according to Duncan Graham, CEO of Retail Excellence, “but I think as this year has gone on, it has become extremely difficult to continue to do so and they have been passing some of those costs onto consumers.

“Retailers have been hit across the board between rising overhead costs, raw materials, and staff. It’s a perfect storm that’s happening right now.”

Austin Hughes, chief economist at KBC Bank Ireland, estimates median earnings will fall by around 2% in “real” or inflation-adjusted terms. “For some better-off consumers, that may mean reduced savings or some cuts in ‘discretionary spending.’ For many other consumers, a sharper adjustment will be required.”

Economic theory suggests that the degree of “price resistance” by consumers depends on whether or not the good or service is a necessity and whether close substitutes exist, Hughes said.

“In reality, even for necessities like food or energy, consumers will cut spending a little bit. So businesses will get a double whammy of higher costs and reduced sales.”

However, the degree of pushback varies greatly from article to article. Even if many of us walk or bike more, traffic volumes remain high because most consumers need to use their cars and can’t help but pay higher prices at the pump.

The price of oil is also driving up air fares.

“When the price of fuel goes up, it’s inevitable that it will eventually trickle down to customers,” Lynne Embleton, chief executive of Aer Lingus, said on Friday.

A flight is often a discretionary expense, but the CEO said the airline still has low fares and hopes to hit 90% of 2019 capacity at its peak. “But ultimately we see fuel costs need to be reflected in the price,” he added.

For other goods and services, the pullback is likely to come at much lower prices. A special question in KBC’s consumer opinion poll for March found that 85% of consumers planned to cut back on spending.

While food is a necessity, producers tend to quickly encounter some element of price resistance. KBC Chief Economist said: “More generally, intense competition among retailers and the growing influence of ‘private label’ products are also factors that make it possible for consumers to avoid extreme price increases in many areas of the market. supermarkets”.

Duncan Graham of Retail Excellence agrees. “I don’t think people will stop spending, but it’s possible that they will cut back and buy more ‘own-brand’ products.”

He said the first-quarter figures were compared to the first quarter of 2019, “but it could be a completely different story in the third and fourth quarters. It’s in the lap of the gods right now.”

Between 2012 and 2021, Irish inflation averaged just 0.6% per year, so most consumers didn’t focus on price increases.

Now, almost all consumers are likely to be extremely price conscious, and this is greatly aided by checking and comparing prices online. Hughes said these conditions have created a buying climate in which “both businesses and consumers must be careful and/or astute when it comes to price increases and purchases.”

“With the prices of essential items rising rapidly, some businesses may find they have little or no pricing power and even modest increases in the prices of more ‘discretionary’ goods or services could lead to a marked drop in sales.” sales, particularly due to an all-out increase in prices. conscientious consumers.”

Graham said he thinks the retailers that will struggle are the retailers that have done well during the pandemic, such as housewares and furniture. People couldn’t spend their money on holidays and many spent it decorating their houses because they spent more time there. “And now, the money saved during the pandemic is now being depleted by rising costs,” he added.

“There is no magic number that consumers can consider an ‘acceptable’ range of price increases,” Hughes said. “With many household budgets under severe pressure this year, it is certainly the case that any double-digit increase in all but the most basic necessities is likely to see demand reduced by more than price increases, meaning that consumers will spend less in these areas, and revenues will fall for those companies.”

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