Category B · Pricing & Cost · Scenario 4
Input Cost Shock
The cost of what you need to run your business has risen sharply. If you can't increase prices at the same pace, your margin shrinks. Fixed-price contracts can turn profitable work into loss-making work.
Trigger
Supplier, wage, energy, freight or material costs increase materially.
First move
Quantify the margin impact, then evaluate passing it on, substituting or managing the cost.
Immediate first response
Calculate how much the cost increase reduces gross profit, and what price increase would restore your margin.
First 24 hours
- List the cost increases, their size and when they take effect
- Identify fixed-price contracts or quotes that are now exposed
- Calculate the effect on gross profit and margin
Next 7 days
- Decide which increases you can pass on, and when
- Ask suppliers about alternatives, volume terms or longer contracts
- Review product specifications for sensible substitutions
- Update pricing on new quotes immediately
- Communicate price changes to customers with clear reasons
Next 30 days
- Build cost-escalation clauses into new contracts
- Review the break-even point at the new cost level
- Reduce waste and improve productivity
- Diversify suppliers where you are exposed to one source
- Set up regular monthly margin reporting
Typical causes
- Supplier price increases or commodity price rises
- Wage increases, minimum wage changes or labour shortages
- Energy and fuel price spikes
- Freight and shipping disruption
- Currency movements on imported goods
Early warning signs
- Supplier notices of upcoming price rises
- Gross margin falling while sales hold steady
- Fixed-price jobs or contracts finishing below budget margin
- Rising energy, freight or wage bills compared to last year
Trigger indicators
- Any major cost category up more than 5% in a period
- Gross margin down by more than 2 percentage points
- Fixed-price contracts forecast below target margin
Financial implications
- Gross profit falls by the full cost increase unless prices rise
- Your break-even sales level goes up
- Fixed-price contracts may become loss-making
- Stock bought at higher prices ties up more cash
Questions management should ask
- Which costs have increased, by how much, and is it temporary?
- What price increase would restore our gross margin?
- Which contracts are fixed-price, and when do they renew?
- Can we substitute materials or suppliers without hurting quality?
- How will customers and competitors respond to a price rise?
Common mistakes
- Absorbing cost rises 'temporarily' and never recovering them
- Applying a percentage price rise that doesn't restore the margin
- Leaving old quotes and price lists in circulation
- Cutting quality in ways customers notice