Friday, 23 June 2017

Yellen’s Bid to Lift Inflation Runs Into Cost-Cutting Buzz Saw

In World Economy News 22/06/2017

It’s like bringing a knife to a gunfight.
That’s how McKinsey & Co. consultant Walter Baker describes the plight of corporate salespeople doing battle with purchasing managers in the U.S. today.
The vendors want to charge more for the in-demand products they’re selling but are deathly afraid of losing the sale. The buyers, armed with sophisticated tools and in-depth knowledge of the competitive landscape, see no danger in refusing to pay up.
The lopsided tug-of-war goes some way to explaining why Federal Reserve Chair Janet Yellen and her colleagues are having such a hard time lifting inflation to their 2 percent goal. For companies from arts-and-crafts retailer Michaels Cos. to industrial giant ABB Ltd., the focus is on cutting costs, not raising prices.
“If you were to look inside a company you’d see more resources, more assets, software, tools, more senior folks focused on procurement than on pricing,” said Baker, co-author with two other McKinsey experts of the book “The Price Advantage.” The reason, he added, is simple: “No company ever worries about going to any of its vendors asking for a discount. The opposite is true for companies that try” to increase prices.
Changing Mindset

An increasingly ingrained corporate mindset sees pricing power as a relic of the past after years of minimal inflation. The brave new world is one dominated by stiffer competition from technological breakthroughs and globalization, and downsized demand from a slower-growing and aging population.
In spite of that, Fed policy makers are pressing ahead with plans to tighten credit by raising interest rates and reducing the central bank’s bond holdings. They’re betting that a scarce supply of workers will force companies to pay employees more and then boost prices to protect their profits, in line with a theory called the Phillips Curve that’s about six decades old.
Many companies, though, still think they can’t push through price increases, even after eight years of economic expansion. In fact, more firms lost pricing power in the past six months than gained it, according to the Institute for Supply Management’s latest semiannual survey of about 700 purchasing managers at manufacturers and service providers.
“We run the business assuming the price pressure is going to continue indefinitely,” John Flannery, president of General Electric Co.’s health-care business, told an investor conference on June 1. “It’s a core mindset.”
“So our response has to be the cost side of the equation,” added Flannery, who takes over as GE’s chief executive officer on Aug. 1.
That’s got to be of some concern to the Fed. If companies are convinced they can’t raise prices, that could turn into a self-fulfilling prophecy, leaving inflation permanently depressed and the U.S. in greater danger of falling into a deflationary funk during a recession. Chicago Fed President Charles Evans said Tuesday that he’s nervous inflationary pressures won’t build as policy makers expect.
Businesses’ “long-run inflation expectations appear to have come down” over the last five years, Brent Meyer, an economist at the Atlanta Fed, said in an email.
An April survey by the bank found that more companies believe the Fed is willing to tolerate inflation below target than above it — a perception the central bank has been trying to fight by stressing that its inflation target is “symmetric.”
It’s no wonder. Since policy makers adopted their 2 percent goal in January 2012, inflation has been below that more than 90 percent of the time. In April, prices were 1.7 percent higher than a year ago.
3M Co., the St. Paul, Minnesota-based producer of everything from Post-it notes to stethoscopes, expects its U.S. selling prices “to be approximately flat” in 2017, Chief Financial Officer Nicholas Gangestad told analysts on April 25.
Companies’ perceptions of their ability to raise prices will influence how they’ll respond to the bigger wage increases the Fed is trying to engineer. At a 16-year low of 4.3 percent in May, the jobless rate was below the level policy makers reckon will fan price pressures.
“If you look at wage inflation, we expect that we recover our wage increases in productivity gains,” said Greg Scheu, president of the Americas region for Zurich-based ABB, a maker of engineering products including power grids and robots. “So if wages in the U.S. are averaging, say, 2 percent, which is about where it’s been, we expect to drive productivity to be able to handle that” rather than attempt to raise prices, he said in an interview.
In trying to ascertain where inflation is headed, policy makers frequently exclude food and energy costs because they’re supposedly inherently volatile. Yet downward pressure in both those areas may prove to be more persistent than expected, the result of technological advances and globalization.
Within energy, it’s all about shale oil worsening the global supply glut. Shale drillers in the U.S. are staging the longest drilling ramp-up on record, pushing prices lower.
In food, it’s about online shopping — think Inc. — and the entry of foreign rivals that spells even fiercer price wars at grocery chains.
Amazon, which is acquiring Whole Foods Market Inc., is expected to cut headcount and change inventory to reduce prices as it steps up competition with Wal-Mart Stores Inc. and other big-box retailers. German discounters Aldi and competitor Lidl are adding to the fray with plans to open a combined 1,000 stores in the U.S.
It’s not just groceries. Heavy discounting has become an almost permanent part of the retail landscape in general.
The arts-and-crafts business “is incredibly promotional,” Michaels CEO Chuck Rubin told analysts on a June 15 conference call. “Over the past many years, our customers as well as our competitors’ customers have grown to rely on discounts in this industry.”

Source: Bloomberg