Personal Wealth Management / Economics

Cost Consumed

Higher production costs aren't necessarily directly passed on to the consumer.

Story Highlights:

  • Some believe rising production costs (tied to increases in commodities' prices) may negatively impact consumer spending.
  • Comparing PPI to CPI shows companies are not passing along full cost increases to consumers.
  • Recent productivity numbers suggest companies are looking to avoid narrower margins not by increasing prices, but increasing efficiency.


(Editor's Note: MarketMinder does NOT recommend individual securities; the below is simply an example of a broader theme we wish to highlight.)

Will the glorious wheels of American consumerism soon spin off their well-oiled axles? Companies facing rising production costs associated with higher commodities' prices are trying to hold on to shrinking profit margins. Airlines are charging more than ever for basic comforts, bagel prices have risen by more than 65% in Wyoming, and McDonald's $1 double cheeseburger will soon need to be rebranded as the $1.09 double cheeseburger. Et tu, McDonald's?

Will these price increases tighten American purse strings and lead to declines in consumer spending—the largest component of GDP?

Inflation Erodes Buying Power, Tax-Rebate Effects
By Bob Willis and Shobhana Chandra, Bloomberg

Interestingly, the Producer Price Index (PPI), a measurement of changes in domestic producer wholesale prices, has recently increased at a faster clip than the Consumer Price Index (CPI). If producers are directly passing on incurred production costs, CPI would grow at roughly the same amount as PPI. But consumer inflation grew 0.8% in June, while PPI increased 1.8%, and prices for crude and intermediate goods increased 3.7% and 2.1%, respectively.* This discrepancy implies companies throughout the supply chain are enduring squeezed margins but not passing along full cost increases to consumers.

Does this mean consumers should brace themselves for a sudden future price shock? Actually, higher energy and other production prices are usually passed onto the consumer (and consumer spending is still growing) fairly quickly. Companies don't generally hold back and bide their time to unleash the full effect of higher production costs.

Rather, many firms are adjusting to higher input costs based on individual strategies within their competitive environment. Some companies have raised prices, while others like Costco Wholesale Corp. have cut prices to lure more customers. Costco's goal is to increase foot traffic now, while the low-cost value proposition resonates with consumers—sacrificing short-term margins in hope of increasing long-term loyal customers.

It's easy to imagine companies palming off any cost increase directly to the consumer, but companies realize consumers are fickle and choices are plentiful in today's global marketplace. A look at recent productivity numbers suggests firms are looking to grow margins not by increasing prices, but by increasing efficiency.

Strong Productivity Defies Trend and Gives Fed Room to Maneuver
By Brian Blackstone, The Wall Street Journal

For some years now, productivity gains have been an unsung economic hero. High productivity ballasts rising costs and helps preserve company earnings even in the face of higher input costs. But caution: Individual sectors and companies may differ. Some parts of the economy are experiencing greater productivity gains than others, and very often those gains have to do with how well an individual firm is operated. Productivity gains can vary widely even among close peers. But on the whole, aggregate productivity gains mean US companies are getting more efficient.

Another way to think about productivity gains? McDonald's introduced its hamburger—replete with bun, one meat patty, ketchup, mustard, pickles and onions—for $0.15 in 1940. That would be $2.34 in today's dollars.** Makes that $1.09 double cheeseburger a real steal, doesn't it?


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*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.

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