3 Steps to Combat Volatile Building Material Prices and Supply Chain Shortages

The combination of very accommodative fiscal and monetary policy has supported high savings rates—as well as surprisingly high consumption among US consumers during the pandemic.

Demand has been driven by excess liquidity in the system. From March 2020 to March 2021, M1 money supply—which refers to the total volume of money held by the public at a particular point in time and usually includes currency in circulation plus demand deposits—increased 38.4% across the world's developed nations and 72.1% in the United States.

This means there's a lot of cash chasing a finite amount of goods, and the amount of goods available is being constrained by low inventories and supply chain issues.

Below, learn about the impacts of 2021 volatility as well as how to mitigate the uncertainty caused by supply chain shortages and pricing irregularities.

2021 Economic Trends

Much of the macroeconomic enthusiasm investors were gearing up for in the first quarter became reality in April of 2021.

  • US gross domestic product (GDP) expanded by 6.4%
  • Retail sales were up 9.8%
  • The Institute for Supply Management (ISM) manufacturing index was at 64.7
  • Housing starts were up 19.4%

These increases all reflect the best readings in decades. This huge surge in demand, which is outpacing supply, has driven prices up across the board. 

Global Supply Shortages

Global shortages of many goods reflect the disruption of the pandemic combined with decades of companies limiting their inventories.

Just-in-Time Manufacturing Strategy

Over the last half-century, just-in-time manufacturing has captivated global business. This strategy aligns raw-material orders from suppliers directly with production schedules, allowing manufacturers of all kinds to stay nimble and adapt to changing market demands. 

Companies employ this inventory strategy to increase efficiency and decrease waste by receiving goods only as they need them for the production process, which reduces inventory costs.

This method requires producers to forecast demand accurately. However, the tumultuous events of the past year challenged the merits of keeping inventories so lean, leaving supply chains vulnerable to disruption.

Inventory Cost Increases

The pandemic hampered factory operations and introduced chaos in global shipping. Many businesses around the world have been bedeviled by shortages of a vast range of goods, leading them to boost prices.

Cost increases in lumber, copper, brick, steel, and aluminum have been particularly vexing in the construction industry.  

Disruptions in Global Shipping

In addition to lean inventories brought on by just-in-time inventory practices, the spread of COVID-19 sidelined vessels, port workers, and truck drivers, impeding the unloading and distribution of goods made at factories around the world.

During the global financial crisis from 2007–2009, shipping companies saw their businesses ravaged. So, when the COVID-19 virus emerged in China—prompting the Chinese government to shut factories to contain its spread—the shipping industry braced for a replay. Carriers dramatically cut their services, idling many of their vessels.

But, unlike the financial crisis from 2007–2009, for which economic recovery took years, demand pressures rebounded quickly in late 2020 as US consumers, flush with cash, refashioned their spending.

Deprived of services such as vacations and restaurant meals, they bought video game consoles and kitchen goods in addition to refurbishing their homes and home offices.

Increased Remote Work and Shipping Demands

Work-from-home dynamics caused the housing market to boom as remote workers chose to move their families to larger homes in the suburbs or more rural areas.

Chinese factories came roaring back in the second half of 2020, yielding robust demands for shipping. As shipping companies deployed every vessel that could float, they had to concentrate on routes with the greatest demand—to the detriment of others.

The Breakdown of the Supply Chain

The pandemic revealed the risks of overreliance on just-in-time inventory management—especially when it’s combined with global supply chain and shipping issues.

Some experts assume that the breakdown will change the way companies operate, prompting some to stockpile more inventory and forge relationships with extra suppliers as a hedge against problems in the future. But others are dubious, assuming—as they have after past crises—the pursuit of cost savings will again trump other considerations.

With the cost of construction materials creating short-term and long-term uncertainties in the construction industry, understanding your company’s cash flows is critical to effectively managing these challenging times.

In addition to the above issues, tariffs, existing labor and housing shortages are also impacting the construction industry. So, while the economy works through the supply pains of turning the economy back on with booming demand, costs will likely be uncertain.

Steps to Mitigate Economic Uncertainty

There are several steps your company can take to navigate the unknowns of the current economic and supply-chain environment.

1. Rely on Cash Flow Projections and Contract Negotiation

With the cost of construction materials creating short-term and long-term uncertainties in the construction industry, understanding your company’s cash flows is critical to effectively managing these challenging times.

Understanding cash flows at a company and job level is essential, especially when managing a project through uncertainty and increases in construction material costs.

Knowing the answers to the following questions can help you plan and mitigate potential impacts from the cost increases.

  • Are you monitoring cash flows at a job level?
  • Are you actively following up on jobs with underbilling to determine the reason for the underbilling?
  • Are you structuring your contracts and schedules of values in a way that allows for billing costs as early as possible?
  • Are there unprocessed or pending change orders preventing billing for all costs incurred?
  • Does your contract allow for alternative materials that may provide cost savings for the owner and the contractor?
  • If needed, do you have access to a line of credit or other financing sources to weather the storm created by rising material costs?

2. Understand Your Contract and Contractual Rights

Understanding your contractual rights is key to securing payment for unplanned costs. Is your contract a fixed price, or does the contract structure allow for more flexibility in dealing with price increases? No matter the contract, it’s critical to apply these best practices:

  • Negotiations. Start negotiations for pricing changes early on, before you’ve committed to and incurred costs.
  • Contract lengths. When bidding new work and negotiating contracts, consider shortening the period for which bids are valid.
  • Contract terms. Include contractual language related to escalations in construction material costs.
Know Your Customer and Contractors

It’s important to build relationships with fellow contractors and project owners. Leveraging that relationship capital can help you have proactive conversations about the project, material shortages, and related costs and delays.

Knowing your customer and their cost and risk appetite for the overall project cost is important. If lumber, steel, or concrete prices increase the total project cost by 30%, 40%, or 50%, is there a point when the owner will either cancel or put the project on hold? 

3. Leverage Data and Technology

There are a few common themes in the current business environment: timing, data insights, coordination, and planning. These are facets of business that can provide valuable insights and put your company a step ahead. 

When supply chains are constrained, it’s important to plan as far forward as possible to secure resources. This means coordinating across multiple teams in your organization. It also means understanding what to expect as your production progresses. 

Many times, there are valuable insights embedded in your historical data that can facilitate decision-making and accelerate the planning process. The question is how to access and leverage that data to facilitate efficient coordination and planning. 

If you rely heavily on spreadsheets, you’re not alone. But there are a variety of solutions that streamline the process and return a positive return on the investment, including:

  • Data analytics platforms
  • Scenario planning with corporate performance management (CPM) systems
  • Enterprise resource planning (ERP) systems
Data Analytics Platforms

Data analytics offer insights into past performance and can reveal trends and opportunities to facilitate change, in addition to supporting a data-driven culture. Organization-wide transparency is highly valuable in keeping an organization nimble. This analytical information informs scenario planning. 

Corporate Performance Management (CPM) Systems

A CPM solution engages coordinated planning across all departments and provides holistic results with realistic timing.

Changes in one department immediately flow through the solution to show bottom-line results and effects on other areas. The ability to plan quickly and holistically is key to staying a step ahead and moving with confidence.  

Enterprise Resource Planning (ERP) Systems

Results from scenario planning flow into the ERP solution to effectively secure resources well in advance when there’s still time to negotiate. Often, these solutions pay for themselves with just a few good decisions by a well-informed team. 

The solutions will automate time-consuming tasks and leave more time for higher value-added analysis to support decision-making. Implementing these solutions successfully is a value-driven exercise. 

Next Steps

When adapting to economic and supply-chain volatility, it’s important to start with the end in mind. It can be easy to get distracted from key steps that are valuable and actionable—such as creating strong contracts and adapting your company’s technology systems. 

When focusing on what’s valuable, you’ll find that it comes back to the common themes: timing, data insights, coordination, and planning. Choosing solutions to help automate information flow will uncover business value and keep your business a step ahead.  

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If you have questions on finding a solution to meet your business needs, please contact your Moss Adams professional.

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