UK Inflation Hits Zero – the Implications for Procurement

The UK inflation figures announced yesterday showed inflation falling to a new low this week – zero, in fact, the lowest since records began. The expectation now is that we will move into negative or deflationary territory over the coming months.

Now I've been around a while, but this has not happened in my working lifetime. Indeed, my early years at Mars Confectionery were during a period of high inflation, when suppliers would routinely come to see me looking for 10 percent or 15 percent price increases. And our salaries rose at similar levels. I seem to remember the Mars starting graduate trainee salary pretty much doubling over a three- or four-year period.

So we are now entering uncharted territory for most of us in the business world and the procurement profession. We therefore need to be thinking about what this means for us, our jobs and organisations - is it significant? Should we be worried? What opportunities and threats might this state of affairs bring?

The fear for economists and politicians is that deflation can drive nations into a spiral of economic bad news. Companies and individuals don't invest because they expect prices to fall in the future - why buy now if items will be cheaper next year? That depresses expenditure, which puts more pressure on prices, which causes further deflation, firms have to cut wages to survive and we are into the Japanese "lost decade" (or lost 20 years, as some would see it) of declining wealth alongside deflation.

But if this is perceived by consumers and firms as just a short term interlude in the usual picture of inflation, then the consequences may not be so bad. Many purchases can't be delayed anyway, from my Sainsbury's weekly shop to raw materials needed by many firms. And consumers may actually take advantage of lower prices if they see it as temporary and they don't lose economic confidence.

Given that the current UK situation has been caused largely by the oil price falling dramatically, we suspect that this more positive outlook is probably the case here. It is more worrying in some other European countries however, where the economic fundamentals are more concerning and it is easier to see how consumers might get into a spiral of despair and deflation.

However, even in the UK, there are implications for procurement. For instance:

- where oil or oil derivatives are a significant part of a supplier’s cost base, it is appropriate to be talking to them about price reductions (or other benefits). Potentially, they are benefitting from windfall profits, so there is nothing wrong with challenging this.

- where goods or services have inflation adjustments built in to the contract and prices, it is worth checking whether the terms actually cover deflation as well as inflation. I have seen some "upwards only " price mechanisms in contracts over the years – we never really expected RPI to come down!

- whilst deflation might be short term, it is worth thinking about whether certain purchases should be delayed for a while. Of course this might mean the procurement profession driving the nation into the deflationary spiral, but we have to do the right thing for our organisations!

There will be a mindset issue here for suppliers too. For many years, they were used to the annual round of negotiating price increases. The last few years, they have had to accept that might be a freeze or a very low increase - maybe one or two percent. But how will they feel if this turns into an annual round of price cuts? I know it has happened in some industries already, but more generically, you feel this will be a bit of a shock to the system. Interesting times, in any case.

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