At 8.6% Inflation, Your Standard Costs Are Fiction

The Number on Every Quote Is Out of Date

The Bureau of Labor Statistics reported this month that consumer prices rose 8.6 percent in the twelve months through May, the fastest increase since December 1981. Producer prices for the materials manufacturers buy have been climbing faster still for much of the past year.

Most manufacturers have felt this for months in their purchase prices. Fewer have followed it through to the place where it does the most damage, which is the standard cost in the ERP. In a typical small or mid-market plant, standard costs are rolled once a year, at budget time. They feed the margin on every quote, every price list and every product profitability report. When inflation runs at one or two percent, a once-a-year roll is good enough. When it runs at eight, the standards drift further from reality every month, and every decision built on them drifts with them.

Where the Gap Shows Up

The first place the gap appears is purchase price variance.

The first place the gap appears is purchase price variance. Every receipt that costs more than standard creates a variance, and in a year like this one those variances pile up. On a monthly report they look like an accounting matter. They are actually a pricing signal that arrives too late to act on.

The second place is the quote. Sales prices new business using standard cost plus a margin. If standard cost is nine months old and materials have risen fifteen percent, the margin on that quote is a fiction. The order may look healthy when it is booked and turn out to be marginal or worse when it ships. Multiply that across a year of quotes and the damage is substantial, and it is invisible until the books close.

The third place is mix decisions. Product profitability reports built on stale standards make some products look better than they are and others worse. Teams then push the wrong products, cut the wrong ones, and allocate scarce capacity to orders that lose money.

Roll More Often, or Quote From Something Else

There are two practical responses, and most plants should use both.

The first is to update standard costs more often. Moving from an annual roll to a quarterly one is usually feasible in any mature ERP. It takes some discipline in purchasing to keep current prices on the item records and some coordination with finance, because the revaluation of inventory at each roll has an accounting effect that needs to be understood and planned. The benefit is that the costs feeding quotes and reports are never more than a few months out of date.

The second is to stop quoting from standard cost alone. For parts with volatile inputs, quote from a current replacement cost: the most recent purchase price, or a supplier's current quote, or an index-based estimate. Many ERP systems support costing versions or simulation costs that can be maintained separately from the official standard. If yours does not, a well-controlled current-cost table that feeds the quoting process is far better than quoting from a number everyone knows is wrong.

Put Escalation Into Customer Agreements

Better internal costing only helps if the price you charge can move too. For long-term customer agreements, now is the time to look at escalation clauses that tie prices to a published index for the materials that drive your cost, such as steel, resin, copper or aluminum. Many customers will accept a transparent, index-based mechanism more readily than repeated, ad hoc price increases, because it treats both sides fairly when prices fall as well as when they rise.

The data to support those conversations comes from your ERP: which materials drive which product families, how much each one has moved, and what that means for the cost of each part number. A manufacturer who can show that analysis line by line negotiates from a very different position than one who sends a letter announcing a percentage increase.

Watch the Variances Weekly

Finally, change the rhythm of the review. Purchase price variance reviewed monthly by finance is a report. The same variance reviewed weekly by purchasing and sales together, sorted by the parts and suppliers moving fastest, is an early warning that tells you which quotes to refresh and which customers to call.

The Bottom Line

At inflation rates not seen in four decades, an annual standard cost roll means quoting, pricing and product decisions are made on numbers that are months out of date. Manufacturers that protect margin this year are rolling costs more often, quoting volatile parts from current replacement cost, building index-based escalation into customer agreements, and reviewing price variances weekly where the people who can act on them see them.

At Cherry Street, this is the work we do. We help manufacturers set up costing that keeps pace with their suppliers, connect it to quoting, and build the material-level analysis that makes price conversations with customers factual instead of adversarial.