American consumers are about to feel the pinch

Firms can be expected to raise prices in response to rising freight and commodity costs

The earnings season three months ago raised one key question for corporate America: Did companies have the pricing power to respond to rising freight and commodity costs by raising their own prices? This quarter’s earnings season is providing an answer: Yes.

So companies are going to raise prices. That aims to protect their profit margins. At whose expense?

The whole idea of “pricing power” is based on a perhaps faulty notion that companies raise prices only when they have the leverage to do so. The epitome of a company with this kind of pricing power is Apple; the average selling price of iPhones grew 20 per cent over the past year.

Rought start

But sometimes companies raise prices for other reasons, even if it means sales volumes are going to fall. And that’s been the story of this quarter’s earnings season. Consumer staples companies like Procter & Gamble, maker of diapers and toilet paper, had a rough start to the year as costs surged but pricing to consumers did not. Profits and margins fell, taking stock prices with them.

But with another three months to evaluate the environment, and with costs not falling, firms have announced their plans to pass on higher prices, even if it means a loss of sales and market share. That’s why Procter & Gamble announced that they were increasing prices on Pampers diapers by 4 per cent and Charmin toilet paper by 5 per cent.

Procter & Gamble stock rallied on the news, and its competitor Kimberly-Clark Corp saw its stock rally even more.

A few extra nickels and dimes in the grocery store may be one thing, but the more significant economic factor may be pricing of durable goods and building materials going up in response to higher commodity prices and the escalating trade war.

Companies ranging from Mohawk Industries to Masco Corporation have announced their intent to increase their prices to offset their higher costs.

The AutoNation CEO said in his earnings call that thus far, auto manufacturers have absorbed increases in the price of steel and aluminium without passing them on while they await the outcome of trade negotiations, but if this becomes a permanent state of affairs then manufacturers will have no choice but to pass those higher costs on. Ominously he said: “Consumers will not pay those higher prices. Volumes will fall, and they’ll have a material impact on the industry and on the economy.”

The third act

We’re moving into the third act of this play. In the first act companies were caught off guard on costs and pricing, and their stocks fell. In the second, as they got a handle on the cost environment, they’ve announced their intentions to pass on higher costs to consumers, Wall Street has gotten confident in that story, and stocks are in the process of recovering. But the third act is perhaps the most worrisome. What happens when all of these pricing increases hit the economy?

And it’s not even just the companies directly impacted by higher costs that need to be concerned. The technology sector may remain the market’s darling, but consumers don’t care which companies are impacted by tariffs and freight and which ones aren’t. They have a fixed budget, and if toilet paper, gasoline, automobiles and home repairs all go up in price, that means less money left over for Amazon orders and streaming media services.

Up until now, figuring out who’s being impacted by the higher cost environment has been a relatively straightforward endeavour, but soon the answer might well just be “everyone.”