The Real Economy

Stories from the middle market

How an electrical contractor and a food business manage rising costs

Mar 01, 2022

RSM recently spoke with two clients about the impacts of inflation on their companies. Here are the stories from John Axelson, the president and chief executive officer of Hunt Electric, and Bob Kafafian, chief financial officer and chief operating officer of Epta America, the North American arm of Chipita Global.

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Economics The Real Economy Inflation

As a contractor with $560 million in annual revenue, Hunt Electric has weathered its share of economic downturns over the years. But the pandemic has been an altogether different kind of challenge.

John Axelson, the company's president and chief executive officer, said that his firm had faced delays of weeks or even months as it waits for delivery of key pieces of equipment. Jobs have to be pushed back and contracts were rewritten as delays have convulsed the market.

The result is inflation.

"We've struggled with higher costs," he said in a recent interview. "Our gross profit is down."

He cited a host of reasons for the rising prices. Some of the reasons are COVID-19 protocols on the job sites, which increase costs, he said. But in the end, the difficulty in securing raw materials have proven to be most problematic for Hunt.

Up and down the supply chain, vendors struggling to retain and find workers, have had to adjust their timetables in delivering their goods. Products that used to take four to six weeks to deliver to a job site are in the 24- to 28-week timeframe, Axelson said. And those that used to take 12 weeks to secure can now take up to a year.

It leaves Axelson, whose firm is an RSM client, scrambling to adjust his firm's own timetables and costs to see jobs through. Scrambling to adjust is especially the case for contracts that were agreed to before the pandemic; pricing is now outdated. As costs have inexorably risen, it's not always possible to pass them on to the customer. Some developers are reluctant, or even unwilling, to adjust a contract. Everyone is dealing with these rising costs, they say.

Axelson recalled one job that required $400,000 in materials. But that contract was signed in 2018, long before the pandemic. Today, costs for the same materials have risen to $540,000.

"It is very difficult if not impossible to pass those costs on, and we're not able to do that to the customer," Axelson said. "You have to honor their price."

Axelson understands their position. "This general contractor was on the hook for other projects," he said.

Embedded inflation

Such stories are common these days as inflation has become embedded throughout the ecosystem of the construction industry.

Today, Hunt Electric is careful to word contracts differently to allow for rising commodity prices.

He said the challenge has only become more acute as demand nationwide has increased, especially in the past year as the economic recovery has gained momentum.

Consider the example of the missing switchgear on a major project in Massachusetts. It was a significant piece of equipment - kind of like an electrical panel in a home, but on a grand scale. The contractor told Hunt that the equipment would be 30 weeks late - a significant setback to the job.

For many contractors, that kind of delay would be a crippling blow, but Hunt Electric was able to draw on its strong relationships with its suppliers and its workers creativity to find a solution.

A custom manufacturer built a temporary piece of equipment that Hunt installed until the permanent piece arrived. The arrangement cost more, but the project owner agreed to the workaround, and the job moved ahead.

That solution is one way Hunt has weathered the changes set off by the pandemic.

If there is any silver lining, Axelson said, it's the workers who have been able to complete the jobs under trying circumstances.

Axelson's firm has largely been able to retain its staff even as its suppliers grapple with workers quitting their jobs in record numbers known as the Great Resignation. Axelson attributes this to the culture of the electrical trades, with its strong work ethic and solid pay.

Without the commitment of Hunt's employees, he said, weathering the past two years would have been much more difficult.

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Bob Kafafian can remember when inflation began to bite. He is chief financial officer and chief operating officer of Epta America, the North American arm of Chipita Global, a manufacturer of popular baked snacks like 7Days croissants that have won a loyal customer base across the United States.

It was early 2021, and the trucking industry was starting to become a chokepoint. The firms that Epta relied on to deliver its goods were reporting delays, and fees were starting to rise.

So Kafafian faced a decision: Try to keep expenses in check and stick with the lower-cost firms, or pay up for more reliable service.

For Epta, an RSM client, there was little choice. Consumers can't buy a product if it's not on the shelf, so Epta, looking to continue its robust growth of 40% to 50% a year, paid up.

"We were forced to start paying more for quality," he said in a recent interview. "By the spring of 2021, we had pretty much moved to more expensive solutions to ensure reliability."

The trucking chokepoint is just one example of the challenges that Epta has faced in managing its supply chain during the pandemic. For the broader economy, these bottlenecks are a big reason that costs are rising and why the inflation rate in the United States 7.5% in January's at its highest level in 40 years.

The container conundrum

All along Epta's supply chain, the company has encountered hurdles that were hard to imagine before the pandemic. Consider Epta's cost of ocean freight, a significant expense for a company that sources its products from Europe.

"Our top item is the croissant, so we ship a lot of empty space, lot of air," Kafafian said. While a durable goods manufacturer can pack a lot of its products into a single container and make efficient use of the space, only so many croissants can fit in a container without being damaged. The result is shipping as a share of Epta's total costs is quite high.

And those costs have soared.

"The cost of our imports from factory to our door has gone up over 100% between April and September of last year," and as much as 150% depending on the specific shipping lane, Kafafian said.

Kafafian cited three reasons for the increase, and they hit every point in Epta's supply chain:

  • Factory to port: The cost of getting the products from the factory floor and loaded onto a ship in Europe has increased. In addition, there are significant delays at European ports, which incur fees.
  • Port to port: Ocean freight rates have spiked.
  • Port to warehouse: In addition to the shortage of truckers, delays at American ports have become routine, with trucks waiting for hours to be loaded.

There are other costs as well. For example, port operators charge fees, known as demurrage, for containers that are not emptied in a timely fashion, and fees for containers that are not returned on time.

These rising costs and delays have forced Epta to change the way it operates.

For example, ambient containers - or those shipped at room temperature - were in short supply early last year, so Epta started to use frozen containers.

Not only did it cost more to keep the containers cold, but frozen containers also held fewer croissants, and there were higher charges once the containers arrived at the ports.
Still, as with the trucking delays, Kafafian had little choice.

"It was either don't ship products or find a way to ship products and pay through the nose," he said.

A breaking point

Finally, all of these cost pressures shipping, trucking, ocean freight幼ame to a head last year. After years of holding prices steady, Epta raised prices in the second quarter. To Kafafian''s surprise, Epta did not receive any complaints. Then in January, Epta raised prices a second time and once again, received few complaints.

In fact, one customer, sensitive to the pressures Epta was facing, accepted a price increase sooner than Epta had planned. As unusual as that was, it spoke to the strong relationships Epta has built over the years with its customers, not to mention the appeal of its products.

The takeaway

Even as Epta navigates a difficult environment, Kafafian remains optimistic about the future. He said one way to change the equation is to gain more control over costs and onshore the production of its popular products.

But any decision like that will take time, and until that happens, Kafafian will continue to grapple with a difficult decision: Keep prices low and live with lower margins or raise prices and risk robust growth.

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