Fifth District Firms and the Prospect of Higher Input Prices
Introduction
Since the middle of 2023, firms' year-ahead input price growth expectations have been relatively steady, hovering around 3 percent for manufacturers and between 4 to 5 percent for service providers. However, recent developments in trade and tariff policy have introduced new uncertainty into firms' decision-making. In December, our surveys showed little evidence that this uncertainty had made its way into firms' price or cost growth expectations. Data from our February surveys show a slight uptick in firms' expected growth in the prices they pay their suppliers.
In addition to the slight uptick in expected growth, most respondents in February reported that in the event of an unanticipated increase in input costs, they would increase the prices they charge customers. The share of the cost increase that firms would pass on to customers varied, with manufacturing firms more likely than service-sector firms to pass on the entire cost increase. Despite their expectation to pass along price increases, most firms acknowledged that it is either as difficult or more difficult to pass on price increases to their customers this year than it was last year.
Firms Expect to Pass Along Cost Increases and Maintain More Frequent Price Adjustments
When we asked firms how they would adjust their prices if input costs increased more than anticipated, almost half of respondents (48 percent) indicated that they would pass the full increase along to customers. Meanwhile, 17 percent noted that they would increase prices by less than the cost increase, 13 percent would increase prices by more, and 13 percent would keep prices the same.
Manufacturers were more likely than service-sector firms to pass through the full cost increase (or more) to their customers. This suggests that service-sector respondents in our survey may have less pricing power than their manufacturing counterparts.
Separately, we asked firms how often they expect to adjust prices this year. We then compared these results to expected price adjustments in 2024 and the adjustments firms made prior to the COVID pandemic, which was arguably the most recent "normal" pricing environment. In February, half of firms expected to adjust prices multiple times this year, compared to 45 percent of firms in 2024 and 36 percent pre-COVID. These results suggest that firms may still be more willing to use price increases to balance the effects of potential input price increases than they were before the pandemic.
Firms Report Increased Difficulty Passing Along Cost Increases
Although most firms would raise prices if their input costs increased unexpectedly, they do expect increased pushback from their customers. Most firms noted that it is equally or more difficult to pass price increases on to customers as it was this time last year. In fact, less than 15 percent reported that passing costs to customers was easier than last year. Almost half of firms reported no change in their ability to pass along their cost increases.
Other Methods for Passing Along Cost Increases
To pass along costs to customers, most firms would directly increase the price of their products or services. Nonetheless, about 33 percent of firms would indirectly pass on increased costs through variable pricing, temporary surcharges, or, in some cases, by offering less of the product or service for the same price. About one-third of firms that found it more difficult to pass on price increases would increase prices indirectly, compared to about a quarter of firms that reported passing along increases was unchanged or easier.
Uncertainty Challenges
According to surveyed firms, unanticipated events can create friction in business planning. For example, one survey respondent — a North Carolina electronics manufacturer — had to renegotiate pricing with customers after a recent unexpected increase in input costs. Although they will be able to pass along the cost increase, the significant resources that went into the planning and renegotiation will be absorbed by the company.
In our February surveys, we find that most firms expect to be able to pass along unanticipated cost increases, although it is harder than last year, and many firms will pass along cost increases indirectly. On the other hand, many firms, particularly service-sector and construction firms, will try to absorb both the cost increases and any expenses that comes from an uncertain environment.
Views expressed are those of the author(s) and do not necessarily reflect those of the Federal Reserve Bank of Richmond or the Federal Reserve System.
