Indias Small Businesses Struggle To Pass On Higher Input Costs

"I'm not the CEO of Apple," says Rohit, who runs a small furniture business in the port city of Visakhapatnam. That half-in-jest retort comes in response to a question being asked more and more these days — are you being able to pass on the surge in input costs?

As prices of inputs from metals to oil, cotton to chemicals rise, the ability to pass on the higher prices to the end consumer remains fractured. Large corporations and those with value added goods may be able to pass on increased input costs, while many smaller businesses are being forced to sacrifice margins.

The struggle is visible in the divergence between wholesale and retail inflation. While wholesale inflation has been in double digits and was at 13.1% in February 2022, retail inflation has stayed lower and is close to 6%. Surveys such as the IHS Markit PMI, which measures the sentiment of manufacturers, have also flagged off the rising margin pressure for businesses. "Despite expenses rising sharply, firms passed on only part of this burden to clients, suggesting pressure on profit margins," IHS said alongside the release of the February Purchasing Managers Index.

"Losing Margins Feels Like Losing My Backbone"

Rohit, who did not want his last name disclosed for the sake of confidentiality, says that pressure for his furniture business is building from a number of fronts, starting from freight costs to the price of key inputs.

A containerful of the material he uses for manufacturing plywood and veneer previously cost him Rs 12 lakh. Now it costs Rs 20 lakh.

That's only the start.

Formaldehyde, a chemical used in the manufacturing process, now costs Rs 24 per kilogram compared to Rs 16 earlier. That has meant additional spending of about Rs 5 lakh a month.

Likewise, melamine for plywood rose to Rs 375-400 per kg from Rs 50-60 previously. "We use about 5 tonnes a month, meaning that we are now spending over Rs 17.5 lakh more on just that every month."

Spending on phenol has risen by just as much, with a rise in its price from Rs 60 per kg earlier to Rs 136 per kg now.

Each of these items have seen a price rise due to surge in crude prices, shortages and supply disruptions.

Margins in Rohit's business were already wafer thin at about 5%. Now they are eroding further.

"Working without margins, everything becomes a challenge," Rohit says.

The company is doing what it can to control costs. Travel has been cut, capital spending deferred. "If the rise in input costs had not been as stark, we would have spent at least Rs 10 lakh on replacing machinery," he said. Some manufacturers are also compromising on the quality of material, Rohit added.

One option is to stretch the amount the company produces. "We have already cut variable costs as much as we could. Now, we are targeting lower fixed costs by bringing economies of scale," he explained.

"Working For Loss"

A few kilometres away, AK Balaji runs Lalitha Metals, an SME unit which manufactures iron castings in Autonagar, one of Visakhapatnam's industrial areas.

Metal prices have surged due to strong global demand but also because of supply disruptions feared amid the ongoing Russia-Ukraine crisis. Balaji's business is feeling the pinch.

Steel scrap, the unit’s basic raw material, has seen a 15% rise in price in less than a month. The price of some secondary materials saw an increase of 100-200%, he said.

Compared to a year ago, prices of steel scrap have doubled from Rs 25 per kg to Rs 50 per kg, according to Balaji. The price of nickel rose by about five to six times from Rs 750-800 per kg to nearly Rs 5,000 per kg. Some of the ferro alloys used in the manufacturing process have seen prices rise from Rs 800 per kg to Rs 2,000 per kg, he said.

Balaji has been able to pass on about 80% of the price rise to customers. But absorbing 20% has hurt margins. In pre-pandemic times, Balaji says the business operated at a 20% margin.

"It's like working for loss."

Some foundries have chosen to halt production altogether till it becomes more viable to produce and sell. Others are supplying the minimum quantity required. Balaji's unit too has cut production. "But, we can't stop because there are commitments that have to be honoured," he said. Some orders have been pushed to later dates in the hope of lower prices.

Trouble doesn't end there.

Balaji's business like many others have to face delays in acquiring material due to supply chain disruptions. Manpower isn't always easily available. Recoveries have become challenging. Working capital requirements have risen.

Lower interest rates have come in handy and the emergency credit line scheme has been helpful, but the repayment schedule has started before businesses could settle, Balaji said.

A workshop of Lalitha Metals

Volatility As Painful As Higher Prices

Harmony Foods which produces flour is facing similar pressures for entirely different reasons.

Russia's invasion of Ukraine has caused wheat prices to rise by 15%. In addition, packaging material costs have risen by 15-20% in the last six months.

This, in an industry where price fluctuations are typically limited to 1-2%, Virat Maheshwari, the sales head at Harmony, said. Supply in the industry exceeds demand - so raising prices is difficult. Also cost of production is the same for most players, he said.

As such, margins are a function of cost price, Maheshwari said.

Alongside the costs, volatility in prices is adding to the uncertainty that Harmony Foods faces. "Without stability in prices, it is difficult to decide whether to purchase or not," Maheshwari said.

A unit at Harmony Foods.

MSMEs On Tenterhooks

MSMEs are on tenterhooks because of the cost of raw materials, said Manguirish Rai Panicker, outgoing chairman of the National Council for MSMEs at ASSOCHAM. "Along with a rise in prices, sourcing and procurement, too, have become challenging for some MSMES because they require these materials in limited quantities, he added.

According to Panicker, the metal sector is the worst hit in terms of input cost increases. Industries using crude and chemicals, too, have seen a sharp surge in costs. Cost cutting is also not helping because of the quantum of price rise, he said.

The rise in prices has also made it difficult for MSMEs to honor export commitments since these contracts are not as easy to renegotiate as domestic businesses, Panicker added.

The abnormal increase in commodities has hit small industries hard and is disruptive for them, said Suman Chowdhury, chief analytical officer at Acuité Ratings. "It could lead to liquidity challenges and even impact their ratings," he said.

Prices can be passed on only when the revival in the economy is steady and consistent. That's yet to be seen, said Chowdhury. Private consumption remains below expectations and until that's fixed, the conundrum of passing on input costs is likely to continue, he said.