How to protect profit margins when business costs keep rising

Businesses are facing significant financial pressure. Diesel recently hit record highs, freight costs are up, insurance prices continue to rise and tariffs have made many items more expensive.

When costs keep rising, businesses can protect profit margins by improving cost visibility, identifying margin leakage early and building more disciplined pricing mechanisms into customer agreements. Your business needs to understand which cost changes require action, where there is room to adjust pricing and where operational improvements can absorb the pressure.

Keep reading to learn how you can protect your business’s margins in this high-cost environment.

How to identify margin leakage

Reviewing the P&L gross margin percentage can tell you there’s a problem. It often can’t tell you where the problem is.

Leaders need the ability to examine true margin by product, customer and market. That means breaking costs into the components that drive profitability, including:

• Materials
• Labor
• Packaging
• Overhead
• Shipping and freight

This level of detail helps leaders see which products or customers are absorbing higher costs and whether certain products are underpriced relative to their production costs.

Percentage margin isn’t the only metric worth watching. Leaders should also look at actual margin dollars and sales volume. A product with a declining gross margin percentage may have a very different effect on the business depending on how many units the company sells.

The practical question is simple: If an input cost changes tomorrow, can you quickly determine which SKUs, customers and markets it affects?

If not, improving the underlying data should come before changing prices.

How to improve cost visibility

More cost data doesn’t automatically produce better decisions. Leaders need to understand how a change flows through the business.

Suppose a manufacturer receives notice that a raw material will increase by 15 cents. On its own, that figure doesn’t answer the questions management actually cares about:

• Which products use the material?
• How much does each product consume?
• Which customers buy those products?
• How will the increase affect margin percentage?
• How many actual margin dollars are at risk?
• Is the impact large enough to require immediate action?

Profitability reporting should connect the original cost change with those downstream effects. That allows leaders to distinguish between small changes they can absorb or monitor and larger increases that require a faster pricing response.

It also keeps teams from chasing every minor fluctuation. Not every increase deserves an immediate customer conversation. But as several small increases accumulate, they can become meaningful margin pressure. Your business needs a system that makes that cumulative impact visible.

For a midmarket manufacturer, that can change the conversation from “our costs are up” to something much more useful: “This particular cost change is affecting these products, these customers and this amount of margin.” That’s information leaders can act on.

What is good data maintenance?

Good data maintenance involves using the most current cost data for profitability reporting. This helps ensure your reports reflect the business’s economic reality at that moment.

Consider a manufacturer that updates its standard material costs once a year. Its supplier raises the material cost after that annual update, but the company’s margin report continues to use the old price. The report may look healthy even as actual profitability deteriorates.

Purchase costs, labor assumptions and run rates also need regular attention.

Data accessibility matters too

Some businesses still build profitability reports by manually combining shipping records, bills of material and other cost information from separate systems. A stronger data structure brings those sources together into a data management platform and provides reporting that leaders can access without waiting for month-end processing or a one-off analysis.

Think of margin data like a dashboard in a vehicle. Knowing you were low on fuel last month isn’t useful when you’re making a decision today.

Businesses can take that idea a step further by loading known future costs into their ERP systems. If a supplier has announced a future increase, management can assess open orders and determine when margins on existing parts could change. That gives the company an opportunity to respond before the increased cost is reflected on the income statement.

What is a good repricing strategy?

A good repricing strategy starts with identifying which costs can reasonably be passed through and which products have room for adjustment.

For manufacturers, raw materials can be a straightforward area for pass-through, particularly when customers influence the material specification or distribution network. Instead of forcing manufacturers to absorb every fluctuation, the pricing structure can allow material changes to flow through to the customer.

Other increases, such as labor or fuel, can require a broader analysis. To start, look internally. Can process improvements offset part of the increase? If you have already exhausted reasonable efficiency opportunities, use margin reporting to identify products and markets where existing prices no longer provide an appropriate return.

Then add market intelligence. Compare margins among similar products within your own business and consider competing products, substitutes and relevant market prices. The objective isn’t a blanket price increase. It’s finding where your business has legitimate pricing leverage and concentrating action there. Repricing everything by the same percentage may be simple, but it ignores major differences among products, customers and markets.

How to renegotiate pricing in customer contracts

Make pricing changes easier to manage by establishing defined pricing adjustment methods in customer agreements rather than renegotiating from scratch every time costs move.

Your methods should focus on two things: timing and transparency.

A contract could establish a regular review cadence, rather than treating each adjustment as an isolated event. Quarterly reviews are preferable, but pricing should be reviewed at least annually. Pricing reviews need to focus on transparent market information such as freight, diesel, oil or commodity indexes. Companies can also share documented material price changes received from suppliers.

Your pricing adjustments need to work in both directions. When the underlying cost increases, prices can rise. If the cost falls, the same structure should result in a price decrease. That transparency can make the process more predictable for both sides and reduce resistance to adjustments.

The same concept can apply to freight. A business might establish a base fuel level and use a surcharge when fuel moves above that threshold rather than absorbing every increase indefinitely.

The main takeaway here is to avoid pricing in a vacuum. Create an agreed-upon process tied to information both parties can see.

Read more

• Financial scenario planning isn’t optional: How to stress-test your capital strategy
• Capital allocation strategy: A guide to help CFOs establish funding priorities
• Why cash flow visibility is becoming a leadership issue