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4.29 Producer Price Annual Change Analysis Questionnaire

Why have an a Producer Price Index Rate of Change analysis in a business plan for a Full Service Restaurant in Westchester County, New York?

In our previous example we took a look at the index values for the Producer Price Index (PPI) for all goods and services for a metropolitan area and compared that to an industry specific PPI for the same metropolitan area. While that analysis gives the readers and small business owners like Jack Gordon a very clear view into the trend of prices over a decade, it does not provide them with the actual rate of change in these prices.

The Producer Price Index Rate of Change analysis does just that - it looks at the rate of change year over year in both the PPI for all goods and services as well as the PPI for the industry in which the small business operates. These numbers that come out of the analysis are key metrics that have to be evaluated for strategic and tactical reasons by every small business owner - if they don't they should know that their competition surely will be doing just that. The rate of change calculates how much prices have been changing year over year and graphically represents this change plotting both the PPI simultaneously adjacent to each other for the entire decade giving great strategic insight into the relationship between the two indices.

Is the Rate of change in the PPI, the same number that we hear about on TV and print?

Yes. Most media sources report the rate of changes in the PPI index as opposed to the index values themselves, since telling someone the index value does not give them the context they need to be able to ascertain what that value is in relation to the previous values. The rate of change analysis is what is needed to deliver that vital piece of strategic information to business owners like Jack Gordon and other readers of the business plan like bankers and potential partners.

How should the Rate of Change in the PPI analysis be interpreted by a small business owner like Jack Gordon?

The Rate of Change in the PPI analysis is presented in graphical format with the data tables which show the actual change serving as the data source. The key here for small business owners like Jack Gordon is to get a sense of just what the rate of change in the PPI indices have been over the past 10 years. To facilitate this, we have represented the two PPI Indices in the form of bar graphs and we compare the bars for the PPI index for all goods and services to the PPI index for the industry segment over 10 years. Thus when looking at the graph the reader of the business plan is able to see with clarity just which of the two indices have been leading the other. When we use the Rate of Change in the PPI analysis and compare that to the PPI Index analysis discussed in the previous section, a very clear picture begins to emerge about which PPI index is increasing at a more rapid pace.

If you are in the fast food industry and see that the producer prices index for your industry segment is growing at a faster rate then the PPI for all goods and services, it quite simply means that prices in your industry are growing at a faster clip then those of other industries as a whole and you are going to have to make some very tough strategic and tactical decisions. For one you could consider passing your higher costs down to the end customer and that is usally what happens - wholesale prices go up and they are passed along to the customer.

Alternatively you could keep your prices the same or increase them very little - this of course means that your profitability will be hurt since your margins will now be squeezed - while you may get more market share from your competitors, you will have to be careful and make sure that your loss of revenues from not passing your higher costs onto your customers is made up by a corresponding rise in volume of sales which keeps your total profitability healthy. Remember, if you keep your profit margins wafer thin, even the slightest change in business conditions can turn a profit making business into a losing company overnight - having very strong cash flow discipline is very important but equally important is to keep having cash flow to begin with!

How about a declining Producer Price Index (PPI) - what does that mean for a business like A Touch of Tuscany?

A declining PPI is not good news. While it is certainly possible that prices may stall or even decline for short durations during an economic cycle, for the most part Producer Price Indices (PPI) have shown an upward bias. Have you ever heard of someone say that they bought a business in 1975 for $35k and sold it in 1990 for less than that amount. Note - that does not mean that it can't happen - it is just very rare - for the most part prices tend to go up.

Thus if you find that you are in a long term trend where the Producer Price Index (PPI) for all goods and services or industry specific PPI is actually declining, you need to very cautious about deflation. Deflationary forces can be very hurtful to a small business like A Touch of Tuscany since they indicate that the demand for the goods and services for that industry are declining and thus there is a loss in the pricing power at the wholesale level. Clearly if that were to continue, eventually the lowered prices would drive many folks out of business given their respective cost structures. This is what happened to manufacturing here in the United States - as the offshoring of manufacturing began to take hold manufacturers who had set up shop overseas were able to sell their goods much cheaper here in the Untied States making it very difficult for local business owners to compete and leaving them with only two choices - shut down or move their own production overseas as well.

It is important to understand deflationary price trends in the PPI since they can indeed be very powerful forces that can change the very nature of industries and economies - in the 1920's and 1930's the making of clothes was considered to be most lucrative business, since until the manufacturing of clothing was common place, all of societies clothing used to be made by small local tailors. With the advent of the sewing machine and other manufacturing innovations, the mass production of clothes became the most lucrative business to be involved in just like the dot com era of the last century. Indeed many immigrants into New York City from Europe were able to make their mark very quickly if they had experience making clothes in their home lands before coming to the United States.

However as time progressed, the business of making clothes started getting very competitive with newer entrants and cheaper labor along with better technology and all this resulted in putting tremendous downward pressure on the prices of clothes to the point that today as almost any of our clients in the garment district of NYC will tell you - the clothing business has become one of razor thin margins and high volume where it is impossible to turn buck if you don't have the ability to move large volumes of merchandise.

Quick Links:

  1. Go to the Corresponding Template section for this industry.
  2. Go to the Corresponding Business Plan section for this industry.

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