Business Cost Inflation: Labor Expenses Will Drive 2024-2025 Budgets

Consumer inflation is declining, but business costs are a different story, challenging many companies. A little relief is in the cards, but not enough to compensate for smaller increases in product prices. Most businesses will need productivity growth to protect their profit.

Labor Costs

Labor is the largest cost for many organizations. Average hourly earnings over the last 12 months rose four percent, down from a peak of seven percent recorded early in 2022. That four percent inflation rate has been stable in recent months. Benefits cost data are only available through the first quarter and show 3.5 percent rate of increase. That was down from a year earlier.

Several signs of mild softening in the labor market suggest that employee cost inflation will diminish slightly in the coming year. The softening signs include fewer voluntary quits, fewer job openings and higher unemployment, but these changes are all pretty small. The Federal Reserve’s interest rate strategy continues to exert mild contractionary pressure on the economy, so further slowdown in labor costs are likely. From the current four percent inflation, the most likely figure is probably around 3.7%, but with a substantial margin of error around that estimate.

Energy Costs

Energy constitutes a major cost at many businesses, more so in manufacturing, mining and transportation than in most service sectors. Electricity prices for commercial and industrial users have been roughly level for the last two years, aside from seasonal and weather fluctuations. The rising utility costs of environmental regulations have mostly been passed on to residential customers. The cost of alternative electricity generation will certainly rise and be blended into prices, but business customers should not have to budget too much more over the next couple of years.

Natural gas prices have been quite low in recent months, with little reason to expect a run-up. Crude oil has averaged around $80 a barrel. It’s outlook depends critically on international relations, with war or other supply disruptions an upside risk, and sluggish economic growth a downside risk. Most likely oil remains about where it is now.

Gasoline and diesel prices have trended down since their peak in mid-2022. They now sit 30% and 35% below that peak respectively. With oil prices stable, gasoline and diesel will likely remain level as well.

Commodity Prices

Non-energy commodity prices have bounced around a fairly narrow range over the past year, though different commodities have widely varying patterns. Companies dependent on particular commodities will need to study those items closely—generalizations won’t work very well.

Exchange Rates

The rising value of the dollar helps all businesses that import products. The outlook for foreign exchange rates is notoriously difficult to forecast, with just as much prospect of dropping as rising in the coming year. Companies that use substantial foreign-made supplies should consider hedges or other risk management strategies.

Productivity And Costs

Any generalization about business costs will be dangerous given the wide variation in purchasing among companies. But labor costs will likely constitute the largest cost increase for most companies in the second half of 2024 and all of 2025. Companies in general will lack the power to raise prices enough to cover the labor cost increase. Productivity gains, then, will be needed to offset all or a part of the labor cost increase. This highlights the importance of productivity gains through better tools, better employee training and better manager training.