How Small Businesses Can Handle Inflationary Pressure
September 2, 2022
In the past few years, the COVID-19 pandemic, supply chain shortages, and other disruptions to typical economic growth have resulted in elevated levels of inflation, and your business’s survival depends on its ability to handle inflationary pressure.
According to the U.S Bureau of Labor Statistics (BLS), the Producer Price Index (PPI) of all items rose 7.4% in the twelve months preceding February 2022, driven mostly by the rising costs of gas, food, and warehousing. Rising producer prices has resulted in an equal rise in the consumer price index (CPI) putting pressure on consumers to spend less.
Whether your business is a software development company or a new restaurant, this sky-high inflation is making an impact.
As inflationary pressures build, the Federal Reserve Bank (Fed) will respond with interest rate hikes making it more costly for businesses to borrow. Higher interest rates are designed to cool-down inflation and that will create a drag on Gross Domestic Product growth.
In the retail industry, that means less access to capital as we approach the all-important holiday season. Business owners may wish to consider making borrowing decisions ahead of the the interest rate hikes to ensure they have adequate working capital for the holiday season and the first quarter of the new year when retail business is historically slower.
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How Did This Happen?
There are several important factors that contribute to the current high inflation rate, like an ongoing war between Russia and Ukraine, but the most important of these is the COVID-related bottlenecks created by a rapid increase in consumer spending.
Back in 2020, the dawn of the pandemic sent millions of American workers home. The U.S. economy effectively came to a standstill while the populace quit driving, spending in brick-and-mortar stores, and faced the lockdowns.
Thankfully, the country has since begun reopening in earnest. But the steep increase in consumers has outpaced the ability of product suppliers to keep up, leading to price increases on, well, almost everything.
According to the Brookings Institute, consumer spending on most goods is up as high as 15% over pre-pandemic spending levels, and in the short-term, the companies making many of these products are simply unable to keep up.
Another cause can be found in the labor market. Coming out of the pandemic, the American workforce’s attitudes toward employment have changed drastically. There’s the Great Resignation, as it’s known, in which millions of fed-up employees are leaving their jobs. But there’s supply and demand in that market too: the shortage of workers has led to higher wages in order to fill roles, and those higher wages mean higher prices on products and services. Add labor market issues to the ongoing global supply chain issues, a very high price on crude oil, and all these factors add up to the inflationary pressure we see today.
What Can Be Done?
The Federal Reserve, or the Fed, is the main central banking system of the United States and is the agent most responsible for combatting inflation. The Fed can raise the interest rates at which banks borrow money. This acts as a sort of targeted slow-down of the economy in order to control inflation. Because the bank is paying more for its money, they’ll hand that higher price tag right along to small business borrowers and other consumers. The higher interest rates mean that consumers generally decrease their expenditures, allowing for supply to catch back up to demand. The converse is also a strategy: in times of excess supply, the Fed can drop interest rates, making borrowing less expensive for all involved.
Congress can also take several actions to help in the battle, including using legislation to help combat rising oil prices and attempt to improve the labor market, but their courses of action will likely be attempts to solve surface-level problems with consumer spending power, not attempts to solve the underlying inflationary issue. That’s the Fed’s job.
As federal monetary policy works to battle the higher inflation we’ve been experiencing the last year, consumer purchasing power will continue to wax and wane.
How Long Will It Last?
The good news is, most economists agree that the price pressures we’re seeing now are temporary. Once we’re more clearly out of the pandemic era, consumer habits will rebalance and allow for better logistical planning on the supply side. That reestablishing of the status quo along with continued fiscal policy adjustments from the Fed will hopefully result in lowered inflation expectation in the next year and a boost to the global economy.
In the mean time, your small business must deal with the higher prices in the present. Here are five prime ways to help your company handle inflationary pressure as we wait for greater economic recovery and a more stable consumer environment.
Five Ways to Handle Inflationary Pressure
In times of high inflation, each dollar is slightly less valuable. You still need to buy inventory, pay your employees, market your business, and pay for real estate. The problem is that there aren’t many pleasant options to counter the issue. You can cut costs, which can lead to supply chain issues of your own. You can raise prices at the risk of pricing your loyal customers out of the picture. Or you can try to deal with making less money, which can also lead to massive cash flow issues.
Instead of taking such drastic measures to make ends meet, consider one of these five ways to help handle inflationary pressure.
1. Clean Up Your Spending
Some goods are going to affect business more than others. If you run a trucking company, the cost of gas is going to directly impact your bottom line, for example. But cutting costs willy-nilly in order to combat the pressure of inflation is a mistake. However, using that pressure as a forcing mechanism to help identify areas in which your company can lead to some productive pruning measures.
For example, is your company doing business with multiple vendors for the same products? If so, consider establishing a larger-scale relationship with a vendor in order to purchase some necessary products in bulk, saving money.
You could also consider measures like subletting if you’re in possession of a large piece of real estate. Other companies are also looking to cut some spending. Would you be able to sacrifice a piece of space in order to make some money back?
How about discretionary spending? Are there expensive employee perks that are getting staff in the door but are under-utilized and don’t necessarily lead to worthwhile retention or productivity benefits?
There are many places you’re probably spending a bit too much money. Try to identify the areas where you can make cuts without sacrificing quality.
2. Carefully Evaluate Staff
With the labor market in such a state of disarray, staffing has never been more important. It’s more expensive than ever to make any hire at all, and in a small business every hire has a large impact on the business as a whole.
Identify redundancies. Are there areas in which you’ve traditionally gone with two less-expensive staffers where one better-compensated person will suffice?
Also consider that different industries and roles will be impacted by inflation differently. If your company hires dozens of lower-wage employees, they can be greatly affected by small changes in inflation. If their dollars aren’t going as far as they used to, they’ll have no second thoughts about quitting and heading to the business across the street for an extra couple dollars an hour. Similarly, if you employee fewer, higher-paid staffers you should make sure that you’re doing everything possible to keep them around and happy. Are there perks to working for you? Excellent health care? A fun work environment?
3. Borrow Money While Interest Rates are Low
While lower interest rates on a national level can lead to inflation like we see now, it also means that it can be a great time to borrow. Do you need to upgrade a piece of equipment to boost sales in times like these? Is there a specific short-term opportunity available to you? Borrowing now means that if interest rates increase later on as noted earlier, you’re paying less for necessary money.
4. Buy in bulk
This is something of a corollary to cutting costs. If you’re able to forecast sales into the near future, stocking up on expensive product or supplies now can be a cost-saving measure. If you’re able to make a substantial purchase on a necessary supply while interest rates are low, you might be able to save some money while setting yourself up for the near term.
5. Consider a Pivot or Change in Product
Finally, consider whether you should continue doing business the same way you’ve been doing it. In times of inflationary pressure, you’re really able to see which parts of your business model are bearing fruit. What can you change?
Supply chain shortages might indicate that you need to remove some offerings, while existing surpluses can create areas for you to try new products or services. Or if one particular offering at your company is driving a majority of your income, consider pivoting the rest of the company’s work to supporting or improving that product or service. Is vertical integration a possibility? Is automation?
There are also ways to reposition your prices as they rise. If a core product has gone up in price and customers seem wary of that increase in spending, consider going over the top with a much-improved version at a significantly higher price point. That might lead your customers to see the still-more-expensive core product as a relative bargain even though the price has gone up.
Another option might be to adjust pricing based on quantity. For a very simple example, imagine you’re known for selling slices of pizza for $2 each, but the prices of your ingredients have led you to increase prices. You’ve got two options. You can try selling pizza for $2.50. But this might alienate your existing customers, who know you specifically for the $2 slice. The other thing to try might be offering a slightly smaller piece of pizza for $2. While still not ideal, this option at least keeps the focus on what you’re most known for while still helping trim some cost.