Inflation is clearly a hot topic in the news & in our minds lately, as the prices for goods and services continue to skyrocket. While the news often focuses on the impact of inflation on consumers, it’s also a major issue for business owners.
In this post, we’ll take a detailed look at inflation and how it may impact the way you run your business. We’ll examine exactly how inflation works and explore some of the best methods for dealing with it as best you can. Whether we like it or not, we all have to face it in some way or another.
Especially in business though, it’s important to not only understand how it can affect things but to be prepared. While we all reminisce nostalgically about simpler, cheaper times of the past.. it’s sadly not our current economic reality. BUT, it’s ok, we’ll press on. Let’s dive into inflation 101.
What Exactly Is Inflation?
Inflation refers to the increased costs of goods and services and decreased spending power. The prices of items rise over time, which limits how far the dollar can go.
There are three main categories of inflation: Built-in inflation, Demand-pull inflation, Cost-push inflation.
Built-in inflation occurs when an increase in wages matches the increase in the costs of goods and services, it also occurs due to past economic activity.
For example, past occurrences of cost-push inflation and demand-pull inflation led to the gradual built-in inflation that occurred over the past few decades. Persistent built-in inflation is a normal part of the economy. In fact, the Federal Reserve works to achieve an inflation rate of about 2% each year.
Demand-pull is a type of inflation that occurs due to increased consumer demand. As demand increases and stock levels decrease, the value of goods and services rises. This type of inflation happens when consumer confidence is high.
As a business owner, you may look forward to demand-pull inflation. It signals that enough customers want to buy your goods or services that you need to increase prices to make demand more manageable.
Cost-push inflation is the type of inflation that most hope to avoid, as it’s often the result of negative economic conditions or major world events, such as a pandemic or large war. Cost-push inflation occurs when the cost of production increases. You may pay more for supplies and services, leading you to have to charge customers more.
How Inflation Impacts Small Business Owners
Small business owners are often the first to feel the actual effects of cost-push inflation. You may notice an increase in the cost of raw supplies and the services that your business depends on.
Here are some of the most common ways that a small business owner may notice the impact of inflation: Decreased demand, Higher cost of production, Smaller profit margins.
Depending on the industry and current economic situation, you may also notice decreased demand for your products and services. Some of the industries and businesses that tend to be most affected by inflation include:
The effects of inflation often start with an increase in the supplies and services that your business depends on. Inflation may lead to an increase in the cost of raw materials, including gas and building materials. This leads to a higher cost of production and more expensive services.
You may pay more for supplies, utilities, and other expenses. The rising prices increase your overhead expenses, which decreases your profit margins.
In response to higher costs during the pandemic, about 67% of small business owners had to raise prices. Higher costs can limit demand, increasing the severity of inflation on small businesses.
How Long Does Inflation Typically Last?
Inflation never truly stops but may cool down and gradually become built-in inflation. Luckily, the high inflation rates that we’ve seen recently are expected to fall in the coming months, according to CNBC’s inflation outlook.
The inflation rate reached over 8% in 2022 and decreased to 4.9% by April 2023.
The Federal Reserve attempts to fight inflation using a variety of policies, including increasing the federal interest rate. Banks use the Fed rate when borrowing and loaning money to each other. It also acts as the benchmark for rates set by lenders.
When the fed rate increases, the interest rates for consumer loans increase. Consumers end up paying more for home loans and personal loans, which helps slow the economy in the hopes of bringing down inflation.
The federal reserve has implemented several rate hikes in recent months to help fight inflation. A decrease or pause in the fed rate may signal that inflation has significantly cooled.
Business Tips for Dealing With Cost-Pull Inflation
Built-in inflation and demand-pull inflation are less of a threat to the success of a business compared to cost-pull inflation.
Decreased demand and smaller profit margins can be difficult for businesses of all sizes. However, many small business owners worry about staying afloat during high inflationary periods.
Here are ten of the most effective strategies for dealing with cost-pull inflation:
1. Broaden Your List of Suppliers and Vendors
Diversifying your list of suppliers and vendors may help you deal with inflation and limit your overhead expenses. It allows you to compare options and select the supplier or vendor that offers the best value to your business.
Working with a wider range of suppliers and vendors also leaves you better prepared for the unexpected. You’re better equipped to deal with a supplier suddenly shutting down, as you avoid placing all your eggs in one basket.
2. Establish Long-Term contracts
Locking in a good price with a long-term contract can help you avoid some of the higher costs of inflation. A long-term contract also leaves you better prepared to deal with fluctuations in the market.
Negotiating longer contracts can also help build stronger relationships with your suppliers. It shows more of a commitment and continued business.
3. Increase Your Inventory of Supplies
If your business relies on a steady stream of supplies and materials, you may want to start increasing your inventory.
Inflation gradually increases the cost of the materials that you depend on. Stocking up on these materials can save you money in the long run, as the same materials are likely to cost more further down the road. To sum it up, while you’re spending more up front, it will end up actually saving you cash.
Along with protecting against price increases, increasing your inventory may help you deal with potential outages & also supply chain issues.
4. Decrease Your Overhead Expenses
Decreasing your overhead expenses helps you address one of the biggest issues that small business owners face due to inflation. High inflation often leads to more costly expenses. You may pay more for everything from rent to supplies. To increase your profit margins, you may need to cut your expenses.
Reducing labor and narrowing your offerings are a couple of ways to lower your operating costs. Narrowing your offerings is a preferable option, as it may keep you from needing to lay off employees.
If you want to narrow your offerings, review your current selection of products or services. Determine which items deliver the best return and which items deliver the lowest return.
You may also reduce business expenses by moving to another location or renegotiating your lease. Cutting back on marketing spending may also help cut costs during difficult financial times.
5. Focus on Growth and Expansion
Focusing on growth and expansion provides an alternative to cutting expenses and keeping your business small. You can try to increase your profits and take on more customers. Increasing your profits may keep you ahead of inflation and minimize its impact on your business.
You may also take advantage of unique opportunities during this period, especially if your competitors choose an alternative approach. Pay attention to your competition and how they deal with inflation.
For example, if your main competition narrows its offerings or increases its prices, you may have the opportunity to fill the gap and gain more customers.
6. Invest in Your Workforce
Improving the productivity of your current employees is often more cost-effective compared to hiring more employees. The hiring process is costly and time-consuming, which are major concerns when dealing with inflation.
Investing in training and employee retention can improve the productivity and effectiveness of your workforce. Providing more perks may help with employee retention. Ask employees what types of benefits they would appreciate most, such as better health insurance, flexible work schedules, or more paid time off.
Prioritizing the happiness and well-being of your employees can help build loyalty, decrease employee burnout, and boost employee retention.
7. Invest in Business Technologies
Along with investing in your workforce, you can invest in technology to help them get more done with less effort. Many types of business technologies can streamline your operations, including automation technology and productivity software.
Automation technology may help your workers complete tasks more efficiently. It may also allow you to focus on expansion without additional hiring. You gain more time and resources for improving your core competencies and improving customer satisfaction.
AT is available in almost every industry. Whether you operate a factory or an office, you can use automation software to help complete simple tasks.
8. Consider Obtaining a Business Loan
Obtaining a business loan may make sense when dealing with the initial stages of high inflation rates. If you anticipate additional rate hikes by the Federal Reserve, you may save money by taking out a loan now.
For example, if the Fed funds rate increases from 5.25% to 5.50%, you can expect lenders to start charging higher interest rates for business loans. Even a small 0.25% increase can result in higher costs over the life of the loan.
Applying for a business loan can give you greater cash flow, which may be necessary for implementing some of the strategies discussed, such as building up your inventory or investing in your workers and technologies.
A business loan can also work well for businesses after a period of high inflation. If interest rates have recently dropped, you may be able to refinance or consolidate high-interest debt to save more. However, a business loan may not be the best option for those trying to cut costs and streamline their operations. Taking on more debt keeps you from lowering your expenses.
9. Consider Increasing Your Prices
Business owners often respond to inflation by increasing the prices of their goods and services. This is why you end up paying more for supplies or raw materials. However, charging customers more should be considered a last resort for dealing with inflation.
Charging more for your goods and services may decrease demand. Decreased demand lowers your profits, making it more difficult to deal with the effects of inflation.
If you must increase prices, make sure that your customers are aware of the potential increases before they occur. Keep your customers in the loop to decrease the risk of losing business.
10. Keep Less Cash on Hand
Businesses need cash to operate, but you should consider limiting your cash reserves during periods of high inflation. The money that you keep on hand has less spending power over time, especially when inflation remains high.
Analyze your cash flow and determine how much you need for expenses each month. Maintain a comfortable reserve and invest the rest. Investing in stocks may allow your unused funds to grow instead of sitting in a bank account.
If you are worried about the risk of investing in stocks, buying bonds provides less risk. You may not earn as much with bonds, but you may keep up with inflation.
In the end, inflation is something that affects just about everyone, from consumers to business owners. Inflation may decrease your profit margins, as you may find yourself paying more for supplies and wages.
Instead of rushing to raise prices, you should first explore other ways of dealing with inflation. Raising prices could lead to fewer customers, further hurting your ability to cope with inflation.
Start by finding ways to lower your overhead expenses and diversify your list of suppliers and vendors. Increasing your inventory and establishing long-term contracts can help prepare you for further increases in prices if inflation does not cool quickly.
Investing in your business with more employee training and automation technology may lead to increased productivity, helping you produce more for less.
If these methods fail, business loans and price increases are often the remaining options. Continue to review your strategies and adapt based on how inflation impacts your business. With the right approach, businesses can still thrive during periods of high inflation. We are truly all affected by it, so the best we can do is stay aware and continue to make good business decisions. Let’s hope this stops being something we continually have to deal with…someday (as delusional a thought that is!).
Stephanie is the Marketing Director at Talkroute and has been featured in Forbes, Inc, and Entrepreneur as a leading authority on business and telecommunications.
Stephanie is also the chief editor and contributing author for the Talkroute blog helping more than 100k entrepreneurs to start, run, and grow their businesses.