Managing Your Business in an Inflationary Environment

Many businesses are facing increased costs. This isn’t necessarily a new business challenge, but the COVID-19 pandemic and other worldwide factors are driving significant and unpredictable “price spikes”. Let’s look at what business leaders should think about so they can manage their business during this inflationary time.

First, what’s driving these changes? 

Here are some of the important factors influencing the cost of goods and services:

• Many manufacturers reduced capacity early in the pandemic. When demand increased faster than expected, they could not ramp up capacity fast enough to meet the demand.
• Prices of many commodities and raw materials have risen dramatically. Steel prices are about three times higher than one year ago, while aluminum prices hit a nine-year high in June 2021.
• The semiconductor chip market faces global shortages that affect the manufacturing capacity of everything from new cars to power supplies.
• As different regions deal with lockdowns and other business interruptions, global supply chains are unstable.
• Demand is also volatile as buyers consider their options during great uncertainty.
• Many people have decided to change their careers, go back to school, or leave the workforce altogether, creating a workforce shortage.  Many businesses have to offer more pay and more benefits to attract the right people.  If they can’t fill the positions, they’re forced to limit their services or products or pass higher labor costs to the consumers.

This results in higher costs and limited supplies of production materials, which are expensive to transport.

What’s the outlook?

The outlook is uncertain. In some cases, we may return to pre-pandemic prices, and in other cases, there have been structural changes that won’t be reversed. Business leaders have the tough job of navigating through this uncertainty!

What are our options as business leaders?

One option is to “wait and see”. This may be the most prudent choice in some circumstances, but there’s a risk that competitors will do a better job of managing their response to increased costs.

Another approach is to try and address some key questions and then develop a strategy. The list of questions will vary by industry/business, but here’s a general approach:

1. What’s happening in our business exactly? 

Which input prices are going up, and by how much? Are these increases temporary or permanent? Are the price increases predictable or erratic? Are we near peak pricing? Clarity (or at least a theory) on these basic questions provides a foundation for strategy.

2. What’s the (potential) impact on our business in different scenarios? 

Whether we “wait and see” or raise prices, we should understand:

• What happens to our product profitability as input and sales prices change?
• How is customer demand impacted by increased prices (price elasticity)? At what point will customers look for substitute products?

While your customers are critical in this analysis, consider how employees are affected due to rising costs: e.g., higher energy bills.

3. What actions can we take?

There could be various options such as:

• Improving procurement practices: Competitive bidding? Renegotiating terms? Changing suppliers? Hedging? Long-term contracts? Holding suppliers to account should ensure that price increases occur due to market forces.
• Updating incentive systems for sales and procurement teams: We may not encourage the best commercial decisions if these are based on lagging costs versus actual achievement.

For those who pass on cost increases to customers:

• Price indexing versus price renegotiation: Both approaches have advantages and disadvantages
• Customer Communication: A price hike is unlikely to be well-received, but honest and straightforward communication to customers can help ‘soften the blow’ and can help positively distinguish a business from the competition.

4. Is our financial reporting frequent and accurate enough? 

Management’s challenge is ongoing, not a one-time decision/event. We need:

• Analysis of historical data AND an understanding of forward-looking gross margins on a monthly or quarterly basis. This requires transparent and accurate cost accounting.
• To understand the time lag between taking action and seeing results.
• A dedicated team overseeing this and presenting recommendations. Some businesses are establishing an ‘inflation team’ for this purpose.

An Opportunity? 

Not surprisingly, seismic shifts in the business environment present opportunities and challenges. Your competitors are dealing with a similar situation, and you may capture additional business from existing or new customers who are disgruntled with other suppliers due to volume or price issues.

And the benefits from revisiting procurement practices to drive margins can be significant and long-term.

Conclusion

The challenge and impact of cost increases are specific to each business. And while things remain uncertain, management should expect the unexpected and make judgment calls based on solid strategies, market insights, and a clear understanding of cost drivers.

Where necessary, get advice from experts in this field.