Inflation in Perspective: How Smart Businesses Can Adapt to Rising Costs
August 4, 2022 |
The C2FO Team
As inflation rises, businesses must adapt to increasing costs and find ways to protect their margins. Here's how.
Inflation continues to soar. Around the world, 82% of businesses say they are facing higher costs and lower margins, with the price of labor, materials, energy and rent increasing rapidly.
The consumer price index (CPI) — a measure of the prices consumers pay for products — recently soared to an annual rate of 9.1%. Meanwhile, the producer price index, a measure of the prices paid to producers of goods and services, reached an annual rate of 11.3%.
Raising prices might be the first option many businesses consider, but there are other tactics you can use to mitigate rising costs.
Why businesses are on alert
Corporate executives are taking a dim view of their prospects, with a majority now expecting a recession, according to the Conference Board. In fact, the board’s C-Suite Outlook 2022 survey results showed that inflation has jumped to the second-highest external threat to business, up from its previous 22nd position.
What makes inflation so complicated is that it’s the result of several connected issues. These include:
1. Labor shortages
The ongoing labor shortage is having far-reaching effects on the economy, from heightening inflation and supply chain disruption, to driving up labor costs and amplifying competition for qualified workers. As the shortages continue, the current market is forcing companies to increase employee pay. That, in turn, can intensify inflation. This is particularly challenging for small to mid-sized businesses, which often have tight labor budgets.
2. Supply chain disruption
The pandemic disrupted supply chains, and the war in Ukraine has exacerbated the disruption by causing shortages of commodities, such as oil and natural gas, which are used in the production of many other goods.
Shortages and logistical bottlenecks have contributed to inflation as supply-constrained goods’ prices rose in response to pent-up demand following a recovery in household spending.
These shortages and disruptions mean fewer items are available for purchase, with longer wait times for orders. When supply is limited, consumers are often willing to pay more to obtain the item — as outlined in the economic principle of supply and demand. As a result, prices increase due to demand-pull inflation.
3. Strong consumer demand
Inflation typically increases coming out of economic downturns as consumer demand outpaces supply, but this trend was compounded by the COVID-19 pandemic. Demand for many goods dropped in 2020 and remained lower into 2021 as further waves of COVID-19 triggered lockdowns and other government restrictions on consumer behavior. As cases dropped in the spring of 2021, many restrictions were lifted, which caused a significant surge in demand.
4. Surging exports
International trade plunged in 2020 due to the COVID-19 pandemic but recovered sharply in 2022. The gradual lifting of restrictions and the introduction of stimulus packages boosted the recovery of economic activity, leading to an increase in demand for commodities and record-high surges in exports.
5. Crop-destroying weather
In recent years, unprecedented weather disasters have caused the price of key commodities to spike. Last year, the US had its hottest summer ever, breaking the record from the summer of 1936. Searing heat combined with a record-breaking drought brought hordes of grasshoppers, which ravaged wheat crops. As a result, wheat prices reached the highest level in years. Corn prices also rose 45% last year.
All of these factors mean that the current inflation and economic landscape is unique. The labor market is unstable, consumer demand hasn't dropped the way it did in 2008 and supply chains are strained.
What you can do
Despite the rising costs and interest rate hikes, your business can meet these challenges head-on. Here are some measures you can take that may ease the effects of inflation on your business:
1. Cut costs
One way you can tackle inflation is to review your business expenses and identify where you can cut costs. Are there services or tools you no longer use, or can you scale back your usage? Look for places where you can save on expenses that are no longer essential for your business.
2. Pass price increases downstream
According to a 2022 Small Business Index report, 67% of business owners surveyed increased prices to adjust to inflation. This is a feasible solution, but ensure you use sound judgment with your pricing increases and be transparent because dramatic changes can risk alienating customers.
3. Absorb prices into profit margins
Absorption pricing is a pricing strategy also known as full costing. It requires capturing the variable costs and fixed costs associated with manufacturing a particular product. Absorption pricing can be used to determine the long-term price of a product that is needed in order to pay for all expenses, therefore helping your business maintain profitability over time.
4. Negotiate new supplier agreements or change suppliers
Review supplier agreements for potential ways to offset rising costs. You may be able to negotiate better contractual terms with your suppliers. Contractual factors to assess include the contract term, indexing, frequency and limits of price increases. Inflation affects everyone, which is why suppliers are usually willing to have a conversation about how to share the burden of rising prices. Failing that, you might look into switching to another supplier for a better price.
How C2FO can help
One thing to remember is that you don’t have to face these challenges alone. C2FO has several tools that can enable your business to thrive during this difficult market:
Accelerate payments using dynamic discounting, a flexible early payment solution that lets you select invoices for early payments and set discount rates.
Shorten your cash conversion cycle. This means you’ll have funds on hand to pay your accounts payable, enabling you to strengthen your balance sheet and meet key metrics.
Boost your working capital, so your business can pay down debt, offset costlier shipping and production, or invest in innovation.
Using these strategies, you can strengthen your company’s financial position and improve its resilience to respond to evolving market conditions.
The infographic below offers a visual breakdown of the inflationary environment in 2022, its potential impact on the end of the year, how it compares to historical trends, as well as advice on navigating what’s ahead.