Market Perspective

Inflation: How to Manage and Respond to the Dreaded “I” Word

July 8, 2021
The C2FO Team

Fueled by both the pandemic’s accelerations and slowdowns, here’s how inflation is broadly affecting consumers and businesses today, and what companies can do to combat it.

Due to the multiple effects of the pandemic, supply woes and purchasing preferences, inflation is rising today like it hasn’t in many years. It’s also changing business and consumer behaviors as it rises.

While some pricing effects are typical of inflationary periods — and what you’d expect over the short-term — others are proving to be unforeseen, watershed-scale impacts that could last for decades.

Increasingly — and you really need to look no further than the corner market or gas station — we’re hearing about the Consumer Pricing Index. CPI, that venerable measure of a basket of household goods, was created in 1919 and is maintained by the US Bureau of Labor Statistics. The May 2021 CPI was up 0.6% over April 2021 and 5.0% year-over-year, easily the highest such growth rate since at least January 2011.

Though inflation is often narrowly thought of as rising product prices, the ripple effects are far-reaching and can impact nearly all segments of the population. While this generally harms consumers and the businesses they buy from, it also creates opportunities for those companies that are well-positioned, capitalized and assertive.

Inflation in the grocery aisle

You’ve likely seen rising grocery prices, which Albertsons’ CEO Vivek Sankaran has estimated have increased between 3% and 4% in recent months. Consumers typically react to such changes by finding suitable product substitutes, such as cheaper cuts of meat for dinner, or by purchasing generic-branded products instead of those sold under preferred, premium or household names.

Outside of the US, consumer food price indexes globally have increased over the past six years by 50% in Asia and nearly 400% in Argentina, with recent hikes impacting even basic staples like onions, tomatoes, rice and cooking oil, according to a new Washington Post article.  Worse still, these impacts may not be a temporary or “let’s get past COVID” situation — they may well endure for a while.

Rising costs for recreation and travel

A different consumer reaction with more far-reaching consequences is reducing or eliminating the use of a product or service. When gasoline prices rose abruptly by 30% in response to supply shortages in the summer of 1979, the resulting rationing caused lake-bound vacationers, and especially boat owners, to stop or greatly reduce their weekend trips.

For resort and recreation areas dependent on seasonal trade back then, that domino effect was devastating, hitting the boating supply, lodging and dining industries especially hard and eliminating jobs along the way. 

The recent rise in fuel prices could have a similar effect on travel and recreation now, save for a “revenge economy” factor that has those stuck at home during the pandemic doing all they can to get away, even at higher costs. As proof, AAA estimated that nearly 48 million Americans would travel for the July 4 holiday at roughly pre-pandemic levels. That said, many others will not travel at all as they consider the combined rising costs of fuel (the highest since 2014), food, lodging and recreation.

Fuel’s impact on everything 

With energy serving as a common denominator of sorts — especially gasoline — the consequences of rising fuel prices are nearly inescapable. 

Since everything you consume comes from somewhere, the rising cost of getting it to you is a major concern. Whether goods are coming from across the world or via a local online delivery service, prices are headed up. For example, Spring 2021 transatlantic shipping rates for 20- and 40-foot containers carrying everything from refrigerators to fireworks were higher by 25% year-over-year. Contributing factors include the dock and delivery labor required to offload the containers along with demand, capacity and port congestion.

Will the housing bubble burst? 

Inflation’s effect on home purchasing decisions and the construction industry is extensive and well documented, with the median cost of an existing home in the US up by nearly 24% year-over-year in May, according to the National Association of Realtors. 

Perhaps most visible are lumber’s cost escalations. The price per 1,000 board feet of lumber tripled from January 2020 to June 2021 before abating recently. The longer-lasting effects go far beyond cost, starting with American consumers reconsidering their plans to sell, build or even move at all.

Others seeking more affordable options are turning to innovative and non-traditional solutions. To fill those unmet needs, builders in many cities are offering apartment rentals with more house-like features and floor plans that are larger by as much as 30%. Conversely, the tiny house movement continues to grow, and micro-housing units made from shipping containers are being built and assembled as housing developments.

How long will this inflationary trend last?

That’s the million-dollar question — and the answer is unclear. The Federal Reserve has shared the view — supported by recent numbers — that the latest CPI increase is boosted by comparing higher recent prices to depressed, early pandemic prices brought on by the lockdown and its resulting low usage of products and services. 

The so-called “base effect” is a mismatch between today’s growing economy and the depressed markets of a year ago. In other words, when you compare today’s prices with prices before the pandemic, inflation looks less severe.

Some examples:

  • Average gasoline prices were up nearly 50% in May 2021 to $2.94 per gallon compared to $1.94 in May 2020, according to data from the US Energy Information Administration. The pre-pandemic price of gas was $2.64 in January 2020, 36% higher than May 2020’s plummet.
  • Many drivers who benefitted from auto insurance rate relief in 2021, when accident claims declined, are not enjoying that temporary reprieve now.
  • New and used car prices are up sharply since mid-2020 due to supply and demand effects from parts shortages, slowed production and plant shutdowns. Kelley Blue Book reported a year-over-year new car price increase in May 2021 of 2.2%, for an average paid vehicle price of $40,768.

The big debate is how much of the record inflation we’re seeing is due to the base effect as opposed to “real” inflation. The Fed’s view is that a significant portion is base effect and will continue to adjust through 2021. So by the end of 2021 inflation may be closer to 1.5% to 2%.  

How can businesses respond to inflation’s effects?

Unless your company’s margins allow you to absorb the cost increases in exchange for smaller profits or you can find operating offsets to hold the line on pricing, you have little choice but to either pass the higher costs along in the form of price increases or adjust your service offering.

For example, shippers may temporarily implement a percentage or per-package upcharge, sometimes stated as a “fuel surcharge,” as UPS has not only done but renewed, effective July 5, 2021. They may also relax delivery commitments or extend delivery times. Likewise, airlines may reduce their flight offerings, and restaurants may change their operating hours to maximize peak periods and efficiency.

Reframing products or adjusting the value proposition may also work. Grocers, for example, have converted traditional per-pound or per-package pricing models to portion-size pricing. Rather than pricing steak at an imposing $18.99 per pound, eight-ounce portions could be sold at a more manageable (and digestible) $9.49 each.

Though labor and packaging prices may increase slightly, turning the inventory for the resulting cash flow is often the higher priority for most businesses. Upper-end restaurants are acting similarly, providing more “cost-effective plates” in response to higher prices for feed and grain.

Converting challenges into opportunities

Faced with higher product or component costs, some business owners may see opportunity rather than outrage.

In less-affected or seasonal industries experiencing their off-season — and with cash-on-hand in place of a bloated list of slow-paying receivables — companies could:

  • Stock up on or commit to inventory from suppliers.
  • Request free freight or delivered pricing, as many online retailers provide. 
  • Seek next-column or end-column pricing for any or all goods purchased through December 31. 
  • Inquire about advantageous or more flexible return policies on paid-for goods.

Inflation’s internal effects on your business 

Inflation can also take a toll on the internal business operations of your business. Those include:

  • Higher costs of living could have prospective hires or staff seeking greater wages.
  • Employers seeking scarce talent may need to sweeten their offers with sign-on bonuses or higher contribution levels for health insurance or retirement plan contributions. 
  • Semiconductor shortages have exacerbated the reliance on technology, with prices rising for PC computers and printers, according to Bernstein Research. The Biden Administration has proposed support for supply chain solutions of these and other in-demand goods to alleviate this.
  • Travel and trade shows may become less affordable and change to online-focused events.
  • Aggressive cost-cutting measures may be necessary. 

Although you or your business may not be able to erase or escape the effects of inflation’s current run-up, taking an active fiscal approach to your company’s cash flow now could be beneficial until the variables shake out.

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