3 Strategies To Protect Your Business From Inflation
he inflation rate has been hitting double digits lately. Everybody understands that inflation implies higher prices, but what does that mean for your business? We need to know where inflation comes from and what it is to answer this question. This will help prepare your business and do as much as possible to become inflation-proof. Below is a quick introduction to inflation and what you can do to avoid the pitfalls of running a business in an inflationary economy.
What is inflation?
Nobel laureate Milton Friedman once stated, “inflation is always and everywhere a monetary phenomenon. It is always and everywhere a result of too much money, a more rapid increase of money than output.” He meant too much money competing for goods, putting pressure on prices to go up. Economists have traditionally looked at the money supply as the cause of inflation. Indeed, inflation was initially understood as money losing its purchasing power.
But this is not a uniform consensus as all prices do not rise at the same rate. As we have seen over the past decade, some prices even fall with computers and smartphones. The devices get better yearly, but the cost in dollars remains the same. People get more for their money.
Modern economists distinguish between “cost-push” and “demand-pull” inflation. The former means that prices go up in production. In other words, your input costs start to rise, forcing you to raise your prices to customers as well. The latter is price increases in the opposite direction, meaning prices rise first in consumer goods and then back up the supply chain.
What inflation means for entrepreneurs
Cost-push inflation will put pressure on your cash flow and profitability. As your costs start rising, you will need to raise your prices to meet ends. The longer you wait to raise your prices, the greater the financial strain on your business. The problem, of course, is that competition in your industry may not allow you to raise prices — it could be disastrous to do so before competitors.
Demand-pull inflation means the opposite. Demand for your outputs is rising, and you can raise prices and still sell everything in your inventory. It would help if you raised prices much sooner than you might think. Because you will need that cash when trying to secure inputs to maintain your production volume. Other businesses will also see increased demand and bid for more information, causing costs to go up. The problem is that your revenue might end up being less than your replacement costs. So you may lose even though your margin for already produced goods goes up.
Both situations are complex and require you to be prepared and act appropriately. And both cases eventually mean that prices overall are higher and that the purchasing power of money is lower. In other words, even if you profit in inflationary times, that profit can buy you less and less. It is worth less over time.
How to become inflation proof
Inflation means that money is losing value, so there is no way of escaping its effects in a market economy. But there are ways of positioning your business and its operations to avoid suffering inflation’s consequences. Here are three ways to think about your business to make it as close to inflation-proof as possible:
1. Position yourself to create value
Savvy entrepreneurs are positioned to build their businesses, thinking primarily about the value they create. Costs come second and are, in fact, a choice. Give value to your customers and be the beacon that guides you in everything from product development, pricing, and building production capacity to marketing. Value is not a dollar amount but is ultimately the satisfaction someone gets from using a consumer’s goods. Value is inflation-proof. Focusing on it brings you closer to being inflation proof too.
2. Use contracts wisely
When inflation is around the corner, it makes sense to fix input prices yet keep output prices flexible. In other words, as soon as you expect inflation, seek to sign long-term contracts specifying costs with suppliers. Even at higher than market prices, this may be a winning strategy as prices start to rise quickly. At the same time, renegotiate or end contracts prematurely with your customers to make it possible to raise prices. You may consider including “cost-plus” price adjustments in your sales contracts. This is not a proper pricing method during regular times but can help you survive periods of high inflation.
3. Don’t go overboard as prices change
Keep your head cool. It is easy to respond to rapidly rising demand by scaling up production. But this may not be the appropriate response if you suspect that this is not customers finally recognizing your products’ excellent. If it is demand-pull, your input prices will soon rise faster than your output prices. Prudently scale up production using contracts to combat unnecessary inflation ramifications.
Source: entrepreneur.com
Cc: Per Bylund
