How Does Inflation Affect A Business & What Can You Do About It?
Wondering how to survive inflation? There's no such thing as an inflation-proof business but there are things you can do to reduce the effects of inflation on your small business.
Inflation is a top concern not just for consumers but also for small business owners. Any small business owners wondering how to survive inflation should start with the basics: how does inflation affect a business? Can you inflation-proof a business like yours? If you’re looking for tips on how to ease the effects of inflation, you’re in the right place.
Table of Contents
- What Is Inflation?
- How Does Inflation Affect A Business? The Quick Answer
- So, Is Inflation Good Or Bad For Business?
- The Effects Of Inflation On Businesses
- Is An Inflation-Proof Business Possible?
- 7 Tips On How To Survive Inflation As A Small Business Owner
- The Bottom Line On How Inflation Affects Businesses
- Business Inflation FAQs
What Is Inflation?
Inflation is a decline in purchasing power. Simply put, it means your dollars don’t buy as much as they used to. The International Monetary Fund notes that inflation is usually measured broadly, referring to price increases across a spectrum of goods, not just one sector, and it indicates a general increase in the cost of living in a country. The bottom line is that inflation makes it more expensive to buy just about everything.
Economists write complete volumes about inflation, and there are many details that average people struggle to understand. We don’t need to get lost in those details, but it does help to understand a little bit about inflation rates and some details of inflation in this country. Bear with us; we promise to keep it simple and quick.
To measure inflation, economists use something called the Consumer Price Index (CPI) to look at trends in prices. The CPI helps economists gauge price changes over time.
The US inflation rate currently stands at 8.3% for the 12 months ending in April 2022, according to the US Inflation Calculator run by Coin News Media Group. While that sounds like a big number, it’s important to put it into context. Although inflation is having an undeniable effect on the US economy, it’s not currently at historic levels. For comparison, the US inflation rate stood at 13.3% in 1979 and has been at about 3% or lower in almost all the years between 1990 and 2021. The last time the US saw inflation at or above 8% was 1981, and that actually represented an improvement from a modern inflationary high point.
With those numbers placed in context, it’s clear that inflation currently isn’t as bad as it could be. The flip side of that reality is that inflation could get worse. And if you’re a small business owner being affected by inflation right now, or waiting for the effects of inflation to hit, it’s definitely time to act to protect yourself.
How Does Inflation Affect A Business? The Quick Answer
The primary effects of inflation on a business are that you’re likely to sell less, see lower profits, and pay higher costs.
Digging just a bit deeper into the effects of inflation, look at two factors: the price of raw materials and production, and the amount of money your customers have to spend. When it costs more to buy the eggs and flour or get the lumber or nails you need, your profits will go down. Raw materials often become difficult to find as well as more expensive to have delivered.
It also helps to consider your customers’ buying power. If they’re paying more for groceries and electricity, they have less money left over to spend on what you hope to sell to them.
So, Is Inflation Good Or Bad For Business?
As to whether inflation is good or bad for business, the opinions of economists may vary greatly, though most would say “it depends.”
By contrast, you get a clearer answer when you ask small business owners. When researchers asked more than 1,500 small business owners about their single most important problem, a clear majority said that inflation is their biggest problem. A total of 31% chose inflation, compared to 22% who said labor quality and 16% who said taxes.
The Effects Of Inflation On Businesses
Inflation is almost never at zero. (The last time the US saw 0% inflation was at the end of the Great Depression in 1939, and that wasn’t exactly the best of times.) The price of goods and materials tends to rise over time. We typically become concerned only when inflation jumps rapidly and significantly, as it started doing in 2021 and continues now.
Let’s look at some of the effects of inflation. These won’t affect every business equally, and they will become more severe at higher levels of inflation.
Goods & Materials Become Hard To Find
Some experts say that inflation starts with scarcity of certain goods. That rings true in 2022, when we’ve seen massive disruptions in normal business due to COVID-19 and ongoing disruptions to the supply chains we depend on to deliver raw materials and finished goods. The scarcity of some goods and materials has been made worse by changes in the way Americans are shopping. Since the pandemic started in 2020, consumers began ordering more by mail instead of visiting brick and mortar stores. Companies have scrambled to adapt, and delays have ensued.
On a larger scale, there are massive global product shortages and shipping delays, with port congestion affecting worldwide trade. As COVID continues to surge periodically in locations around the world, local lockdowns continue to cause regional shipping problems that create global ripples.
Dollars Buy Less & Materials Cost More
Experts call it “eroded purchasing power,” and it means that when the price of goods and materials go up, your dollars don’t buy as much as they used to. Let’s look at eggs, as a simple exercise.
Suppose you’re operating a small bakery that goes through 12 dozen eggs a week. The wholesale cost of a dozen eggs has risen almost 50% over just 4 months, according to the US Department of Agriculture. In January, a dozen eggs would cost your bakery less than $2, on average. In April, you’d pay about $2.95 for the same number of eggs. Your bakery is now paying more than $35 for eggs each week, instead of about $24. You might be able to absorb that extra cost, but doing so becomes more challenging when you get the bill for the flour, sugar, yeast, and napkins and see that those costs have gone up, too, along with everything else you need to buy.
If you’re not operating a bakery, you may not care about the price of eggs. Your raw materials may be steel, nails, paper, or any of a million other commodities that are also going up in price. The people who buy from you may care about the price of eggs, though, and when they’re spending more on groceries they have less money to buy from you. Inflation affects lower-income consumers more than those at the upper end, because a higher percentage of those families’ take-home income goes toward necessities. Of course, if you’re selling high-end goods your customers may be less affected by inflation.
Consumers Redirect Spending
When money is tight, consumers face hard choices about spending. In general, people focus on needs, not wants. That means stocking up on the basics, like gas for their cars, clothes for their kids, and food for the kitchen cupboards. If you’re selling products that are seen as nonessential, you’ll notice a drop-off in sales sooner. And if you respond to inflation by raising prices, your customers will find it even harder to buy.
Labor Costs Go Up
As the world worked to recover from the COVID-19 pandemic, many US small businesses struggled to find employees. Many industries responded by raising wages in hopes of attracting and retaining employees. As their buying power goes down due to inflation’s effect on prices, employees may start (or continue) their search for better-paying jobs, and employers may feel pressure to increase wages or offer benefits to aid retention and attract new workers as needed.
Is An Inflation-Proof Business Possible?
Unfortunately, if there is such a thing as an inflation-proof business, you aren’t likely to find it in the small business sector. The effects of inflation are felt almost across the board, with the exception of a few of the biggest companies, such as utilities, real estate, and commodities.
It’s probably not possible to fully inflation-proof your small business. However, you can do a surprising amount to reduce the effects of inflation. In the next section of this post, we’ll offer some tips from business and finance experts that will show you how to survive inflation.
7 Tips On How To Survive Inflation As A Small Business Owner
We reached out to small business and finance experts, asking for their best suggestions for how to survive inflation. Here’s what they had to say:
1. Capitalize On Demand
Small business owners aren’t the only ones nervously watching prices rise. Your customers are worried about inflation, too. You may be able to capitalize on their concerns — and help them out — by giving them reasons to buy from you now, before prices go even higher, according to Levon L. Galstyan, a CPA working with Oak View Law Group.
“A possible upside to inflation from a small business perspective might be that customers may want to buy as soon as possible when prices continue to rise. So there is a short window of increased demand, and small businesses can take advantage of this,” he said.
Think about advertising a “stock up” sale, discounts, or a buy-two-get-one offer. The sales increase could make up for the loss of profit.
2. Study Your Competition
Remember that yours isn’t the only business being affected by inflation, Annuity Expert Advice CEO Shawn Plummer says.
“It’s a worldwide phenomenon bearing down on virtually every business and consumer. If you’re trying to avoid raising prices so you can be the one shop in town charging lower prices, you haven’t won,” Plummer explains. “The effort it takes to avoid the reality of having to raise prices to cover costs isn’t worth the struggle.”
“Investigate pricing to see what your competitors are charging for comparable products,” Galstyan says. “If your prices are higher, you may need to lower them to remain competitive in the market. Many customers have a preconceived notion of how much a product should cost and how much they are willing to pay for it. Consider this when pricing your product, and raise your price if necessary to meet customer expectations.”
3. Raise Prices Strategically
There’s one way to bring more money in day-to-day: Raise your prices. Of course, that’s not as simple as it sounds. If customers are already struggling to stretch their dollars, will they be willing to pay more for your products?
“There’s no easy answer to this question,” says Austin Dowse, the CEO of eCommerce shop Aimvein, adding, “In some cases, businesses may be able to absorb higher costs without passing them on to customers. If a business does decide to increase prices due to inflation, it’s important to be transparent about the need for the rise. Customers are more likely to accept a price increase if they understand why it is happening. And businesses that communicate openly with their customers are more likely to build trust and loyalty over the long term.”
Irene Graham, CFA of Spylix, said that inflation can actually present an opportunity to correct your pricing.
“Check whether you are undervalued for your administrations or products,” she advises.
The way you talk about price increases can make a difference too, according to Plummer.
“Amazon, for example, has been charging a 5% ‘fuel and inflation’ cost to their third-party sellers,” he says. “One would think this surcharge wouldn’t last forever, or it’ll be rolled into the overall price, eventually. This allows you to keep your base price stable while ensuring your margins don’t get too thin.”
“Increasing prices everywhere is not always the best strategy, as you risk upsetting loyal customers and alienating new ones,” Galstyan advises. “Instead, begin by increasing the price of your most distinctive or appealing products. Then, make minor strategic changes to the prices of other commonly purchased items.”
4. Maintain Your Brand Value
Nobody likes a price hike, but when costs are rising across the board it can be unavoidable. The way you talk about increasing prices makes a difference. Your best bet is to be upfront about it, rather than trying to disguise your increases or, worse, reducing quality and quantity.
“Many businesses habitually increase their rates without informing their consumers,” says Galstyan. “It’s another frequent practice to cut quantity while maintaining pricing. However, these methods may result in client complaints, social media uproar, and, even worse, having to reverse the price rise or losing customers entirely.”
The key, he says, is authenticity and honesty.
“Telling customers the brand can only continue to give the current level of advantages if it raises the cost — and prefers to do so rather than diminish the product’s quality — is a persuasive argument in such instances.”
5. Consider Borrowing
Galstyan suggests that applying for a business loan (or a line of credit) can be smart during a recession. “Taking out a loan when inflation is rising can be advantageous. If inflation continues, you might be able to repay your debts with less expensive capital.”
He offered suggestions for how you might wisely spend the money you borrow: “You can put the loan toward purchasing inventory in large quantities to meet client demand or hiring more employees to keep up with the growing business. You can also use the loan to increase marketing efforts to attract new clients and invest in technology or equipment that makes operations easier.”
6. Hold On To Your Staff
Loyal customers are an asset during peak inflation. So are loyal employees. Indeed.com estimates there’s a potential loss of between $1,000-$5,000 each time you onboard a new employee and says companies generally spend a minimum of $4,000 on hiring. When you’re trying to keep costs down and productivity high, the last thing you want to do is spend any time or energy hiring and training rookies who won’t be able to work quickly and efficiently.
Maybe you’re in a fortunate position and can offer employees raises, bonuses, and retention incentives. Maybe you can’t. Either way, money isn’t the only thing that matters to employees. Look for ways to keep employees informed about the state of the business and get them involved. Some relatively low-cost employee motivation tactics can make a difference, and they may even be tax-deductible.
7. Get Ready For Next Time
You may be so busy trying to stay afloat now that you’re not thinking about the future. That’s a mistake. Inflation is a constant, and although we don’t tend to notice inflation at lower levels, it’s a given that it will flare up now and again and grab small business owners by the budget.
That’s why you need to carve out time to look for cost-saving improvements, for this time and the next. “Examine your processes to find places to automate or add other efficiencies,” Plummer says. “The ability for you to automate marketing, sales, recruitment, HR, and your actual business offerings themselves is greater than ever. Some companies simply haven’t looked or aren’t aware.”
You can also rethink and improve your business supply chain. Where are your materials coming from? How long has it been since you looked for different suppliers who may be closer to you, offer better prices, or be in areas less affected by current conditions? A supply chain audit can help you identify bottlenecks, show you how much inventory you should have on hand, and show you opportunities to create a backup plan that can save you time and money when you need it most.
The Bottom Line On How Inflation Affects Businesses
If your small business isn’t already feeling the effects of inflation, you probably will be soon. A number of global factors, including the pandemic and supply chain disruptions, are fueling inflation to levels that haven’t been seen in the US for many years.
This post offers some tips on how to survive inflation. Although you can’t completely inflation-proof your business, you can take steps to insulate yourself, capitalize on customer loyalty and brand identity, redouble your efforts at employee engagement, and emerge not just intact but stronger from this challenging business environment. Check out the best ways to improve cash flow for more small business tips.