How a Small to Medium Business Can Tame Inflation

It seems like inflation fears are everywhere today. There are supply shortages, price increases, supply chain restrictions, and pressure to grow revenues. We all watch Bloomberg and CNBC, but what does inflation mean for small to medium businesses? This blog will discuss the root causes of inflation, the impact on SMB’s, and what small business leaders can do to convert inflationary pressures into revenue-generating opportunities.

Why is Inflation Increasing Now?

Asset purchasing policies and activities by the Federal Reserve have significantly increased the amount of cash in the economy over the past 3 to 5 years. This has created inflationary pressures, even before COVID, and SMB’s are being hit especially hard.

Inflation is defined as the devaluation of cash and/or currency, and it is governed by the fundamental macroeconomic laws of supply and demand. The inflationary climate we find ourselves in today is a result of many different factors that have combined to create what most economists say will be a short but intense period of inflation:

  • As vaccination rates rise, more businesses open, and consumers are returning to the economy with cash that they acquired and saved during the lockdown phase of the global pandemic
  • Many months of global COVID lockdowns have eroded inventories and stockpiles of critical manufacturing and energy supplies
  • Federal reserve policies and actions have dramatically increased the amount of available cash in the economy
  • In the US, an extreme shortage of available housing has driven double-digit YOY home and property values, resulting in large increases in homeowner equity
  • Multiple rounds of federal stimulus payments have injected massive amounts of cash into the pockets of both businesses and consumers

These factors and others have combined into a perfect storm of high demand (consumers and companies with cash to spend) and dwindling supply (reduced production and inventory due to lockdowns/slowdowns). Much like the real estate markets, there are now bidding wars for basic commodities, raw materials, and energy. These shortages of raw materials for manufacturing have lead to shortages of items like computer chips, automobiles, agricultural and construction machinery, and certain food items like seafood.

Inflation Can Really Hurt Small Companies

You might think that economists who are ringing the inflationary warning bells are like Chicken Littles claiming that the sky is falling. Just because you are not feeling the effects of inflation right now doesn’t mean that it won’t impact your business in the immediate future. Inflation acts like a complicated domino game, with some dominoes falling early while others fall at different times. But eventually, all the dominoes fall.

Businesses that manufacture hard goods tend to be hit by inflation sooner than service or retail businesses. Energy and material shortages prevent finished goods from rolling off the production lines. Even though smaller businesses with less purchasing power tend to get hit harder by inflationary shortages, huge companies with billions of dollars on hand can find themselves hamstrung by inflation. Major car manufacturers like GM and Ford have thousands of vehicles sitting outside of factories that can’t be delivered due to computer chip shortages. Companies that have perfected zero-inventory, “just in time” manufacturing methods might be suffering the most right now.

The short-term reaction of most businesses to supply shortages is to pay more for raw materials (which drives prices even higher…), pay more for faster shipping, and pay more for labor in the form of hiring more workers, working more overtime, or increasing wages. Small businesses in particular may find themselves hard-pressed to pass their increased costs onto their customers because of long-term agreements and contracts, or because their competitors haven’t raised their prices. These higher costs are often subtracted from profits, further increasing financial pressure on the business.

So if your company manages to avoid the pitfalls of material shortages, you may soon begin to lose employees who are looking for higher wages. Your competitors may find that it is worthwhile to poach your workers for a modest pay increase in order to stay ahead of increasing demand and high supply costs. If your business operates with unskilled labor or other low-wage employees, you may end up losing them to states and regions where the cost of living is lower. Recent studies have shown that full-time workers making $15/hour or less cannot afford a two-bedroom apartment anywhere in the US. Low-wage workers are leaving major metropolitan areas in droves to live in areas where they can begin to afford housing. This further exacerbates the labor shortage in low-wage industries like manufacturing, retail, and hospitality (food, beverage, and lodging).

How Can Small Businesses Control the Effects of Inflation?

Identify Your Supply Chain Vulnerabilities

Your supply chain is probably much more complex than you think it is. During inflationary times it’s a worthwhile investment in time and effort to dissect your supply chain, understand exactly how it works, and identify its weakest links:

  • Items that are impacted by a “Just In Time” inventory process or processes
  • Items that are only available through one source
  • Any products, materials, or outsourced services that represent 10% or greater of your cost of goods sold
  • Overseas or foreign suppliers who normally require longer acquisition lead times
  • Large, unusual, or hazardous items that require special handling or storage

Here are some alternative plans to help you avoid supply chain problems:

  • Seek new alternative supply chains
  • Establish domestic alternatives to overseas sources
  • Consider making bulk purchases in advance of demand for key products or materials and warehousing them
  • Evaluate worst case scenarios for JIT supply chains and establish alternatives where necessary
  • Develop a hedging strategy for certain key products

Defend Your Pricing Power

Here are some ways to defend your company’s pricing power:

  • Identify your unique value proposition and lean into that message HARD.
  • Create greater differentiation of your product and/or service through creative bundling and emphasize value through your sales and marketing processes.
  • Identify and seek out “value buyers” instead of “low price buyers” in your sales and marketing activities.
  • Create new product offerings and package them with a vertical market focus.

Use Simulations and Make Contingency Plans

Create financial simulations to test the impact of inflationary changes on your business:

  • Supply cost increases of 150% to 200% or more
  • Supply chain problems that increase revenue recognition time cycles by 2x or even 3x
  • Significant wage increases of 10% to 25%

As you work through these simulations (sometimes known as “stress test scenarios”) ask yourself the following questions:

  • Can these risks actually be mitigated by taking proactive measures?
  • Are we able to identify any leading indicators that would serve as the “canary in the coalmine” that would provide advance warning of a worst-case financial scenario?
  • Will the business have sufficient cash reserves to survive a worst-case scenario?
  • What are the best defensive positions we can take in each of these situations?

Understand Your Labor Position

Labor can become very volatile during an inflationary period. The following labor types have a higher probability of being impacted by inflation than others:

  • Technical Sales, Software Engineers, Web Developers, and Marketing Managers who may have their pick of higher-paying alternatives or more easily leave to work for a competitor
  • Minimum wage and near-minimum wage workers
  • Contract workers (also known as 1099 workers) who can typically demand wage increases more quickly than permanent workers (known as W2 workers)

If your company depends on these types of labor, examine and re-tool your HR processes and recruitment activities in order to better attract and retain talent. Consider doing a compensation audit and offering market-rate wage increases. Are your non-compensation benefits competitive with your peer organizations? What about your company culture? If your workers are not satisfied with their jobs and only show up for a paycheck, your company is much more vulnerable to inflationary pressure. How likely are your best employees to leave for greener pastures? The recent presidential Executive Order that is expected to significantly weaken or even nullify non-compete agreements gives workers another potential degree of freedom to look elsewhere for work.

What About Alternative Financing?

With interest rates at historic lows and inflation on an upward trajectory, it would appear to be a good time to borrow money. Chances are good that you will be paying back your borrowed funds at a much cheaper rate than you would in the future, especially if the Federal Reserve decides to take future anti-inflationary measures and raises interest rates. Here are some excellent ways to invest your borrowed funds:

  • Real estate and other hard assets
  • Bulk purchases of inventory, raw materials, or other supplies
  • M&A activities such as acquisitions of competitors or other related businesses
  • Marketing capabilities such as new software or website enhancements that strengthen and differentiate your brand
  • If your business can benefit from e-commerce, now is the time to take the plunge

Get Ready to Tame Inflation Now!

When it comes to fighting inflation, the future is now! Take an objective and holistic view of your business, and think about how a major upturn in inflation would impact your operation. Investing in office technology that increases efficiency, and reduces cost is one excellent way you can hedge against inflation right now. Contact us to make an appointment to talk to one of our office efficiency experts today!

August 2nd 2021