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4 Small Business Strategies to Navigate Inflation

According to a recent Conference Board survey, 59% of U.S. CEOs think inflation will last at least into next year. To cope with rising inflation, small business owners need to adjust. On today’s episode of Money Talks, host Tiffany Kent, Certified Financial Planner and Founding Partner of Wealth Engagement, LLC, discusses what is causing the rise in inflation, and how small business owners can approach their markets under these circumstances.

Transcription: 

Tiffany Kent:
Hi, everyone. Thanks for joining me this week on Money Talks. Today, I want to talk about four ways inflation can be good for your business. First, let’s start with what inflation is. Inflation is the general increase in prices of goods and services, which means purchasing power of your money goes down when inflation goes up. Inflation hasn’t been an issue for the last 10 years leading up to the COVID crisis. Historically, it has turned it around 2% per year, but there are three good reasons for this.

Tiffany Kent:
First, commodity prices, such as oil, gas, copper, steel, fertilizers, have been low and essentially range-bound for the last five to 10 years. Low prices for commodity producers means there has been no incentive for energy companies and miners to add production growth, because if prices are low, why would any rational business person add production? As the old saying goes, the cure for low prices is low prices. Second, non-commodity companies like retailers, for example, Walmart, face intense competition from other retailers. Walmart wants to offer you low prices to get you into the store. So retailers were forced to get better and more productive by using technology to enhance productivity and also lower their costs through outsourcing production to lower-cost parts of the world. Lastly, consumers like us use our smartphones to help us shop around for the lowest price goods, which also is not inflationary.

Tiffany Kent:
So then what happened when COVID hit, and how did this cause inflation? Three things happened. One, we changed our buying patterns. Two, we had more money in our pockets with some of us having extra savings from not going on vacation and some folks receiving government stimulus. And lastly, money got cheap. Lower interest rates caused us to go on a buying spree with homes and cars. Let’s go into these three points in a bit more detail.

Tiffany Kent:
First, COVID and the stay-at-home order created a huge disruption to consumer buying patterns. People at home spent more time shopping online, buying goods and spent less money on services like travel and hotels. Most of these goods, for example, like home furnishings, come from the global supply chain. People in New York City rushed out to buy cars, and so they could get out of town.

Tiffany Kent:
Also in general, people spent less money and increased their savings. In addition, the US government addressed the downturn in demand for goods or economic activity with fiscal stimulus packages and PPP money. With more money in business people’s pockets, some rushed out to buy more trucks and equipment, some rushed out to buy cars, which are goods with lots of metals, like copper and steel, and computer chips.

Tiffany Kent:
Lastly, the Federal Reserve lowered interest rates and made money cheap. The Fed lowered interest rates, which had fueled a surge in demand because people invested in new houses, vacation homes, cars, and the stock market. Cheap money through lower interest rates helped consumers move into larger homes, buy vacation homes, and these big ticket items have lots of materials in them, like copper and lumber. The surge and demand put upward pressure on prices of copper and lumber, which prices had been historically range-bound. Also, extra savings went into the stock market.

Tiffany Kent:
Back in the middle of last year when the inflation data was really starting to gather steam, the first major culprit was used car prices. As everyone could see, prices were going nuts as demand for cars was booming from both households and from rental car companies, while production new cars was curved by chip shortages.

Tiffany Kent:
Since then, inflation has broadened out. Food prices have gathered steam. Rent has accelerated. This continued to exert extraordinary upward pressure on official inflation readings. For example, used cars historically had contributed 0% to inflation, and now they count for 1% of the inflation increase. If you hadn’t needed to purchase a car, new or used, you haven’t experienced inflation like others have.

Tiffany Kent:
So now we have had consistent inflation for the last few months, which is making the Federal Reserve Bank nervous. People hate inflation. The December monthly report showed the biggest surge in inflation as 6.9% with the biggest increases in transportation, housing, food, and energy. Other causes of inflation have been due to droughts, supply chain hiccups, labor shortages, and increased demand have sent food prices up across the globe by a quarter in the past year.

Tiffany Kent:
Meanwhile, drillers cut back on production of oil during the lockdown, and then demand has rebounded as we all know there is traffic. We are taking trips again, flying or driving, and it’s pretty cold outside requiring us to heat our homes more than normal. So the Fed needs to start to combat inflation by making money more expensive. It’s the only way to slow down demand. How do they do this? They raise interest rates to slow demand for goods and services. So something to think about in the future.

Tiffany Kent:
So now let’s go into the four ways inflation can be good for your business. First, is your business unique? Do you have pricing power? If you provide a unique service, you have a great location or a specialized product, you probably have pricing power. You can raise prices and not suffer a fall-off in demand.

Tiffany Kent:
While haircuts are somewhat of a commoditized service, some places with unique locations and staff can raise prices. Well, I have seen this first hand at our local barber. Even though in December, official inflation readings were reading at 6.9%, our barber took a much higher price increase. For years, we paid $20 for a haircut and gave a $5 tip. Now that same haircut is $25 plus a $5 tip, which means that’s a 25% price increase. Did the rent go up that much? Probably not. So they’re making more money now due to inflation. This is how inflation can be good for your business. If you have a unique service, location, or specialized product, you can raise prices because you have pricing power.

Tiffany Kent:
A second way your business can benefit from inflation is by cost inputs. Are your cost inputs experiencing huge inflationary pressure? For example, is the cost of your goods sold up, let’s say, because of higher aluminum prices or other raw materials?

Tiffany Kent:
Here’s a quick story. We were thinking about adding an aluminum roof structure to our back deck. The contractor we talked to was facing higher metal prices. So he raised his prices as a result of higher aluminum costs. Or the company can just implement a surcharge and the surcharge can be more than your actual increase in the cost of materials because of higher trucking costs and other costs. Most folks don’t go back and look at the price of aluminum and calculate the contractor’s increase in cost, so the business owner can raise prices without a direct link to the cost of the raw material inputs.

Tiffany Kent:
Third way your business can benefit from inflation is that you can cut back on the amount of goods you offer. For example, everyone knows restaurants are experiencing higher food costs, and so they have raised prices to offset this, but some high-end restaurants have even been more aggressive by also cutting back portions. So they are benefiting from higher prices and lower meal sizes, which lowers their costs and expands margins.

Tiffany Kent:
Fourth way you can make more money is if you have a specialized labor or service as part of your business. For example, a really good waiter can earn a much higher tip if he or she offers superior service, or you can charge a service fee when it comes to delivery of stuff. Bottom line, you can raise prices greater than your cost increases, and if your prices do not impact demand, this will help you expand your margins and make more money.

Tiffany Kent:
Prices are most likely sticky, meaning they don’t go back down if inflation goes down. However, a bit of a warning, if you don’t have pricing power and you raise your prices, your sales might go down if not everyone else raises prices.

Tiffany Kent:
Going back to our local barbershop example mentioned earlier, Sport Clips, which is a competitor, hasn’t raised their prices by 25%. Then some consumers will switch to a cheaper option.

Tiffany Kent:
In the second example with the aluminum roof structure, if aluminum prices fall back down, it’ll be hard to justify a surcharge for aluminum prices, unless you just increase your base price to incorporate the higher input cost. As in our case, this made it easy for us to say to ourselves, let’s wait for when aluminum prices come back down or let’s just wait until things settle down. In this case, the cure for high prices is high prices, and we decide to delay this purchase.

Tiffany Kent:
In the third example, if you are a restaurant that increased prices and cut back proportions, some consumers will notice and they will not come back and switch down to a cheaper option.

Tiffany Kent:
Lastly, if your labor force is highly specialized and you have to increase their wages to retain talent, you may not be able to charge more for your services. Look what just happened with Goldman Sachs when they announced earnings for fourth quarter. The earnings were negatively impacted when they had to increase salaries significantly to attract and retain talented workers. Generally speaking, companies do better in an inflationary environment. Some market sectors will do better than others.


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