The inflation rate has just reached double digits. Everyone recognizes that increasing prices result from inflation, but what does this imply for your business? To answer this issue, we need to know where inflation originates from and what it is. This will help you prepare your business and do all necessary to make it inflation-proof. Here’s a primer on inflation and what you can do to avoid the hazards of doing business in an inflationary climate.
What is inflation?
Milton Friedman, a Nobel winner, famously said, “Inflation is a monetary phenomena that occurs at all times and in all places. It is always and everywhere the effect of too much money, of money increasing faster than production.” He meant that there was too much money competing for commodities, putting upward pressure on pricing. Economists have historically blamed inflation on the money supply. Indeed, inflation was first thought to be the loss of buying power of money.
However, this is not a universal agreement because not all prices grow at the same rate. Some prices have even fallen with laptops and cellphones, as we have witnessed over the last decade. The devices improve year after year, yet the price in dollars remains constant. People receive more bang for their buck.
Inflation is classified as “cost-push” or “demand-pull” by modern economics. The former implies that production costs rise. In other words, your input costs begin to climb, pushing you to boost your client pricing. The latter refers to price rises in the reverse direction, which means that prices rise first in consumer items and then move up the supply chain.
What inflation means for entrepreneurs
Inflationary costs will place a strain on your cash flow and profitability. As your costs rise, you will need to boost your charges to make ends meet. The longer you wait to raise your pricing, the more financial burden your company will face. The difficulty, of course, is that rivalry in your business may prevent you from raising prices – doing so before competitors might be fatal.
Demand-pull inflation is the inverse of supply-pull inflation. Demand for your products is increasing, so you may raise your pricing while still selling everything in your inventory. It would be beneficial if you raised your rates more sooner than you expect. Because you will require that cash to obtain inputs in order to sustain your manufacturing output. Other firms may perceive greater demand and bid for additional information, driving up expenses. The issue is that your revenue may be less than your replacement expenses. As a result, you may lose even if your margin on already manufactured items increases.
Both scenarios are complicated and necessitate that you be prepared and behave accordingly. And both circumstances eventually result in higher total costs and reduced buying power of money. In other words, even if you make a profit during an inflationary period, that profit will buy you less and less. It loses value over time.
How to become inflation proof
Inflation implies that money loses value, and there is no way to avoid its consequences in a market system. However, there are methods to structure your company and its processes to avoid the effects of inflation. Here are three approaches you may use to make your firm as inflation-proof as possible:
1. Position yourself to create value
Savvy entrepreneurs are well-positioned to expand their firms while focusing on the value they generate. Costs come in second and, in reality, are a decision. Give your consumers value and be the lighthouse that guides you through everything from product creation, pricing, and increasing production capacity to marketing. Value is not a monetary number, but rather the enjoyment gained from using a consumer’s items. Value is unaffected by inflation. Concentrating on it pushes you closer to being inflation-proof.
2. Use contracts wisely
When inflation is imminent, it becomes logical to set input prices while keeping output prices flexible. In other words, as soon as you anticipate inflation, aim to enter long-term contracts with suppliers that stipulate costs. Even at market pricing, this may be a successful approach when prices begin to grow rapidly. Simultaneously, renegotiate or terminate contracts with your clients in order to boost rates. Consider including “cost-plus” pricing modifications into your sales contracts. This is not a good pricing strategy in normal times, but it can help you survive moments of excessive inflation.
3. Don’t go overboard as prices change
Maintain your composure. It is simple to respond to quickly rising demand by increasing output. However, if you feel that this is not a result of buyers finally appreciating the superiority of your products, this may not be the best answer. If it’s a demand-pull economy, your input prices will rapidly outpace your output prices. To avoid unwanted inflationary consequences, scale up manufacturing prudently utilizing contracts.
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