Inflation occurs when the prices of goods and services rise broadly. When you receive less for the same amount of money, it means the value of money is decreasing. This effect is seen across all industries and businesses of all sizes, as inflation impacts the entire value chain. Prices for raw materials and electricity rise, logistics costs increase (reflecting the price of oil), premises and interest expenses go up, and there’s also upward pressure on wages.
Although this scenario might initially seem devastating for your business’s finances, there are ways to mitigate the negative effects of inflation or even find new drivers of profitability.
1. Optimize Your Pricing Raising prices can help soften the impact of inflation on your business. If it’s not currently possible to raise prices within the framework of your existing contracts, ensure that you have the right to pass increased costs onto your customers in the future. However, avoid sudden across-the-board price hikes without understanding the overall impact of inflation. Rash increases might drive your customers to competitors who have managed to keep their prices more attractive.
Instead, gradually increase prices and plan strategically. Consider what sets you apart from your competitors and highlight that in your marketing messages. Differentiate with minor product improvements, bundling products, or unbundling them from existing packages. Shorten the duration of customer contracts or add temporary raw material surcharges. Train your staff to provide a better customer experience.
Offer additional services or warranties for your products. Increase prices on products or services where customers are less likely to notice. Raise prices for customers who are less price-sensitive. You can also reduce packaging sizes without changing the price and decrease or eliminate discounts altogether. If you’re a restaurateur, consider repackaging menus based on customer feedback.
2. Focus on What’s Profitable In times of inflation, it’s advisable to focus on the most profitable products or services, customers, and distribution channels. Start with careful analysis and thorough internal accounting. Check, for instance, customer-specific pricing and profitability including real costs.
For distribution channels, consider how many intermediaries are in the chain and explore direct distribution opportunities. Also, compare the costs of physical stores to online sales. For businesses with their production, it’s important to consider the role of fixed production costs relative to variable sales margins. Even selling at a lower percentage margin might be temporarily more profitable as it brings in cash to cover fixed costs.
Use scenarios that measure the impact of inflation to test profitability, such as:
- Wages rising by 5-20%
- Raw material prices doubling
- Supply chain disruptions delaying revenue by 25% or more and increasing inventory
When testing different scenarios, answer these tactical questions:
- Do I have enough cash in all situations?
- What contingency moves will I make in each situation?
- Can I currently manage risks with preventive measures?
And finally, what metrics will you use if any of these scenarios occur? If you need help testing scenarios and finding the right metrics, consider a free consultation with Aamu Partners.
3. Minimize Risks in Goods Deliveries To minimize the risks brought by inflation with suppliers, consider not relying on a single supplier and exploring replacing foreign suppliers with domestic ones. You might also rethink the entire supply chain instead of just replacing individual players. Negotiating longer delivery and price frames with suppliers can ease the situation and add predictability for all parties involved. The same applies to other long-term subcontracting relationships or contracts, like premises leases.
Avoid situations where a single raw material constitutes a significant portion of the cost of goods sold. Consider pre-emptive purchasing of critical raw materials with low storage costs if current prices are favorable and future cost increases are anticipated, and storage doesn’t incur additional costs. You can also consider commodity derivatives, like oil futures or forwards. Note, however, that this is not investment advice and each company’s situation should be assessed individually.
4. Cut Unnecessary Expenses As your business grows and evolves, you’ve likely accumulated unnecessary expenses. Now is a good time to analyze these and make easy savings through direct cost reductions. Cancel all product or service orders that no one is using. Also, check what materials could be replaced with cheaper alternatives. Now might also be the right time to move to smaller premises in fields where remote or hybrid work is feasible.
5. Increase Efficiency One way to combat the effects of inflation is to streamline all operations where possible. If your business’s situation allows, consider whether now is the right time to invest in automation. For example, robots in production facilities and service points, remote identification in inventory management, and AI in customer service.
Also, think about what other processes can currently be automated. Are your appointment scheduling, ordering systems, billing, and other repetitive operations automated yet? If not, now might be a good time. When there’s upward pressure on wages, work that can be automated should be done now. The more efficient your operations, the better your profitability.
6. Tap into New Markets Despite all the challenges, inflation can also bring positive changes. New customers who are not bothered by your price increases may emerge. Alternatively, customers of competitors may find your prices more attractive, leading to new business. Consider if now is the right time to conduct a market analysis and explore new applications for your products or services. Or perhaps develop entirely new innovations – products or services with better profitability and differentiation than your current offerings.
7. Refinance Your Balance Sheet and Borrow Carefully Finally, let’s focus on ways to soften the impact of inflation on your financing costs. You can start by first paying off high-interest loans and reorganizing your balance sheet’s debt. For the latter, you have various tools available, such as:
- Negotiating a longer loan term for existing loans, thus reducing monthly repayments
- Renegotiating your collateral and guarantees (this aims to reduce entrepreneurial risk and also affects financing costs)
- Considering what financial instruments you have available (bank loans, account overdrafts) and which suit your situation
- Exploring what fixed assets you could sell and lease back (e.g., premises and machinery)
With interest rates still relatively moderate, you might consider taking out new loans – after careful investment calculations. If you decide to take out a new loan, consider interest rate hedging.
Keep in mind that all the above measures require careful consideration and thorough internal accounting. Does your company have this expertise? If you want to learn more about testing different scenarios and tips for choosing the right actions, consider booking a free consultation with us.