How Does Inflation Affect Businesses & Advice on Controlling Costs

After two years of lockdowns, supply chain issues, and other pandemic-related restrictions, businesses can finally start moving forward in the “new normal,” right? Wrong! Because while the worst of Covid seems behind us, there is now another threat to confront: the highest levels of inflation in 40 years. The costs of living are up as is the cost of borrowing.

In this article, answer the question: How does inflation affect businesses? We also provide practical tips on cutting costs.

Understanding the Basics

Essentially, inflation occurs when prices go up. As a result — and this is the crucial thing to keep in mind — the purchasing power of money goes down. Consider this real-world example:

In 2020, the price for a pound of white bread in the U.S. was $1.48. A year later in 2021, it surged to a record $1.69 per pound. That means in terms of buying bread, the purchasing power of money declined by 12%. Why? Even though demand remained unchanged, consumers needed more money — 12% in this case — to buy the same pound of white bread in 2021 as they did in 2020 due to the increase in cost.

This is important to grasp. A person or business may have (roughly) the same amount of money one year vs. the next. However, with the effects of inflation, they cannot buy as much. The intrinsic value of their money has declined. This in turn causes a rise in employee costs.

What Causes Inflation?

In just a moment, we’ll continue answering our question: How does inflation affect businesses? But first, let’s list some of the factors that cause inflation (or that make existing inflation worse):

  • Increases in production costs such as materials and wages. This is known as “cost-push inflation.”
  • Strong consumer demand for a product or service. This is known as “demand-pull inflation.”
  • When enough people assume that inflation will continue into the future, and therefore purchase more now to avoid higher prices down the road. This is known as “built-in inflation.” Built-in Inflation is the reason runaway inflation is seen as a scary vicious cycle: it breeds yet more inflation (and more…and more!).
  • Increasing home prices and associated utilities, which for many people are unavoidable (at least in the short term) and make up a significant portion of their income.
  • Expansionary fiscal policy by governments, which includes dropping interest rates to make borrowing cheaper. Simply put, with cheaper loans available, demand in the housing market stays robust.

How Is Inflation Measured?

Inflation has a far-reaching ripple effect on the economy, so it’s important that economists have an accurate means of gauging and tracking it over time. The Consumer Price Index (CPI)is the main source of measurement. The CPI measures buying power by tracking prices of a “basket of goods. These include things like transportation, food, medical care, and energy which are typical in many American households.

A higher CPI indicates rising prices due to inflationary pressure, so governments must work to combat further inflation or risk currency devaluation. They may do this by printing more money to meet the cost of living or making laws that boost price stability. Finding a delicate balance between the two can be difficult, but it’s necessary for economic growth and wealth. How Does Inflation Affect Businesses and Industries? Two Words: Higher Costs

A report compiled by MetLife and The U.S. Chamber of Commerce reveals a lot about the impact of inflation. A significant majority of small business owners (86%) worry about inflation and its impact on increased expenses, according to the report.

Specifically, during periods of high inflation businesses find their profit margins shrinking — or in some cases disappearing — due to rising:

  • Inventory costs
  • Overhead costs
  • Shipping costs
  • Supply-chain costs (including disruptions)
  • Raw materials
  • Wages

Any one of these factors can drive inflation. What’s more, inflation itself is not inherently bad. A small amount of inflation — e.g., 2% — is actually a good thing. This makes it less likely that the economy will experience harmful deflation if the economy weakens. But rampant and persistent inflation is always harmful to economies.

Left unchecked, inflation can turn into hyperinflation, which refers to rapid, excessive, and out-of-control general price increases. For example, between July and August 1990, Peru experienced daily (yes, daily!) inflation of 5%, which resulted in prices doubling about every 13 days.

The good news — actually, make that the GREAT news — is that hyperinflation is very, very unlikely to happen in the U.S. After pea in the summer of 2022, the inflation rate is falling; although at a slower pace than many business owners want to see.

Ways Businesses Can Combat Inflation

If all goes according to plan — which is a big IF — then some economists say that inflation should return to its pre-pandemic level of around 2% by late 2023 or early 2024. However, there are those who say that it could take a decade. Either way, business owners need to take action now to combat inflation, so they can protect shrinking profit margins.

With that in mind, here are some practical ways to defeat — or at least, withstand — this costly and stressful inflationary period:

  • Increase prices to offset rising costs. Obviously, this needs to be done with extreme caution. Raising prices too much, and too fast, could lead to customer churn — if not in the short term, then in the long term.
  • Restructure your workforce. Nobody wants to see layoffs, but it may be necessary to let some employees go and/or dial back hours and shifts.
  • Analyze and (if necessary) diversify your supply chain so that you have more options. Relying on just one or two vendors has its benefits, but it can also be problematic if the lack of choice means that you are forced to pay higher prices for items or services.
  • Industries need to look for ways to streamline and automate processes. Ensure your prices are in line and competitive with the current market.
  • Evaluate your current platforms and systems, and identify opportunities to substantially reduce costs, while adding value. For example, in the last few years, many businesses have switched from a conventional landline phone system to a cloud (VoIP) phone system. They are now enjoying substantial year-over-year cost savings, along with a range of calling features that improve productivity, efficiency, collaboration, customer satisfaction, and sales.

The Bottom Line

How does inflation affect businesses? Fundamentally, it persuades — or forces — owners to make changes. Those that are proactive and play the long game almost always come out the other side leaner, smarter, and stronger. The impact of inflation may be difficult in the short run, but those negative effects can be short-lived and actually have a positive result on businesses in the long run.

Carolina Digital Phone’s all-in-one cloud phone system gives your business more for less, which is important at all times — but ESPECIALLY during these high inflationary times.

Furthermore, our pricing is not just easily affordable, but it is also completely predictable. When everything from the price of milk to cars is rising on a monthly basis, you can rest easy knowing that the price in your agreement is the price you will pay, and not a cent more!

Get your free demo and consultation by calling us now at (336) 544-4000.

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