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Business strategy for the high inflation economy

Business strategy for the high inflation economy

Companies around the world are feeling inflation, especially companies in the United States. The cost of many goods is rising while the tight labor market is pushing wages up. Although it is always a good time to look at cost-cutting opportunities, that avoids the issue of what exactly is different about a high-inflation environment. Three business strategies become much more important with high inflation: quickly adjusting prices, prioritizing high profit-margin products and shifting input as relative prices change.

Many companies are still hesitant to raise prices. Small and medium businesses, in particular, often miss on pricing opportunities, as noted in an article about opportunities to boost profits. The reason we have inflation is that massive stimulus, from both fiscal policy and monetary policy, has increased demand. Thanks to this higher demand, many companies can increase their own prices much more than they realize. Consumers have accumulated cash in their bank accounts thanks to stimulus checks and lower spending on vacations, restaurant meals and other socially connected services. They can absorb price hikes.

In business-to-business sales, virtually all companies are used to price increases in a wide range of materials. Any particular item sold in the B2B space is often a very small part of the customer’s total cost of production, making price increases easier.

The second strategy for high inflation is prioritizing the most profitable products. Today many companies are constrained in their ability to meet customers’ demands. They cannot find the workers they need, and they cannot get increased deliveries from their suppliers. Businesses that need industrial, warehouse or laboratory space also find tight real estate availability.

The most common practice is not at all the best. Many companies simply give priority based on the date of the order regardless of profit margin. But most businesses have different profit margins across their product lines. If management believes that the market for certain products won’t accept price hikes to bring their profit margin up to what it should be, then lower their priority in delivery. Tell customers who order them that delivery will be slow. If possible, suggest that other products can be shipped more quickly. Ship the goods or deliver the services that are most profitable first.

Prioritizing high-margin products can have downsides. Some low-margin products enable the sale of more profitable accessories or follow-on work. The change orders on construction projects may justify low bids on the main contract. Although this sometimes is true, verify the assumption rather than blindly accepting the assertion that low-margin products must be sold before high-margin products.

The third business strategy for a high-inflation economy is to closely watch changes in relative prices. Not all prices increase by the same percentage. Especially when economic conditions are changing rapidly—as they certainly are now—price increases vary widely. News reports on consumer inflation highlight rising gasoline prices and used car prices. It’s not the case that these items are causing inflation; they are simply the first prices to rise, based on short-run elasticities of demand and supply, to use economists’ jargon.

With different rates of inflation for different inputs, a company should consider substituting one material for another. In manufacturing, for example, different metals are sometimes suitable for a particular product. Or an adhesive can sometimes substitute for a metal fastener.

U.S. inflation now runs higher than in most other countries, so substituting an imported good or service for domestic inputs may reduce the impact of rising costs. The decision, again, is not so simple, as many companies want to shorten their supply chains rather than lengthen them. The key strategy is still worth considering: look for substitutes away from the high-inflation products.

In the service sector, give consideration to the human talents needed to deliver services. Skilled technicians may not see wage increases as great as unskilled labor, for example, or vice versa. For many years computer prices were falling while wage rates rose, providing strong incentives to automate manual data entry. Today, though, that trade-off may be reversed, so do the arithmetic on what is the least cost method to produce whatever is being sold.

Business leaders struggling with high costs can understand economists’ concern about inflation: it distracts attention from fundamental business practices of serving customers’ greatest needs in the most productive way. Those fundamentals continue to be important, but now managing inflation effects is added to an already lengthy company leadership to-do list.

 

This article was written by Bill Conerly from Forbes and was legally licensed through the Industry Dive Content Marketplace. Please direct all licensing questions to legal@industrydive.com.