Business costs are rising
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Businesses around the world are feeling inflation, and especially businesses in the United States. The cost of many goods is rising as the tight labor market pushes wages up. While this is always a good time to examine cost-cutting opportunities, it avoids the question of what exactly is different in a high inflation environment. Three business strategies become much more important with high inflation: adjust prices quickly, prioritize high-margin products, and change inputs as relative prices change.
Many companies are still hesitant to raise their prices. Small and medium-sized businesses, in particular, often miss out on pricing opportunities, as noted in an article on opportunities to increase profits. The reason we have inflation is that massive stimulus, both fiscal 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 been hoarding money in their bank accounts from stimulus checks and lower spending on vacations, restaurant meals and other social services. They can absorb price increases.
In business-to-business sales, virtually all businesses are used to price increases for a wide range of materials. Any particular item sold in the B-to-B space often represents a very small portion of the customer’s total cost of production, which facilitates price increases.
The second strategy in the event of high inflation consists in favoring the most profitable products. Many businesses today are limited in their ability to meet customer demands. They can’t find the workers they need and they can’t increase deliveries from their suppliers. Companies that need industrial, warehouse or laboratory space also find limited real estate availability.
The most common practice is by no means the best. Many companies simply prioritize based on order date, regardless of the profit margin. But most companies have different profit margins depending on their product lines. If management feels that the market for some product will not accept price increases to bring its profit margin to where it should be, then reduce its delivery priority. Tell customers who order them that delivery will be slow. If possible, suggest other products can be shipped faster. Ship the goods or deliver the most profitable services first.
Prioritizing high-margin products can have downsides. Some low-margin products allow for the sale of more profitable props or follow-up work. Change orders on construction projects can justify low bids on the main contract. While this is sometimes true, verify the hypothesis rather than blindly accepting the statement that low margin products should be sold before high margin products.
The third trading strategy for a high inflation economy is to closely monitor changes in relative prices. Not all prices increase by the same percentage. Especially when economic conditions change rapidly, as is certainly the case now, price increases vary widely. Reports on consumer inflation highlight rising gas prices and used car prices. It is not the case that these items cause inflation; they are simply the first prices to rise, based on short-term elasticities of demand and supply, to use economists’ jargon.
With different inflation rates for different inputs, a company should consider replacing one material with another. In manufacturing, for example, sometimes different metals are suitable for a particular product. Or an adhesive can sometimes replace a metal fastener.
Inflation in the United States is now higher than in most other countries, so substituting an imported good or service for domestic inputs can 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 high inflation products.
In the service industry, consider the human talents needed to provide services. Skilled technicians may not see salary increases as large as unskilled labor, for example, or vice versa. For many years, computer prices have fallen while wage rates have risen, creating strong incentives to automate manual data entry. Today, however, that trade-off can be reversed, as can the arithmetic over which method is cheapest to produce whatever is sold.
Business leaders struggling with high costs can understand economists’ concern about inflation: it distracts from the fundamental business practices of meeting customers’ most important needs in the most productive way. These fundamentals continue to be important, but managing the effects of inflation is now added to an already long to-do list for business leaders.
