Inflation has become a critical short-term worry for practically all enterprises throughout the world for the first time in at least a decade.
Nobody knows how long the current inflation wave would endure, but a poll of economists conducted in the summer of 2021 suggested that it may last for years. More recently, the Federal Reserve of the United States hinted that the current inflationary surge might not be as severe as previously thought “temporary,” as some had speculated.
The traditional reaction to inflation is to choose one of three unappealing options. Managers might irritate their customers by raising prices, irritate their investors by decreasing margins, or irritate almost everyone by cutting corners to save money. When faced with this trilemma, most managers raise their rates and then look for creative ways to deal with the ensuing drama.
What they fail to see is that those three possibilities are tactical relics from a bygone period. When I was a kid in the 1970s, “Managers lacked the technology, data, and, in many cases, the idea to do anything bolder or more strategic when “stagflation” grabbed major economies. When inflation arrived during the Great Recession of 2008-09, managers were caught in the same trilemma as before.
Inflation will be different in 2022. Managers now have market visibility and adaptability that their forefathers could only have dreamed of even a generation ago. Managers now have access to much better data as well as more sophisticated tools for analyzing and transforming it into meaningful information for decision-making. It’s the perfect time for them to view inflation as a strategic opportunity rather than a tactical obstacle, and to choose from a wider range of possibilities. Rather than worrying about how much more they should charge their clients, they should focus their efforts on determining how and why they should charge them.
How do firms guard against inflation?
A company loan might help you keep up with client demand if you need more working capital. Almost half (45%) of small business owners polled in the Small Business Index have taken out a loan to deal with inflation in the last year. The silver lining of taking out a loan when inflation is strong is that your dollars go further; if inflation continues, you’ll most likely be repaying your debt with less expensive cash.
However, in order to ensure that you can repay your loan properly, you must reinvest your funds in your company. In an ideal world, you’d use your loan to fund costs or projects that help you go forwardand improve your bottom line. This could imply:
What do businesses do when prices rise?
Companies are scrambling to deal with rising commodity prices, supply bottlenecks, and increased salaries resulting by labor shortages as the economic recovery gains traction amid an uncertain epidemic outlook. In the first half of 2021, the producer pricing index (PPI) in the G7 countries increased by 10%. The PPI is a key indication of company pressure since it gauges the prices of goods shortly after production.
In the first half of 2008, during the early months of the Great Recession, the world saw a similar increase in PPI. Companies who were able to weather the storm the best took decisive action to combat growing inflation by implementing price hikes in line with PPI but this was insufficient. The top performers also made substantial initiatives to increase productivity, notably through cost reduction. Those companies who cut costs the greatest to enhance productivity during earlier inflationary periods had greater total shareholder returns (TSR) the median was 27 percent than those that took less action, according to our examination of the performance of 5,700 worldwide companies. (We measured EBITDA and revenue growth to assess productivity.) The evidence is clear: lowering expenses remains a key aspect of managing in this economic environment, even as many companies deal with inflation by spending more attention to modifying prices or finding new sources of growth.
During the 200811 inflationary period, BorgWarner, a U.S.-based automotive supplier, experienced significant hurdles and used a variety of strategies to outperform the market. The corporation lowered the amount of work and the amount of labor necessary to complete it, as well as adjusting production capacity to meet consumer demand. It centralized information technology to support more efficient back-office procedures, established a worldwide procurement structure to better spend and acquire, and concentrated capital investment on the most critical strategic challenges. These initiatives aided the corporation in achieving a compounded annual TSR growth rate of 43 percent.
We discovered that organizations who were able to achieve such advantages through cost-cutting efforts during inflation utilized comparable strategies. This current inflationary period, on the other hand, is unique: Consumer demand has not plummeted as dramatically as it did in 2008, and supply chains are more limited. Companies will need to take steps to not just cut costs but also construct more scalable growth platforms as they prepare for higher inflation in this new climate, allowing them to deliberately reinvest in programs that provide better resilience and stronger purchasing and pricing capabilities. They require cost-cutting strategies that enable them to increase top-line revenue while reducing their reliance on uncertain labor markets and enhancing staff retention. To attain these objectives, successful firms employ six strategies. We’ll take a look at each one separately.
Get spending visibility:
Any cost management capability must start with high-resolution spending visibility. It allows managers to see exactly where money is spent and who is spending it. It is vital to establish repeatable, end-to-end, actionable visibility of expenditure by cost category, business process, function, and business unit during an inflationary time. All subsequent productivity attempts are built on this basis. It allows for the appropriate amount of accountability throughout the organization, ensuring that all choices are taken with full knowledge of the financial implications.
Differentiate between strategic and nonstrategic spending:
In any disruptive situation, the chances of leaders making decisions that compromise the company’s long-term strategy are greater. It’s fairly uncommon to make broad-based cuts that aren’t in line with the company’s strategy and, as a result, don’t produce the best return on investment or maximize shareholder value over time. Instead, make a clear distinction between strategic and nonstrategic cost-cutting, as well as the protection of signature customer and employee experiences and fiduciary obligations. To prioritize greater ROI investments, use consistent, accessible financials. In both good and bad times, a sustainable cost management system should fuel a company’s strategy and enable it to out-invest competitors on strategic costs at scale.
Managers must choose where investments should be reduced and cost savings realized; where costs can be cut more selectively to increase the return on operational expenses; and where growth can be boosted by investing more in the strategic skills required to achieve differentiated results. This investment stance lays the groundwork for redesigning the P&L, cost structure, operating model, and capabilities to support the chosen strategy. It assists leaders in reaching consensus on fundamental decisions such as which capabilities should be best in class built to enable and sustain competitive advantage versus best in cost. In times of economic turbulence, it prepares a firm to make better decisions about how to utilize increasingly precious resources to renew its strategy and maximize shareholder value. This includes, for example, investments in people. The choice to engage in allowing employees to pursue debt-free education is a strategic investment for retailers like Walmart and Target to differentiate themselves in the labor market.
Unpack the drivers of spending:
The next step is to establish a more thorough understanding of the true drivers of cost in an inflationary environment, with enhanced visibility and a clear sense of how expenses match with strategy. Examine the rate (price paid) and consumption (quantity or volume) of major cost categories, as well as the underlying drivers. This stage enables businesses to build detailed, trackable initiatives connected to a specific cost category driver. It paves the way for a slew of potential movements. Creating a preferred vendor program to boost purchasing power, reevaluating the right make-vs.-buy mix for core functions like software development, and deploying AI-powered sourcing tools to generate automated insights from spending data and flag savings and compliance opportunities in real time are just a few of the most important.
These techniques can help you save money in the short run. One energy firm reviewed all of its apps and found more than 80 that may be deleted in the near future, saving the company $10 million each year. Getting a thorough picture of what’s truly driving expenditure is especially important in times of rising inflation since it allows businesses to move on to the next three strategies.
Reduce consumption:
Companies may modify their approach to match the inflationary climate with better spending visibility and the ability to separate factors. Companies, for example, can ensure that they spend better even if they are unable to acquire better due to supply chain and producer pricing pressures. Setting up a spending czar or spending control towers is one approach to do this. When a multinational healthcare business discovered that too many acquisitions had resulted in cost inefficiency, it appointed a spending czar to break down silos and make decisions for the entire company. It was the first important step toward saving more than $300 million every year.
Cross-functional transformation can result from a focus on improved expenditures. Many of the cost concerns that one large technology company had while building new facilities were caused by organizations outside of the decision makers on new construction projects, according to the company. By increasing cross-functional collaboration, the company was able to reduce construction time by six months and save more than $400 million. Setting up cross-functional spending controls allows organizations to home in on costs that can no longer be justified or that can be avoided by doing things differently, allowing them to continuously prioritize spending and ensure that any savings uncovered don’t creep back in over time.
Eliminate work:
With labor shortages and rising labor costs, the most effective solution is to eliminate the task itself. Companies that excel at this adopt a clean-sheet mindset, also known as zero-based redesign, to help reset how work is done. With precise levers to minimize needless work and automate, this method drives firms to analyze both what activities are performed and how those activities are conducted.
As inflation approaches, businesses across the board are reevaluating their work and identifying what offers the greatest value and is absolutely necessary, resulting in cost reductions as well as the ability to focus funds and scarce labor resources on areas that will help them develop. Work can be eliminated in a variety of ways. Mondelez International, a snack company, is well on its way to eliminating one out of every four products in its portfolio, a goal it established in the early months of the Covid-19 outbreak. Housekeeping is becoming an opt-in vs. opt-out service in hotels all over the world.
Automate:
The ultimate strategy is to automate after removing work. Robotic process automation (RPA), workflow, and intelligent document processing are examples of technologies that can free up workers and increase their productivity. Important colleagues at retailers, for example, spend far too many hours, days, and weeks manually inputting item and product data (e.g., case size, pack size, dimensions, website photos) when they might be engaged on more strategic activities like data analysis and insight generation.
Automation can help an organization maintain stability in addition to saving money on manpower. According to our findings, organizations that invested more in automation prior to the pandemic fared better than others throughout the crisis. Meanwhile, they’ve generated more revenues and seen fewer supply chain, labor productivity, and demand interruptions in our experience. Companies can invest in automation with the productivity and cost savings gained from implementing the preceding five techniques.
Despite the necessity of automation, digital transformations frequently fail to produce the anticipated outcomes. According to a Bain survey, 76 percent of digital transitions resulted in value erosion and lackluster performance. The most critical transformation aspect in digital leadership is orchestration; without it, a digital transformation will not be able to proceed at the speed or scale required to produce the results that businesses require. Companies that are successful spend not just in identifying possibilities and potential solutions, but also in ensuring that they have a solid plan in place for implementing automation. This is a crucial consideration for anyone hoping to use automation to offset inflationary pressures.
Cigna and David’s Bridal, for example, have both publicly stated the advantages of automating at scale. Within a year, Cigna’s value from automating operations jumped from $2 million to more than $100 million, with the firm expecting it to eventually reach $1 billion. David’s Bridal decreased contact center operating costs by over 30% and transferred 30% of appointment-booking phone traffic out of stores when it launched its Zoey messaging concierge service in early 2020, allowing employees to focus on offering more value-added in-person services.
These and other businesses are putting in place cost management systems ahead of time, allowing them to strategically invest while developing the resiliency to weather rising inflation. They position themselves to outperform less proactive opponents long after the volatility has subsided by playing both attack and defense in a disruptive environment.
What are your strategies for dealing with inflation?
- Governments can fight inflation by imposing wage and price limits, but this can lead to a recession and job losses.
- Governments can also use a contractionary monetary policy to combat inflation by limiting the money supply in an economy by raising interest rates and lowering bond prices.
- Another measure used by governments to limit inflation is reserve requirements, which are the amounts of money banks are legally required to have on hand to cover withdrawals.
What businesses thrive in a high-inflation environment?
- In the past, tangible assets such as real estate and commodities were seen to be inflation hedges.
- Certain sector stocks, inflation-indexed bonds, and securitized debt are examples of specialty securities that can keep a portfolio’s buying power.
- Direct and indirect investments in inflation-sensitive investments are available in a variety of ways.
Is inflation detrimental to business?
Inflation is a time in which the price of goods and services rises dramatically. Inflation usually begins with a lack of a service or a product, prompting businesses to raise their prices and the overall costs of the commodity. This upward price adjustment sets off a cost-increasing loop, making it more difficult for firms to achieve their margins and profitability over time.
The most plain and unambiguous explanation of inflation is provided by Forbes. Inflation is defined as an increase in prices and a decrease in the purchasing power of a currency over time. As a result, you are not imagining it if you think your dollar doesn’t go as far as it did before the pandemic. Inflation’s impact on small and medium-sized enterprises may appear negligible at first, but it can quickly become considerable.
Reduced purchasing power equals fewer sales and potentially lower profitability for enterprises. Lower profits imply a reduced ability to expand or invest in the company. Because most businesses with less than 500 employees are founded with the owner’s personal funds, they are exposed to severe financial risk when inflation rises.
Should I invest in a business during an inflationary period?
During a 2015 shareholder meeting, Berkshire Hathaway’s Chairman and CEO noted that “the best firms during inflation are the ones that you buy once and then don’t have to keep making capital investments thereafter,” while “any business with heavy capital investment” should be avoided. He recommends real estate as a good investment during inflation since you can buy it once and profit from the increase in value; nevertheless, he advises against utilities and railroads as suitable investments during inflation.
Buffett also said that the best way to protect against inflation is to invest in yourself and your skills: “If you’re the best teacher, if you’re the best surgeon, if you’re the best lawyer, you’ll get your share of the national economic pie regardless of the value of whatever the currency may be,” he said at a 2009 shareholder meeting. “The second best protection is a good business,” he says, referring to a corporation whose products are in high demand even if the company has to hike prices.
Buffett may have spelled it out as clearly as ever in a 1981 letter to shareholders, writing that companies that tend to withstand an inflationary environment “must have two characteristics: (1) an ability to increase prices relatively easily (even when product demand is flat and capacity is not fully utilized) without fear of significant loss of either market share or unit volume, and (2) an ability to accommodate large dollar volume increases in business (often referred to as “capacity expansion”).
All of this said, maybe the most important lesson that individual investors can take away from Buffett is that instead of trying to pick individual stocks, whether we’re in an inflationary environment or not, you should stick to the tried-and-true strategy of having and holding an index fund. Buffett stated at a shareholder meeting in 2021 that “I do not believe the typical person can pick equities,” and that the S&P 500 index fund is one to “have for a long, long time to people.”
What is creating 2021 inflation?
As fractured supply chains combined with increased consumer demand for secondhand vehicles and construction materials, 2021 saw the fastest annual price rise since the early 1980s.
Inflation favours whom?
- Inflation is defined as an increase in the price of goods and services that results in a decrease in the buying power of money.
- Depending on the conditions, inflation might benefit both borrowers and lenders.
- Prices can be directly affected by the money supply; prices may rise as the money supply rises, assuming no change in economic activity.
- Borrowers gain from inflation because they may repay lenders with money that is worth less than it was when they borrowed it.
- When prices rise as a result of inflation, demand for borrowing rises, resulting in higher interest rates, which benefit lenders.
How do you protect yourself from inflation?
If rising inflation persists, it will almost certainly lead to higher interest rates, therefore investors should think about how to effectively position their portfolios if this happens. Despite enormous budget deficits and cheap interest rates, the economy spent much of the 2010s without high sustained inflation.
If you expect inflation to continue, it may be a good time to borrow, as long as you can avoid being directly exposed to it. What is the explanation for this? You’re effectively repaying your loan with cheaper dollars in the future if you borrow at a fixed interest rate. It gets even better if you use certain types of debt to invest in assets like real estate that are anticipated to appreciate over time.
Here are some of the best inflation hedges you may use to reduce the impact of inflation.
TIPS
TIPS, or Treasury inflation-protected securities, are a good strategy to preserve your government bond investment if inflation is expected to accelerate. TIPS are U.S. government bonds that are indexed to inflation, which means that if inflation rises (or falls), so will the effective interest rate paid on them.
TIPS bonds are issued in maturities of 5, 10, and 30 years and pay interest every six months. They’re considered one of the safest investments in the world because they’re backed by the US federal government (just like other government debt).
Floating-rate bonds
Bonds typically have a fixed payment for the duration of the bond, making them vulnerable to inflation on the broad side. A floating rate bond, on the other hand, can help to reduce this effect by increasing the dividend in response to increases in interest rates induced by rising inflation.
ETFs or mutual funds, which often possess a diverse range of such bonds, are one way to purchase them. You’ll gain some diversity in addition to inflation protection, which means your portfolio may benefit from lower risk.