Businesses around the world are feeling the effects of inflation, especially businesses in the United States. The cost of many goods is rising while the tight labor market is pushing up wages. While it’s always a good time to look for ways to cut costs, it avoids asking what exactly is different about a high-inflation environment. Three business strategies become much more important when inflation is high: adjusting prices quickly, prioritizing high-margin products, and shifting inputs when relative prices change.
Many companies are still reluctant to raise prices. Small and medium-sized businesses, in particular, often miss price opportunities, as mentioned in an article on ways to increase 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 are able to increase their own prices much more than they realize. Consumers have accumulated cash in their bank accounts thanks to stimulus checks and reduced spending on vacations, dining out and other socially connected services. They can absorb price increases.
In business-to-business sales, almost all companies are used to price increases for a wide variety of materials. Each individual item sold in the B-to-B space often represents a very small part of the customer’s total production costs, making price increases easier.
The second strategy for high inflation is to prioritize the most profitable products. Many companies today are limited in their ability to meet the needs of their customers. They can’t find the labor they need, and they can’t get increased supplies from their suppliers. Companies that need industrial, storage or laboratory space will also find a scarce supply of real estate.
The most common practice is not the best at all. Many companies simply give priority based on the date of the order, regardless of the profit margin. But most companies have different profit margins for their product lines. If management feels that the market for certain products will not accept price increases to increase their profit margin to what it should be, then lower their delivery priority. Tell customers who order them that delivery will be slow. If possible, suggest that other products can be shipped faster. First ship the goods or provide the services that are most profitable.
Prioritizing high-margin products can have disadvantages. Some low-margin products allow for the sale of more profitable accessories or follow-up work. The change orders on construction projects can justify low bids for the main contract. While this is sometimes true, instead of blindly accepting the claim that low-margin products must be sold before high-margin products, test the assumption.
The third business 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 are changing rapidly – as they certainly are now – price increases vary widely. Consumer inflation news reports highlight rising gas prices and used car prices. It’s not that these items cause 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 replace a metal fastener.
US inflation is now higher than most other countries, so substituting imported goods or services for domestic inputs can mitigate the impact of rising costs. Again, the decision is not that easy, as many companies want to shorten rather than lengthen their supply chains. Nevertheless, the core strategy is worth considering: look for substitute products away from the highly inflationary products.
In the service sector, consider the human talents required to deliver services. For example, skilled technicians may not see wage increases as large as unskilled workers, or vice versa. For many years, computer prices fell while wage rates rose, providing strong incentives to automate manual data entry. Today, however, that trade-off can be reversed, as can calculating the most cost-effective method to produce what’s being sold.
Executives grappling with high costs can understand economists’ concern about inflation: It diverts attention from fundamental business practices to meet customers’ greatest needs in the most productive way. These fundamentals are still important, but now managing the effects of inflation is adding to an already long to-do list for corporate executives.