What Every Business Needs to Know About Inflation

We have to go back three decades to find a period of inflation remotely comparable to today. This alone underscores two vital realities that every business needs to consider in approaching the present situation.

First, many individuals and companies have grown used to goods and services generally becoming cheaper, not more expensive. Increasing economies of scale and technology-enabled productivity rises have fuelled this trend.

The second is that an entire generation of business people have never had to confront the difficulties that high inflation brings. Many don’t completely understand what the phenomenon entails, and many don’t appreciate why they need to revise their decisions and behaviours.

Everyone recognises, of course, that high inflation is a grim phenomenon. Politicians and economists don’t want it, so the mere fact that it’s here is sufficient to tell us things have gone badly wrong. It means the economy is out of control.

At a more granular level, your purchasing power is being eroded. You can buy less and less over time for a given amount of money. As a result, to avoid decreasing in value, your assets need to be generating wealth at a higher rate than inflation.

 

Causes and Consequences

Many years ago, Nobel laureate Milton Friedman observed that inflation is “always and everywhere a monetary phenomenon”. It had never occurred, he said, in the absence of money growth outstripping the number of goods and services.

Reflecting this argument, the main reason for today’s high inflation rates is the enormous increase in monetary supply used to bolster the economy during COVID-19. There’s invariably a price to pay – literally and figuratively – for such extraordinary interventions, and history suggests the enduring impacts could take years to work their way through the system entirely.

The continued restrictions stemming from the pandemic also contribute to the chaos by forcing capacity reductions within numerous global supply chains. In addition, we have the political and economic uncertainties sparked by Russia’s invasion of Ukraine.

In the face of these and other issues, prices are now being driven up – and many might never fall again. This is a key characteristic of inflation and its wealth-robbing nature: what goes up doesn’t always come down.

Some asset classes may recover. These include those principally affected by temporary shocks. But most will stabilise at a new level and fail to revert because any given amount of money has become less valuable.

 

Responding as a Business

Businesses must recognise this constitutes a very distinct challenge from recent years. In this case, crucially, it would be unwise to expect a fleeting blip and an eventual return to what might be regarded as normality.

Given this, the main objective must be to put money and assets to work to generate wealth and counter the devaluation that inflation causes. This is essential if overall purchasing power is to be preserved – and, by extension, if the quality of life is to be maintained.

With mounting costs exerting pressure on the bottom line, a company should first ask if it can raise its prices. This might be possible in some instances, but cost management becomes the number-one goal in others – particularly in competitive industries or where prices are fixed.

Companies also need to consider whether a recession is in prospect and what could be done to mitigate the risks such a turn of events could bring. Similarly, they need to assess which assets are likely to stay high and which factors – such as new purchasing policies and other supply issues – may help offset escalating costs.

Business forecasting can therefore serve as a potent tool. Even the most fundamental forecast can be used to “flex” parameters under various scenarios to determine the impacts on your business.

 

Experience in the Face of the Extraordinary

European Central Bank data reveals many smaller firms in the UK are “discouraged borrowers”. This means their expectations of success when applying for loans are so low that they don’t even bother to try.

Inflation certainly won’t help reverse this unhappy trend. Higher borrowing costs usually follow it, so anyone not already “locked in” with a low-cost provider is poised to take a hit from rising Bank of England interest rates.

This further underlines the importance of making the capital within a business work harder. Because it’s losing value, cash has to be put to better use – whether via investment or other means – so it can grow. Equally, this is no time for courting excessive risk.

This may all sound daunting for those who have never experienced high inflation in the past. But remember that plenty of people have experienced it – and their knowledge and insights are available to tap if you’re prepared to seek them out.

Ultimately, getting advice from business people who have successfully worked through an inflationary environment might be the best investment you can make right now. “Been there, done that” can carry a lot of weight, not least during the most troubled times.

 

David Falzani MBE is a Professor at Nottingham University Business School’s Haydn Green Institute for Innovation and Entrepreneurship (HGIIE) and president of the Sainsbury Management Fellowship.

 

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