As signs of continued significant inflation surface weekly, business leaders and business owners are making decisions to guard against shrinking profitability and to protect long-term viability. Are they the right decisions?
Each inflationary period has its own distinct set of pressures. Successful decisions made during 2008’s inflationary period might not translate successfully to the next inflationary period. Even within the same inflationary period, the impacts on different organizations won’t be the same.
To actively guard against negative inflation impacts, assess and test three key areas: supply chain, labor, and pricing.
Supply chain strains and disruptions can be both a cause of and a result of inflation. Inflation impacts each organization differently. Identifying inflation in your organization is a key skill to help you make decisions to guard your margins.
To identify inflation quickly and conclusively within your organization’s product mix, know historical and current revenues, costs and margins. Track leading indicators to help identify inflationary trends early.
To guard against supply chain disruptions, consider strengthening existing supply chain relationships, developing redundant suppliers, establishing long-term contracts with suppliers, and carrying bigger inventories of key components.
As costs of products and services begin to grow, knowing current spending levels in key categories can aid cost-cutting decisions. Cost-cutting considerations include substituting alternative materials or labor, assessing import versus domestic sourcing, and adjusting delivery time length.
Inflation’s impact on wages and, in turn, on the cost of labor to an organization is usually easy to measure and identify. However, having a pure cost approach to managing labor can have significant negative impacts to your organization’s cohesiveness.
Inflation can quickly impact high-demand and minimum-wage positions. Look for ways to reduce your dependence on these classes of labor through scrutiny of the type and method of activities performed, evaluation of products and services offered, and elimination or automation of activities.
Increasing prices of the products or services you offer may be the most obvious decision to make during inflationary periods. The timing of price increases can have significant impacts on profitability. Leaders are frequently too slow to recognize signs of inflation in costs, and then don’t raise prices quickly enough.
Price increases don’t have to be across the board. Increases can focus on your differentiating products, with a marketing focus on distinctiveness and strength of brand, while targeting less price-sensitive customers.
Understanding the elasticity of customer demand for each product is important to implementing a successful price increase. Also consider building variable pricing into contracts with customers.
Stress-test your tolerance
To make informed decisions, run tests to financially quantify the impact of inflation and corresponding decisions. A strong financial modeling tool allows you to see the expected causes and effects of multiple impacts and/or decisions before you make them.
Running various “what-if” scenarios can help you stress-test your organization’s tolerance to inflationary pressures and potential responses. Models don’t have to be elaborate, nor have a long history of use. Use a simple model that mimics true financial behavior, allows you to easily adjust key assumptions, and has buy-in from leadership.
Transform the way you do business
Looking at how various factors may influence your future can highlight new opportunities and risks — and allow you to react and respond in real time to the opportunities and challenges on the horizon. A professional advisor can help you assess your current financial modeling approach.