What is Inflation?
Inflation measures how much prices are going up on average and how much purchasing power is decreased over a certain period. For example, if inflation was 10% over the past year, your one dollar today can buy you 10% less than it could last year.
The Impact of Inflation on Small Businesses
In general, high inflation isn’t ideal for business. Here’s why:
Negative Impact on Consumer Behavior
The lifeblood of any business is consumers who purchase their goods and services. Unfortunately, when inflation occurs, consumers lose purchasing power and have to make trade-offs to stay within their budget. For example, as staples like food and transportation get more expensive, consumers may cut out or reduce spending on things they don’t deem vital.
When inflation is high, many business owners decide to raise prices to keep up with inflation. While this sounds reasonable, it creates ripple effects throughout the economy. For example, if a supplier of raw materials raises prices, this represents a rising cost for the manufacturer who creates the end product.
Inflation can cause profits to be pinched due to a combination of reduced consumer demand, as well as higher costs to run the business. As a result, it can come down to more money going out and less money coming in.
Will inflation continue to rise?
Inflation will always be something that you have to deal with, but the inflation rate we’re currently experiencing isn’t normal. Generally, the government tries to keep inflation at around 2-3% per year. So hopefully, in time, we’ll see inflation come back to normal levels.
What you can do to counteract inflation
You can do two main things to counteract inflation: reduce costs or focus on growth.
Here are some ideas on how you can reduce costs within your business.
One way to reduce costs is to leverage technology and focus on becoming more efficient. While this may take a cash investment now, it can help create a competitive advantage in the future. In addition, if you can find a way to keep your costs down and possibly maintain or reduce prices for customers, this can help you win customer loyalty and increase your bottom line.
Another way to reduce costs is to outsource jobs to places where labor is less expensive. This could be in the form of hiring independent contractors that do not require benefits, or it could come in the form of outsourcing certain tasks to other countries with lower labor costs.
Focus on Growth
Alternatively, or in addition to reducing costs, you can also decide to focus on growth. Here are a few options to consider.
Low Margin, High Quantity
Inflation may be squeezing your margins. However, that does not have to lead to financial ruin. Some companies can strategically decide to keep their prices the same as they were and simply increase the number of items they sell. This can work well if all your competitors are raising prices. Then, consumers may appreciate that your company’s prices are the same, and you could take revenue share from your competitors.
Focus on Profitable Niches
If your profits are being pinched, this is a good time to reassess where your company is headed in the future. Right now, 80% of your business may be coming from a certain product or service, but the profit margin may be going down. However, you may have a new niche that is very profitable; it just hasn’t been given a lot of time or business resources to help it grow. This may be the time to rethink your business strategy and focus on areas where there is opportunity for growth and higher margins.
It can be stressful to run a business when prices are up and consumer demand is down. The SBA offers free business consulting programs that can help you make decisions. You can also talk to your business banker about the types of loans and lines of credit you can access if cash flow is tight.