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Inflation risks

We’re in a time of high inflation – something that few business owners and managers have experienced unless they were in the trade during the 1970s and 1980s when double-digit inflation figures were common.

Just a few months ago central bankers were suggesting that the currant increase in the rate of inflation was transitory and would be a short-term problem. However, as has become apparent, that is not the case, hence the chancellor’s mid-May mini-budget and the steps being taken by governments elsewhere around the world.

Rising inflation was expected as societies re-opened post-Covid, but a combination of consumer demand, factory shutdowns, and labour shortages has exacerbated the problem. And the matter was made worse as central banks raised interest rates to damp-down consumer-led inflation by encouraging saving and making borrowing more expensive. However, much of the more recent rises follow the international response to Russia’s invasion of Ukraine.

As background, central banks such as the Bank of England or the US Federal Reserve, are tasked with keeping inflation low or rather, preventing falling prices and deflation. Although on the face of it, the latter seems ideal, the reality is somewhat different.

The problem with deflation is that it kills demand for consumer-led products and services because it encourages buyers to delay any purchases that they were planning because whatever they buy today will be less expensive tomorrow. Worse, firms in those sectors seek to keep stock as low as possible – or almost non-existent – since again, what they hold would drop in (retail) value.

On the other hand, low levels of inflation help those selling to consumers for the opposite of the reasons above – consumers have a reason to buy today as prices may rise tomorrow. Moreover, inflation devalues debt in the long-term and helps firms mask price rises while keeping markets on their toes as prices are not static.

It’s important to remember that inflation affects individuals and businesses differently depending on what they buy and their obligations; sub-groups of a population often have different personal inflation rates. Further, official figures on inflation don’t reflect the fact that people will still buy goods and services but may substitute for less expensive brands and alternatives.

Regardless, inflation means higher input costs and the conundrum of whether to absorb or increase prices, both of which can affect the attractiveness of a retailer’s position in the marketplace. Alternatively, inflation reduces the purchasing power of consumers and in turn, leads firms to record lower revenue.

What to do
How businesses and consumers react depends on the product and how essential it is. The concept of ‘price elasticity’ illustrates the impact of rising prices on sales. Essential items such as food, fuel, and even mobile phone contracts (not the phones themselves) are price-inelastic in that while volumes sold may drop as prices rise, the fall will be gradual. But non-essential items such as TV subscriptions and gym memberships will see greater drops as prices rise. This means that retailers must understand the demand curves for their stock before raising prices.

For many retailers one solution to rising inflation and faltering sales may be to change the product mix to match the demand of what people are now buying. Consider, for example, how some distillers moved from making gin to hand sanitiser. A change such as this may permit a move toward more price-inelastic goods which suffer less as prices rise.

Regardless, goods shouldn’t be sold without examining the profitability and level of demand for each product line. With a true understanding retailers can drop poor selling items with low profitability in favour of higher margin products or lines that sell in volume. There is, after all, little point in being a busy fool.

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