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The impact of inflation can be felt in every corner of the economy. On a personal level, we feel the financial pinch each time we fuel our vehicles, buy groceries, and even heat or cool our homes. But as a business owner, the impact of inflation can be a double-edged sword. Not only are you feeling it on the homefront, but you’re likely also experiencing increased production costs and the margin erosion that can come with them. Join me to see how you could protect or increase your profit margins during inflation, using strategic levers.
Follow Along With The Financially Simple Podcast!
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- Annual inflation rates in 2022
- How inflation changes the nature of business
- The pros and cons of adjusting the pricing of your products or services
- The ‘five by five principle’ and controlling your spending
- during inflationary times
- Differentiating strategic and non-strategic expenses
- The power of accurate accounting and inventory controls
- Using the efficiency of technology
- Prioritizing high-profit margin products during inflation
- The economic cycle
Are Inflationary Pressures Slowly Killing Your Business?
This past June (2022), it was announced that inflation in the United States reached 9.1%, the largest annual increase since November of 1981. But this trend has been revealing itself for some time now. Since April of 2021, producer prices have gone up by at least a 5% year-over-year increase each month. Through September 2021, producer prices saw an 8.6% increase, marking the largest annual increase since the Producer Price Index (PPI) begin reporting annual changes in 2010.
When you combine all of this with supply chain disruptions, labor shortages, rising energy costs, etc., the impact of this trend has been rough on business owners. Each of these crises on its own would be difficult, but the combined weight could potentially lead to profit loss and margin erosion. Friends, it would be really easy to just curl up in a ball and try to pretend none of it was happening right now. But that’s not who you are. You’re business owners! You press on in the face of adversity, charging hell with a water pistol. You’re tenacious. That’s good because these are traits you’ll need to weather the storm and come out on the other side.
This is no surprise to you, though. The business climate isn’t necessarily the most hospitable right now. So, what can you do? How do you make the best of a less-than-ideal situation and position your business to come out better than before? The same thing you’ve always done… you adapt! Let’s take a look at some of the financial and strategic levers you could use to increase profit margins during inflation.
It’s Not Just About Price Adjustment
Following the previous recessionary trend in 2008, Harvard Business Review analyzed 5,700 global companies and found that those that cut costs to improve productivity the most during previous inflationary periods saw higher total shareholder returns (a median of 27%) than those who took less action. Beyond simply adjusting pricing to accommodate the inflationary increase, the best performing businesses in this study employed multiple levers to increase their margins and outperform the market. Like these companies, you must be vigilant and agile.
While it may seem obvious, I can’t emphasize enough, the importance of protecting your cash flow. You must have enough in reserve to prepare for the unexpected. When times are tough, having the cash reserves on hand to cover your business’s operating expenses can be the difference between thriving and merely surviving. Having a healthy cash flow and maintaining a well-funded reserve enables you to be agile. It can allow you to quickly shift to new ways of operating or explore new opportunities. While targeted pricing actions could offer some short-term relief, properly managing your cash flow and reserves could present long-term solutions.
However, this doesn’t mean you should ignore your pricing strategy. Increasing prices may be necessary, but you should evaluate the pros and cons before making any long-term decisions.
Pros
Raising your prices to combat inflationary pressures often offers some immediate relief. This could be an opportunity to increase your cash reserves to allow greater maneuverability. Additionally, most companies are actively adjusting their pricing strategies to offset shrinking profit margins amid inflationary pressures. This opens the door for your business to do the same with less backlash from your clientele.
Cons
On the other hand, price adjustments are a short-term solution. They don’t offer the same long-term strategic value as other strategies during inflation. In fact, increasing prices could do more harm than good. Although you’re moving your price point to be more aligned with the costs of production, it could exacerbate the decrease in your clients’ buying power. They might accept the price increase, but it could cause them to buy less often. Therefore, increasing prices could negatively affect your bottom line in the long run.
Before deciding whether to adjust your pricing, be sure to review all outcomes. Schedule some time to speak with your advisory team and weigh the benefits against the consequences. You may find that it’s a necessary tactic as long as it works in conjunction with other strategic levers in your business. However, you could also find more effective strategies for your business. But, beyond pricing, what other levers can you employ?
Control Spending: Strategic vs. Non-Strategic
It isn’t uncommon to see businesses making broad-based cuts to their spending during times of financial hardship. However, doing so could cause you to miss out on the optimal return and fail to maximize shareholder return. Therefore, you must differentiate between strategic and non-strategic spending, making your cuts on the non-strategic side. But, how do you determine which of your expenditures are strategic?
Strategic expenses are those that will yield an immediate (or soon after) profit. For example, strategic spending could include the protection of your intellectual property if you’re spending money to file patents or copyright protections. Similarly, employing outside consultants or advisors could be a strategic expense. Let’s say your company uses a tax strategist. The annual tax savings they could help you receive, potentially, could be far greater than the money spent to retain their services.
On the other hand, non-strategic spending doesn’t yield a return. Some examples of non-strategic spending might include salespeople who don’t close on a consistent basis, non-commercialized research & development, or even the “nice to have” but not needed items (a certain type of coffee, premium brand toilet paper, etc.) in the office.
In addition to reviewing strategic vs non-strategic spending, you could implement controls to consume less. Although you may not always be able to negotiate the ability to buy better, you could control costs by employing more accurate inventory and accounting practices. One of the companies in the HBR study discovered that they were able to save $300MM in annual costs by empowering a “spending czar” to break down silos within the organization and make all spending decisions go through them. This could provide greater control over how and when your business spends.
Use Technology, Systems & Processes More Efficiently
It may seem counter-intuitive, but sometimes it’s necessary to cut products or services that don’t net enough of a profit. In doing so, you can maximize efficiency by focusing your efforts on the most profitable actions in your organization. Additionally, by eliminating unprofitable or low-profit work, you could also increase profit margins by cutting the labor required to perform it. The strategic elimination of work could save businesses a substantial amount of money.
Automation like Robotic Process Automation (RPA), workflow, and intelligent document processing can also provide many benefits from labor cost savings to greater stability. Additionally, it can free up your team members to work on more strategic activities. The more efficiency you can incorporate into your operations, the more you can cut costs. These are cost savings that can be passed on to your bottom line.
Speaking of your bottom line, you want to make the highest and best use for your profitability. This requires an effective review of your products, services, systems, and processes. In doing so, opportunities to improve efficiencies or cut costs could be revealed. For example, rather than hiring delivery drivers, you could use a service such as DoorDash or GrubHub.
You might also move to discontinue the products or services that net the lowest ROI, or begin offering once standard services by request only. These strategies have already been successfully used by many businesses. For example, many hotels now offer “By request” housekeeping services, rather than the traditional daily cleaning and replenishing of rooms. Similarly, Oreo maker, Mondelez International has been working toward a goal of phasing out 1 out of every 4 product offerings since the early months of the pandemic.
Wrapping Up…
It is possible to increase profit margins during inflation. However, you must be vigilant and agile while actively seeking ways to control costs. Identifying the right levers ones for your organization and then implementing them is a time-consuming endeavor. That’s where a trusted coach and advisor could be of value. If your don’t have one, reach out to our team.
Look, I know life is hard. But, my friends, life is good. Navigating your business through the tumultuous waters of inflation can be frustrating. It doesn’t have to be. With a little determination and some help from your advisory board, you can make it at least, financially simple. Let’s go out and make it a great day!
If you have further questions or need someone to come alongside you to implement the appropriate levers for your business, reach out to us. We have trusted advisors throughout the country, who are ready to help you.