Of the many pressures currently facing Australian businesses – rising inflation is one of the most pressing. It impacts everything from consumer confidence to the price of the raw materials. However, it can also create an environment for business owners to raise prices.
So, why does inflation occur, what are the effects of inflation on business, and is it good or bad? A little of both, depending on factors such as industry and overheads, as we discuss below.
What is inflation?
Inflation is a general rise in prices within an economy, which correspondingly results in the decline of the purchasing power of a currency.
To put it another way: the higher the price of goods across the board in Australian dollars (AUD), the lower the purchasing power of one dollar. Say a movie ticket cost $10 last year and $10.50 this year – you could reasonably suggest that the price movement might represent an annual inflation rate of five per cent.
However, a price rise by any singular business does not mean inflation is trending upwards. The Australian Bureau of Statistics (ABS) is in charge of calculating the official interest rate in Australia, and it is measured quarterly. It has recently indicated that it is transitioning to monthly inflation reporting.
What are the current trends of inflation?
At the time of writing, inflation is trending upward in western countries. For a snapshot: this year Australia experienced a 7.3 per cent rise in the Consumer Price Index (CPI) in the 12 months to the September quarter; in the USA the rate of inflation is at 8.2 per cent (September 22); and in the UK the CPI is at 9.9 per cent (August 22).
To put those numbers into context, the Reserve Bank of Australia (RBA) has an inflation target of two to three per cent. The USA Federal Reserve has targeted an annual inflation rate of two per cent since 2012.
There is a ‘sweet spot’ when it comes to inflation, as governments do need to maintain a gradual increase in prices over time to keep an economy ticking and unemployment levels low.
The reasons for the recently high inflation in major economies are many and varied. There have been supply chain disruptions due to lockdowns, labour shortages and international conflicts, and spiking prices for fuel and raw materials. Households saved money during the low purchasing times of 2020/21 and then flooded the economy with excess cash for goods that were still resupplying.
What are the negative effects of inflation on businesses?
The following represent some general negative effects of high inflation on Australian businesses. Not every business is impacted equally by rising inflation numbers. For some, it may even generate higher profits. The level to which the below may impact any business depends on what industry it is in, its state of financial health, its level of stock, and other factors.
Some of the negative effects of high inflation include:
- Rising prices often represent rising overheads – Higher inflation can spell trouble for businesses that do a high volume of purchasing annually. These can be raw materials, goods to put on a retail floor, or other necessary items. As the prices for those essential goods rise, management needs to determine how much of this increased cost can be passed onto consumers. For goods with high elasticity of demand, the consumer base may not be prepared to take on the price hike.
- Lower consumer sentiment – As prices appear to unilaterally rise, consumers will naturally look to spend less and save more, conscious of their own budgets. This applies, in particular, to discretionary or luxury goods. In Australia, the Westpac-Melbourne Institute Index of Consumer Sentiment has dropped from approximately 102.2 in January ’22, to a near-historic low of 83.72 in October ’22. Businesses need to be careful to maintain revenue numbers, especially in the face of rising overheads.
- Potentially lower investment – This one depends on the business’s susceptibility to rising overheads and lower consumer confidence. If profit margins dwindle in the face of these factors, investment levels in that business may reduce. Investors may also be feeling the pinch in consumer confidence, adopting a more bearish approach to the market.
- Increased interest rates – Higher inflation has encouraged the Reserve Bank of Australia to raise the official cash rate from record low levels which has subsequently increased repayment amounts on loans.
Are there any positive effects of inflation on businesses?
Yes, there can be positive impacts of inflation for some businesses, as higher inflation does not affect all businesses equally. Some enterprises may actually witness their profit margin increasing due to higher levels of inflation. Some of the general positive impacts of inflation are as follows:
- High profits for businesses that sell goods with fixed demand – Also known as inelastic goods, if the consumer base must continue purchasing your product, despite the rise in prices, then your business may actually see a surge in profitability. Your ability to pass on costs increases, as your goods are essential for your consumers no matter the economic conditions. The classic example would be a business that sells necessary medication to consumers, which they must buy despite changing conditions. Equally, a business with an especially loyal customer base may be able to sustain sales for longer at higher prices.
- Rising investment in profitable business – If, as outlined in the point above, your business can leverage price hikes to increase profitability then you may correspondingly witness an increase in investment. These investors may grow wary of other enterprises more grossly affected by inflationary prices, and funnel more of their investable income towards you.
- Efficiency born out of necessity – Some businesses may use rising inflation as an incentive to review their practices, outgoings and productivity. Sometimes rising costs can stimulate ownership and management into taking action, where otherwise they may not have. Perhaps you might renegotiate the price of your goods or review the costs of utilities and rent within the business. Innovation can be born out of times of pressure.
What can businesses do to combat inflation?
Below are some general suggestions that a business might consider to combat rising inflation. Recommendations more specific to your business will depend on the impact that rising costs and other factors have had on your bottom line, workforce and so on.
- Pass on the price hikes – Where applicable, passing on the increase in the price of the means of production or purchased stock to your consumers will stave off a lot of the cost pressures. As previously stated, this depends upon the elasticity of demand for your goods. The more discretionary the goods that you sell, the harder it will potentially be to pass on any increases to your customer base. If you forecast higher inflation on the horizon, you may even choose to raise your prices early in anticipation.
- Review your costs – This includes everything from rent to utility costs, workforce wages and any other overheads. There can be cost efficiencies found in most businesses, and perhaps higher inflation is the kick that your business needs to conduct such a review. Reducing your exposure to costs that are inflating will go a long way towards protecting the business.
- Take advantage of fixed interest early – If you’re aware that interest rates could continue to rise to combat rising inflation, then you could take advantage of some of the fixed-interest debt options on offer to get out ahead of it all. Repayments will only stand to increase if interest rates keep rising, so it’s important to pick the right time to increase liabilities.
- Ensure you have multiple supply options – As the cost of production inputs rises, ensuring that you have options from multiple suppliers will allow you to better identify the best deal or price option at any given time for your business. The more reliant you are on a particular supplier, the more vulnerable you are to their price increases.
- Increase your levels of essential stock – Now is not the time to be playing games with the supply of your goods. You need to ensure that you have enough stock to be able to supply your customer base without needing to reorder excessively from a supply chain under enormous stress. Excess stock, so long as it can be stored adequately, may be a boon during these times, as there are some long delays in ordering.
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