So What’s the Big Deal About Inflation?

Talk of inflation has the Federal Reserve taking swift action and has sent the stock markets tumbling. What’s the big deal?
Many entrepreneurs have never had to do business in an age of inflation. In fact, the last bad inflationary period we had was almost thirty years ago. Since then, careful control of the economy with interest rate policy has helped to keep things in check.
Recently, many small business owners have begun to feel the pinch of inflation. Health care costs, fuel costs, and many raw material costs due to the many hurricanes of last season are pushing up prices on almost everything. Add to that labor shortages in key areas, and you have the recipe for inflation.
During times of inflation in the past we were still in the old economy and big companies could pass along the increased prices to consumers, who due to stronger unions in those days were able to push wages higher to keep up. If their ability to raise prices fell behind, they had lots of cash reserves and knew that they could soon catch up. They just laid people off, shrunk inventories, and tight supplies then pushed up prices. All of this would continue until the economy ran out of gas. We then had a recession to cool things off.
But, we are now in an entrepreneurial economy. Small businesses are always tight on cash flow. And if their inputs of raw materials and other direct operating expenses go up, they may not be able to pass along these costs quickly enough to keep their cash flow positive. And managing cash flow is not their only problem. From the AP:

Raising prices is a difficult process for many small businesses. Every increase potentially makes them less competitive, and raises the possibility that customers might go elsewhere.

Since everyone will be experiencing inflation if it happens, small businesses will have a little more room to raise prices than they are used to. But, if we have a period of inflation in our near future, it will be different that we’ve seen in the past.
First, some of the major causes of inflationary pressures right now are not within the ability of the Fed to control. Many of the top oil producers in the world are not the most reliable governments right now. Iran, Russia, Venezuela, Nigeria, and Saudi Arabia are all among the top 10 exporters. Some or all of these countries could decide to use oil as a weapon and hold back supply. If that happens, our current gas prices would seem like a nostalgic memory from days gone by. There are predictions of several more years of bad hurricanes. Some say even one more bad season is more than our economy will be able to take.
Second, we are in a much more open, global economy than we have been in the past. When we had inflation in the mid-1900s, everyone was faced with the same pressures and all could raise prices in relative harmony. Inflation is quite variable around the world, and therefore foreign competitors might not face the same inflation rates that we do in the US. That would put us at a huge price disadvantage.
Third, China and India are lurking. Both countries see themselves as the potential economic superpowers of the next century. They are big enough, strong enough, and centrally controlled enough to potentially use inflation and a weak economy in the US as wedge to gain advantage in the world economy.
So what can a small business do these days to try and weather this storm?
– Keep overhead low.
– Build cash reserves to buffer short term price increases that precede higher prices on your part.
– Watch your margins carefully. Worry about growing profits, not sales.
– Don’t lock into long-term contracts that have narrow margins with large customers.
– When inflation heats up even a little, be aggressive with frequent small price increases rather than waiting and trying to catch up at some point with one big jump.
– Pay down variable interest loans ASAP. As long as there is inflation, interest rates will keep going up.
(Thanks to RM Cornwall for passing this idea along).