The beast is back. Inflation is roaring, and showing no signs of letting up. Small business owners concerned about inflation has increased from 74% in Q4 of 2021 to 85% in a recent update of the Metlife/Chamber of Commerce small business index.
Vulnerability of Small Businesses
The problem for smaller businesses is that they are less able to adjust to inflationary pressures. Small businesses are the weak player when it comes to market power. Time is your enemy right now, as inflation is raging at levels we have not seen in decades.
If you have big suppliers or customers, they can tie your hands. Your costs go up, but you are unable to pass along these costs with higher prices quickly enough to keep up with the inflationary squeeze.
An additional worry is that we have a weak economy with inflation — this is called stagflation. In this scenario, customers begin to sit on their hands. When you raise prices they either buy less from you or even decide not to buy at all. Consumers go out to eat less often and when they do, they buy less expensive meals. They travel less and choose cheaper options. They postpone buying new goods. They also postpone maintenance on our big investments, such as houses, cars, and appliances.
Employee costs were already on the rise due to recent labor shortages, but now will likely accelerate as a result to their own challenges with inflation in their everyday lives.
What to do?
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. Don’t let yourself get behind, as small businesses can almost never play catch-up if the delay price increases.
This can be tough to implement for some businesses, particularly if you publicly list your prices. For example, it can get very costly to print up new menus each month for a restaurant owner who wants to follow this strategy.
But be vigilant. Customers are less likely to pay attention to price increases if they are small, so it is essential to find creative ways to communicate your pricing to allow you to implement this strategy during inflationary times. For example, a restaurant may use menu inserts that can inexpensively be replaced. This was actually very commonly used in restaurants during the 1970s and 1980s when we had high inflation.
In addition, prudent management of finances can help a business survive inflation:
- Find ways to cut expenses without impacting the core value offered to customers.
- Keep overhead low.
- Build cash reserves to buffer short term price increases that precede your ability to get higher prices from your customers. I know this sounds contrary to the investment advice we are now hearing about holding cash during inflation. Don’t think of this cash as investment — it is your lever to hold back the rising tide of inflation. Think of it as an internal line of credit to hold off the impacts of inflation.
- Watch your margins carefully. Worry about growing profits, not sales.
- Don’t lock into long-term contracts that have narrow margins with large customers.
- Pay down variable interest loans ASAP, especially now that interest rates are temporarily relatively low. As soon as inflation heats up, interest rates will continue to rise. And given the stubbornness that the Fed is now showing with interest rates, we may soon see huge spikes in rates over just a few quarters as inflation takes hold.