For consumers and businesses alike, inflation is driving up the price of everything from food and fuel to building materials, housing and vehicles.
According to the US Department of Commerce report released on June 30, the Personal Consumption Expenditure (PCE) price index rose 6.3% in May 2022 compared to the same period last year, fuel prices rose 35.8% year-on-year and food prices rose 11. The %PCE price index hit 6.6% in March, the highest rate seen since January 1982, according to a recent CNBC report.
The report noted that goods price inflation rose by 9.6% and services prices rose by 4.7%. The national average for a gallon of gas was about $4.76.
Add in ongoing labor shortages that prompt higher wages to attract and retain workers, and that makes some businesses’ margins even tighter.
With many consumers already feeling strapped for cash, further news of price hikes at their favorite restaurants, shops and service providers will likely not be a welcome development. So, what is a business to do?
We asked some economic experts to weigh in with their best advice for business leaders in the current inflationary economy.
Jose Fernandez is associate professor of economics and chair of the Department of Economics at the University of Louisville, and he says that when it comes to business activity, inflation has both early and late effects.
When input prices—think ingredients for manufactured goods or ingredients purchased by restaurants—start to rise, business leaders often feel the need to cover their margins by sharing the burden with customers and raising prices, he said.
However, doing so risks alienating a fraction of your customers, who may leave in search of a better deal.
“In general, just raising your prices may not be the best course of action unless you have a specific product where consumers are not sensitive to price changes,” Fernandez said.
Some businesses adopt a cost-plus pricing model, Fernandez said, taking into account their own cost to sell and characterized by a fixed margin across the board. But instead, business owners should identify which products are both in high demand and not consumer-sensitive to price changes, and focus on increasing margins on those products.
Business owners can take this opportunity to reevaluate their product mix and get creative with the inputs they need to produce higher-margin products, he said.
Fernandez noted that business owners also need to consider that their employees, who are facing price increases in many areas of their daily lives, may also want higher wages.
Brad Smith is the managing partner of tax, accounting and consulting services firm MCM CPAs and Advisors, with offices in Louisville, Lexington, Indiana and Ohio. Smith works mostly in the manufacturing and distribution sectors.
Normally, Smith said, inflationary pressures lead to a quick rebound in hiring, but today there are more jobs available than people to fill them.
While there are many predictions about how long or deep this deflationary cycle could be, Smith said that’s just speculation, especially with the combination of a global pandemic, supply-chain disruptions and a shrinking workforce.
Still, he said, the economy has caused anxiety among his clients, who worry about what the ultimate impact will be.
When the rising cost of doing business is passed on to customers, business leaders must ask themselves, “At what level is the ceiling hit or a breaking point that can be passed or not?” she said.
Timing is also a factor in how quickly companies will respond to price increases. A smaller gap between a business cost increase and the ability to recover the cost of additional costs from increased market value is good for a company. Later, if the price comes down, the price adjustment can be reconsidered.
Smith’s advice is not to panic but to be proactive in assessing the risk to determine what steps need to be implemented if something happens. He likes to see that client companies plan ahead and are disciplined about maintaining and controlling costs in good times, a practice that pays off when times are tough.
“From my experience, the organizations that have been most successful maintain that discipline as much in the good times as in the bad times,” he said.
Blue & Co. In LLC’s Lexington office, Ryan Graham is a CPA and Director of Audit, working primarily with clients in the manufacturing and distribution industries.
He encourages business leaders to “keep an eye on costs and not hesitate to pass those increased costs on to customers, perhaps more frequently than in the past.”
“If traditionally there was an annual price increase, it may be necessary to have a semi-annual or even quarterly price increase/adjustment,” Graham said. “Today, more than ever, transparency with customers is important.”
He said it’s also important to keep an eye on the lower margin line of business and, when possible, prioritize higher-profit-margin products.
With borrowing rates rising, it’s crucial to monitor business lines of credit and budget for potentially higher interest expenses in the coming months or even years, Graham said.
Although inflation will affect all businesses, Graham notes that it will certainly affect some more than others and that different parts of the economy will experience different rates of inflation. For example, fuel costs have risen at a higher rate than other aspects of the economy, so businesses with high transportation costs will feel those effects more.
“Reevaluate business processes and procedures to determine if there is an alternative method or input that can be used to reduce costs and increase margins,” he said.
The importance of messaging
Thomas H. Carver is a CPA and Director/Commercial Products at Forvis Tax, Audit and Consulting Services in Louisville. Carver says that if we’ve learned anything in the past two years, it’s that early estimates of how long an economic problem will last are “almost always too optimistic.”
Last fall, some economists predicted a back-to-normal supply chain and inflation projections by the end of this year. Yet now, “the prospect of seeing any sort of resemblance to pre-pandemic supply chains and mid-2023 inflation levels looks dim this month,” he said.
Forvis clients have taken a variety of approaches to mitigate these issues, Carver said, with many trying to shift from international suppliers to North American-based options to increase reliability and reduce freight costs. Still, even domestic freight costs have risen dramatically, he said.
Some lucky clients have the space, capital and suppliers to buy inventory in advance and in bulk, taking advantage of price discounts to beat forecasts of future cost increases, he said.
“However, after decades of improving lean inventory processes, many clients have reduced warehouse space and no longer have the available square footage to hold additional inventory,” he said.
As a result, companies have raised prices to protect their margins, Carver said. He, too, stressed the importance of sending a message to consumers about the price hike
“What most customers are looking for is an explanation,” he said. “They want to understand the background of why costs have gone up, rather than thinking you’re taking advantage of the situation and pushing through big increases.”
Understand the impact of price increases
Michael Clarke is director of the Gatton College of Business and Economics at the University of Kentucky’s Center for Business and Economic Research and thinks the Fed “put the brakes on the economy months earlier than it should have.”
“It could have moderated some of the inflation we’re seeing,” he said, adding that most economic forecasters expected inflation to moderate by the end of 2021.
He was once among them, distributing Covid vaccines, reopening schools and returning workers to their jobs, thus boosting production and improving supply chain issues. Clarke said there were fears at the time that raising interest rates could significantly slow the economic recovery.
“But those assumptions turned out to be wrong,” he said. “At the very least, raising interest rates early will help moderate inflation over the past few months.”
Given the resulting level of inflation, Clark said, business leaders should make sure they have a healthy understanding of how large and unexpected price increases can affect their bottom lines.
“Many businesses have to price inputs or outputs months in advance,” he said. “This can be extremely risky as prices can quickly move differently than you expect and reduce profit margins. Some businesses such as construction contractors may be able to transfer some of the uncertainty to their customers by setting flexible prices for their contract materials rather than fixed prices.”
Businesses can find ways to increase production of goods and services to take advantage of higher prices — the lumber industry is a good example — providing a strong stimulus and temporary opportunity for some, Clark added.
Given the impact of the pandemic and the embargo on Russian oil after Russia invaded Ukraine, Clark said the causes of inflation are somewhat unique this time around. As a result, it is difficult to predict how long the high prices will last.
Pamela F., Managing Director of Mariner Wealth Advisors. The economy is actually in a strong position with low unemployment and high job openings, said Thompson, who has offices in Louisville, New Albany and Cincinnati.
“The tight labor market has put upward pressure on wages, pandemic-driven supply shortages and the war between Russia and Ukraine have added to inflationary pressures,” Thompson said. “This ‘perfect storm’ has driven year-on-year CPI inflation to the highest level in 40 years, leading to significant increases in interest rates.”
Although some slowdown is likely, he expects the Fed to end raising interest rates by the end of the year, or thereabouts.
“While the economic impact of rising rates occurs with a lag, it has already begun, so we would expect the recession to be over by mid-2023,” Thompson said. “As far as financial markets go, they always move ahead of economic data, so while the Fed’s outlook for rates and inflation is expected to moderate in 2023, we’re cautiously optimistic that it could actually be a strong year. Markets and Investment Perspectives.”