If you feel like it keeps getting more and more expensive to run your small business, you aren’t imagining things. The country is dealing with the highest inflationary pressure in decades, which is pushing prices up and creating new challenges for business owners.
Wayne Winegarden, Ph.D., a senior fellow in business and economics at the Pacific Research Institute, explains what’s driving this trend and how small businesses can manage going forward.
What Is Inflation?
Inflation is a cycle of rising prices for goods and services. When one price goes up, other businesses respond by raising their prices while workers push for higher wages, causing everything to gradually become more expensive.
“An anecdotal example would be walking into a restaurant and seeing pieces of tape on the menu because the owner raised a meal price from $12 to $13 to $14,” says Winegarden. “Or you go to the grocery store and every week, the prices are higher.”
Inflation causes the value of the dollar to drop, too, because each individual dollar buys fewer goods and services. Over the past decade, inflation has remained between 0% to 2%, so prices went up a relatively low amount.
However, in October 2021, the annual inflation rate hit 6.2% — much higher than what the country has been used to.
What’s Causing Inflationary Pressure?
Winegarden explains that there are two main factors creating this inflationary pressure: “First, we’re dealing with bottlenecks in the supply chain. Not only are the ports backed up, but there are issues later in the chain, like not enough warehouses to store goods as well as a lack of truck drivers.” This is creating shortages of goods and materials at a time when demand is high, resulting in increased prices.
The second factor is action from the Federal Reserve and the government. The Fed has been following loose monetary policy to help the economy recover from the COVID-19 pandemic, actions known as “printing money.” The downside of this approach is that it can cause inflation.
The federal government has also passed bills with trillions of extra spending — between their COVID-19 relief bills and new infrastructure spending — and they’ve been financing this spending mainly with debt rather than cutting other spending or raising taxes.
On top of it all, consumers are looking to spend more after being stuck in lockdown. All of these factors combine for rising inflation and prices.
How Does Inflation Impact Business Owners?
Rising inflation is a challenge for any business but particularly small businesses. “A small business has less leverage when it comes to negotiation,” says Winegarden. “This means they’re less able to pass on the higher costs from inflation and need to absorb more of the hit against their bottom line.”
Bigger companies also have more resources and contacts, meaning they can track the supply chain better, anticipating shortages and finding ways around them — while small businesses can’t access that information. This is most easily seen in industries like construction with shortages of lumber and other raw materials.
“A construction company that only works on a few projects at a time is like the smallest dog at the dinner bowl,” says Winegarden. “Often, they end up last in line to make purchases and are more likely to get stuck waiting.”
Small retailers are struggling, too, because they can only raise prices so much without losing sales to competitors. Winegarden notes that some larger companies, like Walmart, are using this inflationary environment as an opportunity by not raising prices as much.
“They’re taking a temporary hit to gain market share,” says Winegarden. Small businesses likely do not have the cash reserves to do the same.
How Can Business Owners Manage Inflation?
While managing rising inflation isn’t easy, there are strategies business owners can use to get through this challenging stretch.
Explain price increases to customers
If you need to raise your prices because of inflation, explain to your customers what’s going on. For example, a contractor could send an invoice showing the rise in the cost of their materials or a restaurant owner could post a sign saying that the price of meat has gone up 15%. When customers see that the extra charge is due to your costs, not to boost your profits, they might be more understanding.
Buy early and in bulk
Since prices could keep rising for the foreseeable future, you could buy supplies and raw materials in advance when you have access to them. That way, you avoid future price increases and trouble with shortages.
You could also talk to your suppliers about potential ways to qualify for discounts, like by making bulk purchases or paying purchases upfront in cash. This could help offset an increase.
Loans and equipment financing could help you make these larger purchases now before prices go up.
Reduce your offerings
If you’re worried about raising your prices, you could slightly reduce the quality/quantity of your product or service. For example, you can sell smaller packages of goods for your current price or reduce the number of employees working at once (though customer service may take a hit).
While you still need to run an effective business, this is another way to pass on the inflation costs to your customers without raising prices.
Be careful with idle cash
Inflation gradually reduces the value of each dollar. Money sitting in the bank won’t have the same buying power a year from now, meaning you could lose wealth even if your balance is the same.
Try to put some of that money to use, possibly by prepaying inventory. For the money you do keep in savings — perhaps for your emergency fund — see what you can do to earn a higher return. Maybe you can find a high-yield business savings accounts or inflation-linked CD, which pays more as inflation rises.
Are There Upsides to Inflationary Pressure?
Overall, inflation is a challenge for small businesses. However, there’s one way it can be an advantage, and that’s by taking out a small business loan. In the same way that inflation reduces the value of your savings over time, it also reduces the value of your outstanding debt.
For example, if you borrow $100,000 and inflation is 5%, a year from now that same debt will only be worth $95,000 in today’s dollars because of the inflationary loss.
A loan could help you implement some of the strategies mentioned, like advance buying materials. If you do borrow, aim for a loan with a fixed interest rate so the loan payments don’t increase along with prices.
How Long Will This Inflationary Pressure Last?
Winegarden doesn’t see rising inflation being resolved any time soon. “Given all the issues in the supply chain, it’s going to take months, maybe even an entire year, before everything gets sorted out.”
He also notes that government spending, like from the infrastructure bill, will continue over the next year, creating more inflationary pressure. Further, the Fed doesn’t seem ready to raise interest rates (a move to offset inflation) until 2023.
That’s why Winegarden thinks rising inflation will continue throughout 2022 and possibly even 2023. “Business owners should realize that this is not a short-term issue, and they should take steps to prepare,” he advises.
By planning for more inflationary pressure and using strategies to manage it, small business owners can better position themselves within this tough economic environment.