For consumers and businesses alike, inflation has been putting a price pinch on everything from food and fuel to building materials, housing and vehicles.
According to a U.S. Department of Commerce report released June 30, the personal consumption expenditures (PCE) price index rose 6.3% in May 2022 compared to the same time last year, energy prices rose 35.8% over the past year, and food prices climbed 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 inflation was up 9.6% and the price of services rose 4.7%. The national average for a gallon of gas hovered around $4.76.
Add the ongoing labor shortage that’s prompted higher wages to attract and retain workers, and that’s made some business’ margins even tighter.
With many consumers already feeling strapped for cash, more news of price hikes at their favorite restaurants, shops and service providers won’t likely be a welcome development. So, what’s 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 economics department at the University of Louisville, and he said when it comes to business operations, there are early and late impacts of inflation.
When the price of inputs—think manufactured product components or the ingredients purchased by restaurateurs—starts going up, business leaders often feel a need to cover their margins by sharing the burden with consumers and raising prices, he said.
However, doing so risks alienating a fraction of your customers, who may leave in search of a better deal.
“Typically, just increasing your prices may not be the best thing to do unless you have a particular product where consumers are not that sensitive to price changes,” Fernandez said.
Some businesses adopt a cost-plus pricing model, Fernandez said, taking into account their own cost of items to be sold and marking them up by a fixed margin across the board. But instead, business owners should pinpoint which products are both in high demand and aren’t consumer-sensitive to price changes and focus on increasing the margins on those products.
Business owners might also take this opportunity to reevaluate their product mix and be creative with the inputs that they do have to make even more higher-margin products, he said.
Fernandez noted that business owners also have to consider that their employees, who are also experiencing price increases in many aspects of their daily lives, may also ask for higher wages.
Brad Smith is managing partner for tax, accounting and consulting services firm MCM CPAs and Advisors, which has offices in Louisville, Lexington, Indiana and Ohio. Smith works mostly with manufacturing and distribution sectors.
Typically, said Smith, inflationary pressures result in a quick pullback in hiring, but today there are still more available jobs than people to fill them.
While there are lot of predictions as to how long or deep this inflationary cycle may go, Smith said it’s only speculation, especially given the confluence of a global pandemic, supply-chain disruptions and a shrunken workforce.
Still, he said, the economy has sparked concern among his clients, who worry about what the ultimate impact is going to be.
When the rising cost of doing business is passed through to customers, business leaders must ask themselves, “At what level does the ceiling get hit or a breaking point get hit of what can get passed along or what can’t?” he said.
Timing is also a factor in terms of how quickly companies should respond to escalating prices. A shorter lag time between a business’s cost increase and the ability to recoup costs of added expenses from increased market pricing is better for a company. Later, if prices decrease, price adjustments can be revisited.
Smith’s advice is to not panic but be proactive in performing a risk assessment to determine what steps need to be implemented if certain events do occur. He likes to see that client companies have planned ahead and in good times were disciplined about maintaining and controlling costs, a practice that pays off when times get tighter.
“From my experience, the companies that have been the most successful maintain that discipline as much if not more in good times as in tough times,” he said.
At Blue & Co. LLC’s Lexington office, Ryan Graham is a CPA and director of the audit department, working primarily with manufacturing and distribution industry clients.
He encourages business leaders “to be monitoring costs and to not hesitate to pass along those increased costs to customers, possibly more frequently than in the past.”
“If there was traditionally an annual price increase, it may be necessary for a semi-annual or even quarterly price increase/adjustment,” Graham said. “Today, more than ever, transparency with customers is key.”
He said it’s also important to be mindful of lower margin lines of business and when possible, prioritize high-profit-margin products.
With borrowing rates increasing, 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 impact all businesses, Graham notes it will certainly impact some more than others and different parts of the economy will experience different rates of inflation. For example, fuel costs have spiked 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 approach or input that could be utilized to reduce costs and increase margin,” he said.
The importance of messaging
Thomas H. Carver is a CPA and director/commercial products for FORVIS tax, audit and consulting services firm in Louisville. Carver says if we’ve learned anything over the past two years, it’s that any early estimates of how long an economic issue will last “are almost always too optimistic.”
Last fall, some economists predicted a back-to-normal supply chain and inflation projection by the end of this year. Yet now, “the prospect of seeing any sort of resemblance of a pre-pandemic supply chain and inflation level by mid-2023 is looking dimmer by the month,” he said.
FORVIS clients have taken various approaches to mitigate these issues, Carver said, with many attempting to move away from international suppliers to North America-based alternatives to increase reliability and decrease freight costs. Still, even domestic freight expenses have dramatically increased, he said.
Some fortunate clients have the space, capital and ability of suppliers to purchase inventory in advance and in bulk, taking advantage of pricing discounts to beat predicted future cost increases, he said.
“However, after decades of lean inventory process improvements, many clients have reduced warehouse space and no longer have the available square footage to house excess inventory,” he said.
As a result, companies have raised prices to protect their margins, Carver said. He, too, underscores the importance of messaging to consumers about price increases.
“What most customers are looking for is an explanation,” he said. “They want to understand the background of why costs are up rather than feeling like you are taking advantage of the situation and pushing through large increases.”
Understand the impact of raising prices
Michael Clark is director of the University of Kentucky’s Center for Business and Economic Research in the Gatton College of Business and Economics and feels that the Fed “should have hit the brakes on the economy a few months earlier than it did.”
“This could have eased some of the price increases we’re seeing,” he said, adding that most economic forecasters expected inflation to moderate by the end of 2021.
He was once among them, buoyed by COVID vaccine distribution, schools reopening and workers returning to their jobs, thus increasing production and improving supply chain issues. Clark said there was fear at the time that raising interest rates may have substantially slowed an economic recovery.
“But those projections turned out to be wrong,” he said. “In hindsight, raising interest rates early would have helped moderate inflation over the past few months.”
Given the resulting levels of inflation, Clark said business leaders should ensure they have a healthy understanding of how large and unpredictable price increases could affect their bottom lines.
“Many businesses must set prices for inputs or outputs months in advance,” he said. “This can be extremely risky because prices could quickly move differently than you expected and erode profit margins. Some businesses such as construction contractors might be able to shift some of the uncertainty to their customers by having flexible pricing on materials built into their contracts rather than fixed prices.”
Businesses that can find ways to ramp up production of goods and services to take advantage of higher prices—the lumber industry being one good example—can provide a strong incentive and temporary opportunities for some, Clark added.
The causes of inflation are somewhat unique this time around, said Clark, given the impact of the pandemic and the ban on Russian oil after Russia invaded Ukraine. As a result, it’s difficult to gauge how long high prices will last.
The economy is actually in a strong position, with unemployment low and job opening high, said Pamela F. Thompson, managing director of Mariner Wealth Advisors, which has offices in Louisville, New Albany and Cincinnati.
“The tight labor market has put upward pressure on wages, adding to the inflationary pressure created by pandemic-driven supply shortages and the war between Russia and Ukraine,” Thompson said. “This ‘perfect storm’ has led to year-over-year CPI inflation at its highest level in 40 years, which in turn has led to a significant increase in interest rates.”
While some degree of recession is likely, she expects the Fed to be finished, or nearly so, in raising interest rates by year’s end.
“While the economic impact of rising rates happens with a lag, this has already begun, so we would expect the recession to be over by sometime mid-2023,” Thompson said. “As far as financial markets go, these are always moving in advance of the economic data, so with the Fed winding down and the outlook for inflation hopefully declining going into 2023, we are cautiously optimistic that it could actually be a strong year from a market and investment perspective.”