If everything seems more expensive today than it did a year ago, you're not alone. And if you're a small retailer, you've seen those costs chip away at your bottom line. The culprit? High inflation. Fortunately, it won't last forever, but high inflation is a factor for every retail business in 2022. And it's why we put this guide together — to show the difference between regular inflation and high inflation and how you can soften its impact on your retail business. During the past 6 months, 45.7% of U.S. retail businesses have reported a noticeable increase in the price of goods and services. What Is Inflation and Why Is High Inflation Bad? Inflation is an economic term used to describe an overall increase in the price of goods and services within an economy. A devaluation of the currency used within that economy is a byproduct of inflation. For example, if you’re a clothing retailer and used to pay $4 for a T-shirt two years ago, you may now pay $5 for that same shirt. The shirt has not changed at all, but it’s become 25% more expensive. Inflation and the dollar’s devaluation are part of the reasons you now pay $1 more for that same T-shirt. Most people hate the word inflation because they associate it with volatile expenses like gas prices, which rise and fall sharply depending on many unpredictable factors. However, inflation is neither good nor bad, but rather a natural process within a healthy economy. Inflation is simply a reaction to many other uncontrollable factors within an economy. It tends to be a response to two overarching occurrences: increased demand and elevated costs. Increased demand is considered a more positive signal for inflation. It happens when an economy has more money and can afford to purchase more goods and services. This increased demand will eventually lead to a decrease in supply, which causes businesses to raise their prices. On the other hand, cost-push inflation is typically a more negative form of inflation because it occurs when input expenses rise. As direct and indirect costs within a business increase, it’s often offset by businesses increasing their prices. Both forms of inflation are completely normal and expected across the life of an economy. In fact, the Federal Reserve claims 1.5% to 2% as the normal rate of annual inflation for the US. At this rate of inflation, economies can grow predictably and without any drastic changes in consumer or business behavior. Unfortunately, the US economy has experienced 13 straight months with inflation of over 2.6%. In fact, the last time inflation was below 2% was in February 2021 (1.7%). Chart: US Inflation Calculator Long periods of elevated inflation create more issues than the occasional peaks and valleys that we’ve come to expect. While retailers can typically deal with a few months of high inflation, extended inflationary periods often require some strategy changes. For retail businesses, inflation can cause cash flow disruption, inventory surplus, elevated storage fees, lower revenue, and shrunken margins. To help combat these issues, it’s important for you to have a deep understanding of inflation and how it affects your retail business specifically. With this insight and some strategic maneuvering, you can better position your retail business to survive this and future periods of high inflation. Let’s take look at how inflation affects retailers and what you can do about it. How Does Inflation Affect the Retail Industry? During the 12 months ending in January 2022, the retailers experienced wide ranging price increases. Here's a view of some key items: Food: 7.9% Electricity: 9.0% Natural gas: 23.8% Other items: 12.3% Shipping: 11.14% Rents (shelter): 4.7% Computers: 1.03% Meat, fish, poultry, eggs: 13.0% Fruits and vegetables: 7.6% Non-alcoholic beverages and materials: 6.7% Truck transportation of freight: 18.3% Maintenance and repair: 18.1% The retail industry is a pretty large umbrella that covers many categories like electronics, clothing, appliances, furniture, personal care, and more. The effects of inflation on your specific retail business will often depend on the market within which you operate, your size, and other direct and indirect factors. However, most retailers will have a similar relationship with inflation—and the parties associated with your retail business will share some of the experiences below. Customers (negative): If you happen to raise your prices to offset inflation, you are pushing the burden of inflation onto your customers, which leads to higher prices and less consumer value. Staff (negative): Most retailers pay employees hourly or salary, which is a fixed rate determined before the inflationary period. Because your staff’s pay is not tied to the inflation rate, the value of their paycheck decreases as inflation rises. This could lead your staff to push for higher wages. Supply chain partners (negative): Your supply chain partners are also facing inflation within their business and might be passing on those added expenses to you. For example, If your retail store has a fulfillment partner, you may have noticed some increased expenses recently due to the higher gas prices. If it costs more for your partners to deliver your products, it could lead them to increase their fees. Retail business owners (negative): Unless you make strategic decisions to combat inflation, you run the risk of letting it shrink your margins and eat away at your financial stability. How Does Inflation Impact Your Retail Operations? Inflation has both a direct and indirect relationship with how you operate a retail business. While other businesses like restaurants and construction companies worry most about the direct effect of inflation on input costs, retailers have a much more complicated relationship with inflation. The impact of inflation on retailers is quite nuanced and involves several considerations. For example, one of the biggest impacts of inflation on your retail store isn’t even within your business—it’s how your customers respond to inflation in their own lives. If your retail store sells nonessential items, inflation could cause a decline in demand as consumers reallocate spending to more essential goods and services. Fortunately for most retailers, consumer spending has been largely consistent following the pandemic thanks to government stimulus checks and low-interest rates. However, we could start to see this trend pull back soon with the Federal Reserve raising interest rates and if inflation continues to stay high. Beth Ann Bovina, the US chief economist at S&P Global, recently told the NY Times that “inflation is crimping into household purchasing power,” and that even though people are starting to see increased wages they aren’t growing at the same pace as the inflation rate, which means “... you can’t buy as much stuff with it anymore.” In February 2022, retail sales grew 0.3% over January 2022, but it was below the expected 4.9% pace. This could indicate that customers are already starting to decrease their nonessential spending. While consumer spending habits are definitely important to your retail operations, so are the many direct effects of inflation on your day-to-day operations. For example, retailers usually work with wholesalers who provide the goods you make available to customers. The typical markup is about 50% for a retail store. So, if your wholesaler charges you $10 for an item, you would charge $15 to the customer. If that wholesaler wants to raise their prices to you by 10% to offset their own inflationary issues with production, this would take the cost from $10 to $11 ($1 more). While only a 10% increase in cost to you, if you don’t raise your prices to your customer your profit goes from $5 to $4, which is a 20% decrease in profit. Beyond wholesalers and customers, inflation can also affect rent fees if you have a brick-and-mortar store, energy costs, warehousing, fulfillment, and pressure from employees for higher wages to cover their higher standard of living. Ways to Mitigate Inflation’s Effect On Your Retail Business Many retailers have yet to feel the full effects of inflation because of the surge in demand following the reopening of the economy after the lockdown. However, as interest rates rise and consumer buying power lessens, many retailers may begin seeing a pullback in demand, which will create more need to respond to inflation. Forward-thinking retailers will look to get out ahead of these trends and begin mitigating the effect of inflation as soon as possible—not only when necessary. Below are some strategies to help manage inflation within your retail business. Consider Digital Sales Channels In the wake of COVID-19, many brick-and-mortar retailers looked into alternative sales channels like eCommerce and buy online, pick up in-store (BOPIS). These digital sales channels allowed retailers to capture business without requiring foot traffic in their stores. These new revenue streams for retailers have stuck and should continue to be a big part of the retail landscape moving forward. A recent study from eMarketer estimates that 20.3% of worldwide retail sales will be done online in 2022, totaling $5.542 trillion, and by 2025 that number will be $7.39 trillion and 23.6% of retail sales. Source: eMarketer Retailers looking to combat inflation should consider adopting digital sales channels because they: Collect sales 24/7: Online sales channels are available around the clock to convert customers and collect sales. Require low overhead: Operating online sales channels requires fewer resources than operating a brick-and-mortar location. Offer more value to customers: Customers appreciate options and having an online store with delivery can increase sales and provide more convenience to your customers. Find and Fix Inefficiencies While you can’t control inflation, you can look into your operations and find areas to improve and limit waste. These small, incremental changes can have a significant impact on your retail business while mitigating the effect of inflation. Some areas within the retail business model where you might find inefficiencies include: Inventory management: Most retailers don’t have a good handle on their inventory, which, with inflation, can be one of the more costly resources for your retail business. In fact, the inventory accuracy of retailers is roughly 60% to 65% on average. If you can improve your inventory management, you can avoid overstocking underperforming items while always having your best sellers available. Sales trends: Do you know the trends that exist within your retail business? Are you seasonally dependent? Does it take your customers six months on average to convert? If you understand the actual data behind how your customers interact with your retail business, you can use that to make better strategic decisions. Maybe you’re extremely depending on holiday sales to turn a profit, which might mean you only operate three days a week throughout the rest of the year to minimize overhead. Fixed and variable costs: Inflation is often felt most in your business expenses. From rent and electricity to advertising and payroll, inflation can drive these costs up quickly. These areas are also where you may find inefficiencies. Maybe you’ve noticed that advertising in the local paper has been less effective since the pandemic or maybe you can negotiate better terms with your landlord. If you can cut costs in these areas, it can help your retail store manage inflation better. Manage Inflation with Consistent Cash Flow At the end of the day, the goal of mitigating inflation’s effect on your retail business is centered on the principle of maintaining consistent cash flow. If you negotiate better rental terms with your landlord, it's because you want to decrease your monthly overhead. If you launch an eCommerce arm, it’s in an effort to increase your revenue. Both activities aim to increase the cash coming in while decreasing the cash going out—cash flow. If your retail business is spending more than you’re making, you’ll have negative cash flow. If you’re bringing in more cash than you’re spending, you’re cash-flow positive. The benefit of consistent cash flow cannot be overstated. It gives you the stability to continue operating as usual, and it also allows you to capitalize on high-yield opportunities. If you have enough money on hand to cover payroll, you can keep your staff happy. If you have enough money to double your next reorder for a sold-out item, you can capture more sales in the future and avoid having a good product out of stock. Consistent cash flow mitigates inflation’s impact because your business can continue operating without pause. If you’re able to have a steady flow of working capital, you don’t need to make any sweeping changes. Now, that doesn’t mean you shouldn’t always be looking to improve, but it does give you more flexibility to grow at your own pace. Fortunately, you don’t have to rely solely on your retail store to drive consistent cash flow—which is especially important if you're a seasonal business. Retail borrowing solutions like a business line of credit and merchant cash advance can provide cash flow relief. If you’re a retailer looking for help managing consistent cash flow year-round, a business line of credit may make a lot of sense. This type of financing acts as a safety net for your retail store. When business is good, you don’t have to touch it—and you won’t be charged. If you do have a down month or are dealing with added expenses because of inflation, you can pull from that line of credit to cover those costs. You are only charged for what you borrow. Finding a financing option for your retail business gives you assurance and stability. If you’re looking into loan options for your retail business, consider Lendio’s network of vetted lenders, which provide flexible business financing solutions for retailers. Don’t Be Deflated by Inflation If your retail business is still alive in 2022, that means you’ve survived one of the most challenging periods for small businesses in our history. Your retail store made it through a global pandemic, so you can definitely make it through some inflation. As you look for ways to manage inflation in your retail store, focus first on how to operate more efficiently and eliminate waste in your business. This mindset is not strictly for inflationary periods, you should always strive to run leaner—but it’s especially helpful for managing costs. If you still find that you need additional capital to run your business, look into small business loans with favorable, flexible terms. Interested in financing? Find out what your small business is eligible for with Lendio’s 15-minute online application. Additional resources and data sources: https://www.ers.usda.gov/data-products/food-price-outlook/summary-findings/ https://fred.stlouisfed.org/categories/33583 https://www.bls.gov/ppi/ https://www.nbcdfw.com/news/local/construction-costs-hit-highest-spike-in-50-years/2891677/ https://www.agc.org/sites/default/files/users/user21902/PPI%20Tables%202022_01.pdf https://www.cnbc.com/2022/03/10/rising-airfares-are-giving-people-spring-break-sticker-shock.html https://www.macrotrends.net/countries/USA/united-states/inflation-rate-cpi Disclaimer: The information provided in this post does not, and is not intended to, constitute business, legal, tax, or accounting advice and is provided for general informational purposes only. Readers should contact their attorney, business advisor, or tax advisor to obtain advice on any particular matter.