small business inflation prices

What Is Inflation and Why Is It So High?

10+ min read • Apr 01, 2022 • Derek Miller

 

Wayne Curtiss is the founder of Smack Apparel, a Tampa-based sports T-shirt company. In his 23 years of business, he’s never faced supply chain issues like the ones he’s experienced during the pandemic.

Inflation is a natural and expected part of a healthy economy. But while 2% annual inflation is optimal, the current inflation rate is closer to 8%.

As a T-shirt business, Smack Apparel works with many vendors to produce and distribute its goods—from freelance designers, shirt manufacturers, and screen printers to retailers and fulfillment partners, the path of a T-shirt from concept to customer changes many hands.

While this connected system spreads wealth well during good times, it doesn’t flow as smoothly during tough periods. Rising vendor prices, stock shortages, inconsistent labor, and other supply-chain bottlenecks have forced Smack Apparel to reevaluate some of its processes. 

For example, their biggest fulfillment partner raised its monthly storage fees by 10% this year, making sell-through and inventory management a huge priority. As a result, Wayne has worked to find solutions to mitigate the risks and expenses of excess inventory. “Our goal,” he says, “is not to raise our shirt prices but to improve on operational inefficiencies so we can remain profitable.”

Smack Apparel is just one of the millions of American small businesses experiencing the effects of supply chain shortages, global uncertainty, and elevated inflation (7.9%)—the highest it’s been since 1982.

Rather than shuttering its doors, businesses like Smack Apparel are fighting back and using their available resources to weather the storm. What are these resources, and how can you prepare your small business for inflationary times?

What Is Inflation and What Causes It?

Inflation is a general rise in the overall cost of goods and services within an economy over a period of time. It results in, or is caused by, a devaluation of the currency used to purchase those products and services.

Do you remember your grandparents telling you that soda cost a nickle back in their day? Its rise in price is an example of how inflation works over time. The beverage hasn’t changed much, but the costs associated with producing, marketing, and distributing it have increased while the dollar’s value has gone down.

Inflation is a rise in the overall cost of goods and services over a period of time. Its result: a devaluation of the money needed to purchase those products and services.

While inflation is a natural and expected part of the economy—the Federal Reserve has stated that 2% annual inflation is ideal—periods of high inflation can be a cause for concern. The true causes of inflation are incredibly nuanced—but at the highest level, inflation boils down to 2 key factors: cost and demand.

Demand-pull inflation occurs when demand exceeds inventory or when an economy has a general surplus of buying power. We witnessed an example of this recently with the US housing market. The pandemic increased remote work and the desire to move out of cities, while record-low interest rates made it easier to afford homes.

Demand—as well as the ability to purchase homes—outpaced available inventory, especially with many sellers delaying or delisting their homes because of the economic uncertainty. These and other factors led to homes selling in an average of 14 days and the median housing price in the US reaching a record high ($310,600). 

Cost-push inflation, in contrast, this occurs when input prices for goods or services rise, causing businesses to raise their prices. As raw materials, labor wages, and other direct and indirect costs increase, businesses are often forced to pass those added expenses on to the customer.

For example, the harsh climate in 2021 led to the worst North American barley harvest in 88 years and an increase in its price. Aluminum prices also reached a 13-year high. These 2 goods play a huge role in the beer industry, and combined with increased energy, transport, and labor prices, have put immense financial pressure on brewers.

In fact, the CEO of Heineken recently told The Guardian, “In my 24 years in the business, I’ve never seen anything like it, not even close. Across the board, we are faced with crazy increases. There’s no model that can handle this kind of inflation.” He estimates a 15% increase in costs—which will ultimately force Heineken to raise its prices to consumers.

Why Is Inflation at Record Levels Right Now?

The annual inflation rate rose to 7.9% in February 2022, the highest it’s been since January 1982. Many experts forecast it to continue rising as we begin to fully recognize the financial effects of the war in Ukraine.

The Consumer Price Index (CPI), which measures average prices across several key categories, is rising across almost every sector because of both cost-push and demand-pull factors, including:

How Inflation Affects Different Businesses

Inflation affects every business differently. Generally, inflation will lead to cash flow issues, lower sales, tighter profit margins, and more pressure to increase employee pay.

A business’s vulnerability to inflation is influenced by its industry and offerings as well as its size and buying power, but even the market within which it operates plays an important role.

Companies operating in industries with many customer options—like apparel, tech, and restaurants—are usually some of the hardest hit by inflation. Consumers in these industries are less loyal and more price sensitive, so as businesses increase their prices to offset higher input costs, their customers seek out alternatives.

Whether your business is “essential” or “non-essential” can also play a big role in your ability to handle inflation. Essential goods and services, like gas or healthcare, tend to have lower price elasticity of demand—which means they can raise prices without seeing a huge drop in demand.

Why Should Small Businesses Care About Inflation? 

Inflation directly affects small businesses’ ability to turn a profit. While large brands can typically use their scale and buying power to navigate rising inflation, small businesses don’t have that same luxury.

For example, if you run a small coffee shop, you already have competition with powerhouse corporations like Starbucks and Dunkin’. If your coffee vendors decide to increase their beans by 15%, what can you do?

You could also raise prices by 15% to offset the added cost, but you risk losing customers to the chains with larger profits—and therefore more price flexibility. You could keep prices the same and eat further into your profit margin, but that’s not sustainable long term. Ultimately, you’ll have to make a strategic decision one way or the other.

How Business Owners Can Handle Inflation

Inflation raises the costs of doing business—it can decrease your profitability and have a significant effect on your cash flow. Fortunately, businesses don’t have to sit idly by while inflation eats away at their profit. 

Businesses can combat inflation by increasing prices, selling more goods, lowering costs, or utilizing financing, as well as other strategic techniques. Let’s take a look at some ways businesses can manage inflation.

Businesses Can Raise Prices to Offset Inflation

A recent survey from CNBC and SurveyMonkey asked small businesses how they were dealing with inflation. The resounding answer was increasing prices—47% already raised prices, with another 32% planning to raise them.

Raising prices to offset increased input costs is typically the way businesses handle inflation. If the cost of making and selling your pizza increases by 10%, you simply raise the price from $2.50 a slice to $2.75 (i.e., 10%). 

This approach is usually the easiest for businesses to implement, but it does have risks. Raising prices doesn’t solve the underlying causes of inflation: it simply passes the cost on to your customers, the lifeblood of your business. Depending on their loyalty, a price increase can drive customers to a competitor.

Janeale Dean, a member of the National Small Business Association, had this to say recently about small businesses increasing prices because of inflation: “When small businesses have to raise their prices, the decision is not made lightly. It’s to survive.”

If you decide to raise your prices in response to inflation, consider:

  • Communicating that it’s a short-term increase and not a permanent change: Customers are usually more understanding and accepting of interim price increases.
  • Explain why you are increasing your prices: Customers can appreciate an honest explanation of why you are raising your prices.
  • Raising prices at the same rate of your own cost changes: Don’t arbitrarily raise prices; take time to understand your actual cost increases so you can raise prices only as much as needed.

Businesses Can Decrease Costs to Manage Inflation

Another strategy for handling inflation: controlling your costs and trimming the fat within your business. Lowering business expenses can provide the financial relief needed to offset inflation.

What are some ways for businesses to lower their costs?

  • Evaluate outdated, unused, or inefficient processes: If you examine every business process, you’re bound to find wasted resources. Maybe you have a manual process that takes a salaried employee 10 hours a week to complete that could be automated with software at a fraction of the cost. 
  • Consider the cost savings from remote or flexible work: The pandemic lockdown paved the way for remote and hybrid work. Many businesses are recognizing the cost-saving opportunities that come with a more flexible workforce. One study found that businesses could save upwards of $11,000 a year per employee in overhead costs through remote work. On top of that, more remote work means less reliance on commercial real estate, which creates opportunities to lower rent fees by downsizing.
  • Research your vendors and partners: If your vendors and partners are raising their prices, it may be time to reevaluate those relationships. Are there other vendors providing similar materials or services at lower rates? Can you negotiate a long-term commitment with those partners at a lower monthly fee?

Business Financing Can Help With Inflation

Businesses can also use financing solutions to weather the storm or reposition their company for long-term success. A recent study from the US Chamber of Commerce found that in Q4 2021, 45% of small businesses had taken out loans to deal with inflation.

Solutions like a business line of credit or a merchant cash advance can quickly provide cash flow relief and a safety net for inflation. It can also allow you to make strategic decisions like purchasing more inventory at a potentially lower cost per unit or investing in new technologies to improve efficiencies.

Some businesses are even considering refinancing their current debts. If you’re able to find a lower-interest loan that allows you to consolidate and repay other high-interest debts, a new loan can offer some added relief. Also, be sure to consider your immediate needs. Do you currently have the cash flow to keep your business running? If so, a loan could be a great option, but if you’re looking to get a handle on your business right now, shorter-term financing can get you the funding you need quickly to help get you through the immediate increase in prices. Keep in mind, interest rates will rise in order to offset inflation—so make sure you understand all conditions of the business loan before committing.

What Should Small Businesses Do Now?

Inflation isn’t just felt at the gas pump, it’s felt everywhere—especially within a small business. Inflation is raising the cost of raw materials, making distribution more expensive, and causing employees to push for needed raises. 

These financial pressures are leading many small business owners to wonder about their options. Fortunately, there are ways for businesses to handle inflationary times. From increasing prices to improving efficiencies, owners can take actions to improve the financial health of their business both now and moving forward.

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.

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Derek Miller

Derek Miller is the CMO of Smack Apparel, the content guru at Great.com, the co-founder of Lofty Llama, and a marketing consultant for small businesses. He specializes in entrepreneurship, small business, and digital marketing, and his work has been featured in sites like Entrepreneur, GoDaddy, Score.org, and StartupCamp.