Inflation is healthy in small doses, but what happens when it spikes?
High inflation affects entire generations as the level of prices for goods and services rise while simultaneously the value of currency falls. The immediate reaction to this is usually to cut costs and raise prices – but who is impacted the most when this happens? More so, what can businesses do to weather the storm?
Inflation in the US: A brief history
We’ve seen it before; inflation rates peaking and troughing throughout history for various reasons including (but not limited to) government spending, monetary politics, and financial pressures brought by periods of war.
1946, for example, saw YoY inflation reach 18.1% due to government deficit spending during the war.
Since then, the US has experienced other periods of high inflation most notably in the 1970s (AKA the era of “stagflation”), peaking at 12.3% in 1974 and again at 13.3% in 1979. This was then followed by a rate of 12.5% in 1980.
Amidst post-pandemic volatility, inflation in the US is spiking once again and has climbed to a 40-year high – reaching 8.3% for the first time since 1982.
Where are we today?
The good news is forecasters believe inflation has peaked, and is now slowing down. However, they estimate it will remain at 6.3% towards the end of 2022. The resulting uncertainty and inflationary pressure creates a challenge for pricing teams – and the solution often involves pushing prices up.
But, when this happens, who feels it most acutely? Who ultimately bears the brunt of price inflations, producers or consumers?
Using the Consumer Price Index and the Producer Price Index, Vendavo has researched the disparity between production price and consumer price to see which consumer items have the highest markup as a result of inflation. The results can be seen on the graph below, and broken down by the following; all items, energy, food and all items less food and energy.
In the food industry, they found that it’s the producers who are currently absorbing the increased costs. In March 2022, consumer costs were 1.4 lower than that of producers.
Energy companies, on the other hand, are passing their expenses on to consumers. January 2022 saw the beginnings of production price increases. By March, those costs had been shifted across to consumers with their costs notably overtaking production costs for the first time this year.
Across all other sectors, consumer costs remain lower than production costs with a difference of 0.8.
So, why are we experiencing such a steep inflation?
Economists have differing views on the precise causes of inflation. The pandemic has evidently had a role in pushing prices up but there is more to the spike in our daily living costs. Among some of the reasons are; supply chain issues, surging demand, production costs and ongoing relief funds.
Obama’s stimulus package during the 2008 recession was a total of $787 billion. Together with the pandemic stimulus support between Trump and Biden, the total comes to $5 trillion. While essential, this aid has ensured supply has yet to respond in kind to growing demand from consumers.
Some blame may also lie at the feet of those corporations who leveraged excessive independent price increases to take advantage of outsized profits.
In response to the inflation and in an attempt to slow down the current economic behavior, the Federal Reserve is discussing raising interest rates – though this could be detrimental if not worked out proportionately.
The advantages and disadvantages of inflation
As we know, inflation can be a double-edged sword.
Moderate inflation is a sign of a healthy economy. It gives the economy an opportunity to grow which also encourages the adjustment of real wages. When average wages are increasing based on inflation it is easier to increase productive wages.
From a pricing perspective, when relative prices are increased by small increments, it makes it easier to adjust pricing overall – which helps to maintain a competitive place in the market. Inflation is also regarded as the better alternative to deflation, which is a warning sign of slow economic growth.
On the other hand, high inflation can create an environment of uncertainty. It is this uncertainty which slows investment, lowers consumer confidence, and slows growth.
This instability leaves pricing teams with the challenge of maintaining the bottom line – a particularly difficult endeavor for organizations who have designed their pricing practices around a stable economy. While low inflation encourages stability and investment, high inflation has the opposite effect.
So, what does this mean for businesses over the next 12 months?
We have extensive resources and guides surrounding how to prepare and price during times of inflation but know this; while there is no silver bullet, there are ways to weather the storm. These include:
- Data-driven, proactive price adjustments
- Price optimization
- Prioritization of high profit products
- Reducing margin leakage
Data is the best tool for times of volatility. Without it, teams are left in the dark and relying on gut instinct to blindly set prices. When the market is uncertain, having greater visibility will leave you in a much better position to be proactive rather than reactive. This means getting ahead in a changing market by leveraging past data to pinpoint pricing opportunities within particular groups eg, specific products, customer locations, or sales channels.
Demand has increased which means that businesses have the scope to increase their prices without losing their customer base. Price optimization allows organizations to improve profits without compromising on sales and internal business objectives. More specifically, price optimization is driven by an infusion of AI insights and human intuition.
Identifying which products bring in the most profit is another key way to ensure your business is hitting its profit goals. Don’t be restricted by demand as this could potentially reduce your profit margins.
The final strategy is one of the most overlooked. More often than not, businesses are unwittingly leaking profits because of poor price optimization at a granular level. Preventing this kind of leakage requires a better understanding of price setting on a transaction-by-transaction basis. A good tool for this is a price waterfall, this enables teams to have better control over price drops, offers and additional discounts to capture more profit with each transaction.
Inflation is expected to drop next year after this year’s peak, but we are unfortunately expected to sit under its dark cloud for the time being. Until the supply chain issues are resolved and Russia’s invasion of Ukraine comes to an end we can’t expect to see a drop off anytime soon. This means we can expect to see inflated prices hitting both producers and consumers in the coming months. For pricing teams, it seems the biggest hurdle is knowing how to price much more intelligently and more proactively to mitigate the worst effects of high inflation.