You’d have to go back to May 1991 to find a month where UK inflation was as high as 7.5%. And with economists projecting that price increases are here to stay for some months longer, you may be asking: “How does inflation affect businesses?”
Of course, inflation has always been a concern for businesses, but in recent times, the impact of inflation on business has become more pronounced, and in 2023, small and medium-sized businesses (SMBs) are grappling with the challenges posed by rising inflation.
The perils of inflation show little signs of slowing yet, so what can you expect if you’re running an SMB? This article aims to shed light on the effects of inflation on SMBs and provide strategies for survival in these challenging economic conditions.
Think of it as our inflation survival guide for SMEs where we review how to negotiate:
The first impact of inflation on small businesses that business owners feel is a general increase in costs.
In many cases, these will be ‘leading’ increases. In other words, they appear ahead of inflation figures.
A good example of this would be fuel and energy prices. As the Ukrainian conflict escalated, the spot price of gas and crude oil spiked, which immediately impacted commercial electricity, gas prices, and the cost of filling up vehicles.
Leading indicators tend to happen before society realises that inflation is happening, whereas ‘lagging’ indicators’ are price rises after we have seen inflation increase.
An example of a lagging indicator would be wage increases.
People see their costs going up and high inflation announced in the news (leading indicators like fuel, food etc), and they feel they need to earn more to compensate, so lagging indicators start to rise (wages, input prices, rents etc).
The above means that large increases in inflation affecting small businesses actually end up being inflationary in their own right.
Business owners will therefore see a general increase in the cost of inputs. Rising inflation leads to higher costs of raw materials, energy, and other inputs, so SMBs relying on these inputs face a squeeze on profit margins unless they can pass on the increased costs to customers.
One of the most troubling effects of inflation on small businesses is that inflation affects consumers' purchasing power, leading to a decline in discretionary spending.
SMBs that are heavily dependent on consumer spending may experience reduced sales and revenue, and it isn’t confined purely to the B2C sector.
Businesses that supply public services could find reduced demand due to austerity measures set by the central government.
Additionally, as the economy slows down, B2B companies will also start to see a reluctance to spend. To paraphrase a famous saying, when the B2C sector sneezes, the B2B sector catches a cold.
As inflation starts to bite, businesses should start to think about ways to stimulate demand, and one way to do it is by reducing prices.
The flip side of this is they may also want to reduce input prices, which means that suppliers will face price pressures. Similarly, consumers will be looking for better value and a market that previously was fashion-driven or quality-led may suddenly exhibit price sensitivity.
When inflation takes off, businesses soon face uncertainty, foggy forecasts, and planning challenges.
The problem is that for a small business inflation creates uncertainty in the business environment, making it difficult to forecast costs, prices, and demand accurately. This uncertainty can hinder strategic planning and decision-making.
Finance businesses love certainty because they can accurately price money.
It means that they understand what they will have to pay funders for the cash they bring in, and it also means that they can easily price their outputs which means that they can in turn accurately forecast profits.
But when inflation rises, it increases uncertainty in the market and in turn, increases the price of money as funders start to ‘price in’ this uncertainty.
So, for businesses that need to borrow to fund expansion or development the cost of money will likely rise significantly in inflationary times.
Given that there is little that any SMB can do to reduce inflation, the most pressing question has to be how to deal with inflation as a small business.
Here are our top tips:
SMBs must analyse their cost structures and evaluate pricing strategies.
Assess whether raising prices is feasible without significantly affecting customer demand. Explore value-added offerings or bundle products/services to justify price adjustments.
Think also about adopting different pricing models. For example, is a subscription model appropriate or would consumers be more attracted to a pay-as-you-go model?
Optimise business operations to reduce inefficiencies and cut unnecessary costs.
Identify areas where cost-saving measures can be implemented without compromising quality or customer experience. Negotiate better deals with suppliers to mitigate rising input costs.
Focus on improving productivity and efficiency within the organisation.
Invest in training employees, leveraging technology, and automating processes wherever possible. This will let businesses achieve more with fewer resources and maximise output.
SMBs should explore diversifying their revenue streams to reduce reliance on a single product or market.
Identify new opportunities and target niche markets that may be less susceptible to the impact of inflation. Expand into complementary products or services to increase revenue sources.
During inflationary times, building and nurturing customer relationships becomes crucial.
Enhance customer loyalty programs, offer personalised experiences, and provide exceptional customer service. Engage with customers through social media and other channels to stay connected and understand their evolving needs.
Remember that a customer who gets exceptional service and benefits they can’t find anywhere else is much less likely to become price sensitive and shop around.
Stay informed about economic trends, industry changes, and customer behaviour.
Make sure you regularly monitor key performance indicators and adjust strategies accordingly. Being proactive and agile in responding to market dynamics is essential for surviving inflationary periods.
Separating small and medium businesses from inflation is impossible. Every aspect of daily operations is likely to be affected and so it’s important to make sure you’re forewarned by adopting excellent environmental scanning.
Back to our original question, what is the inflation effect on small business?
The effects of inflation on SMBs in 2023 are undeniable, with increased costs, reduced consumer spending, and planning challenges posing significant hurdles.
However, it’s possible to take proactive steps to mitigate the impact of inflation on businesses and ensure their survival. By understanding the effects of inflation, implementing effective strategies, and adapting to changing circumstances, SMBs can navigate through these challenging times and emerge stronger.
Embracing innovation, building resilient business models, and fostering strong customer relationships will be key to not only surviving but thriving in an inflationary economy.
Looking to take control of cash flow as step one in controlling costs under inflation? Book a demo today.
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