Surging inflation continues to impact customers and businesses alike, even in the wake of the interest rate hikes intended to abate it. While rate hikes have had some impact, The Fed’s November Survey of Consumer Expectations still predicts moderately elevated inflation over the next three years.
The year’s rising inflation brings with it unprecedented challenges for businesses, who must manage increased costs, volatility, and unpredictability. Because this cycle is driven by multiple factors – including demand-driven inflation during the pandemic, supply-side inflation from a loss of manufacturing, and geopolitical factors – businesses may find themselves grappling with multiple, or more nuanced, challenges compared to past cycles.
But careful planning can help businesses meet customers’ changing needs, as well as develop strategies to succeed in times of inflation. Here's how inflation may be affecting businesses today, as some helpful practices for effective inflation planning.
How does inflation impact businesses?
Rising prices often prompt customers to tighten their wallets, as wages fail to increase in line with inflation. But inflation is regressive, and not all customers – or businesses – are affected equally.
“The pressure is always on those who are most economically constrained,” explains Karen Harris, managing director of the Macro Trends Group at Bain & Company. “Energy prices and food prices are going to take up people’s disposable income, as their spending shifts to needs rather than wants.” As a result, businesses whose customers are most vulnerable to the effects of inflation may face more volatility than those with a more affluent customer base – especially if their goods aren’t considered essentials.
Some service businesses may not yet see the same squeeze, as demand for services remains high in the wake of the pandemic and the economy recalibrates demand between goods and services, Harris says.
But strong demand brings its own set of challenges during times of inflation, as companies may need to stretch their budgets to secure staff. Base pay is the top reason job-hoppers left their last employer, according to a 2022 report released by Grant Thornton, and job hunters identified base pay that did not meet their needs as their top reason for declining job offers. As employees' cost of living increases, employers may have to pay more to attract the talent they need.
Why inflation planning is important
On a basic level, inflation raises costs – of supplies, labor, and energy. This means businesses may be forced to rethink their pricing and develop strategies to help the company survive – or even thrive – during times of volatility.
Businesses need to do some scenario planning to weather the storm, says Harris, and create strategies to address multiple potential outcomes. “This is not the time to over-estimate certainty and conviction in a single outcome,” she says.
The bet on the length of inflation, for example, isn’t a clear one. As Deloitte reports, their baseline scenario, in which the experiences very slow growth at the start of 2023, forecasts inflation moderating back to 2% by the end of the year. However, they note the possibility that consumers may increase spending in anticipation of greater inflation and rate hikes, keeping prices high and to sustain higher levels of inflation for longer.
How companies can plan for inflation
When it comes to inflation planning, there’s no one-size-fits-all approach, Harris says. The impact of inflation differs from business to business. However, she recommends the following process to start mapping out your next steps.
Start by identifying key variables for forecasting
Inflation planning goes far beyond taking a high-conviction forecast and torquing it up and down by 20%, Harris says. Instead, companies should consider the three to five factors that matter most to their business, and consider how they may be impacted by inflation.
Trends in customer spending should be top of mind as businesses look to the future. “If you’re creating a consumer product, for example, the type of household you appeal to will matter a lot,” says Harris. “Our team has found that the affluent spend tends to be highly correlated with equity market performance, whereas the middle class spend is more closely correlated with housing and housing wealth.”
Customers’ changing preferences are key, too. “Focus on understanding your customer’s engagement. Think about what their pain points are and how you can work to solve them and provide the value they want,” Harris says. “That doesn't mean you can't price for confidence, but you should be confident about what you're providing in a way that's generating value.”
Finally, companies should consider how larger economic trends shape their business. “If you’re a software company, then macro may not matter much to you. If you’re in natural resources, the geopolitical climate will matter a lot,” she says. However, beware of focusing too heavily on the macro, Harris cautions. “If you have more than five macro variables, then you’re probably over-specifying your model.”
Then, rethink your value and adapt
Once these key variables have been identified, companies can begin modelling how their business may change as a result of inflation – and develop strategies to address these changes.
The best plans will differ from business to business: some companies may find they need to adjust their pricing strategy, refine their offerings to address changing customers’ needs, or adapt their hiring strategy to meet consumer demand. Others may find their current business plan is the best one, and opt to stay the course.
The bottom line
Rampant inflation has forced customers to rethink their spending, and businesses need to anticipate to how inflation may impact their business in the short-, medium-, and long-term and plan accordingly.
Strategic planning ensures these decisions are intentional. “This is not a world where you can plan, then do,” says Harris. “It is truly a world where you need to think about different future states, and how you would create options and hedges to protect your business through times of volatility.”
By forecasting and focusing on your customers' evolving needs, you can put your organization on track to succeed in these turbulent times – and, potentially, come out the other side even stronger.
