The return of inflation is likely an unprecedented situation in your professional career. You will have to adjust some of your habits, even though the rise in prices remains moderate compared with what it has been in the past and what it still is in certain regions of the world (for the record, the exchange rate between the Deutsch Mark and the US dollar rose from 4 DM to the dollar in 1918 to 4.2 trillion DM to the dollar in 1924).
First of all, remember that inflation makes virtually no difference to your business if your prices rise in the same proportions as your costs. There is a problem, however, if you cannot transfer the increase in your costs to your prices. So it all depends on your negotiating power with your suppliers and your pricing flexibility with your customers. If the two move along at the same rate, the impact of inflation is entirely manageable.
However, there are three specific points to bear in mind:
1. Firstly, to combat inflation, central banks raise interest rates, which increases the cost of credit. This creates a performance differential between companies that are paying back loans at a variable rate and those that are not.
2. Secondly, inflation rates differ from one country to the next. This means that if it carries out part of its business abroad, your company may be at an advantage in some countries (where price rises are higher than at home) or at a disadvantage in others (where your costs are rising faster than local prices).
3. Thirdly, if all your competitors experience the same cost increases and vary their prices in the same proportions, your competitive position should not be significantly affected. However, it is possible that some of your competitors, as well as some of your suppliers or customers, particularly those with low debt levels or a high degree of internationalisation, will take advantage of a windfall effect to increase their margins. Therefore, you need to keep a close eye on price and cost differentials.
The current wave of inflation is the result of two successive shocks: the Covid-19 pandemic and the war in Ukraine. While the war in Ukraine mainly impacted energy and food costs, the Covid-19 pandemic had more widespread consequences. Governments have injected billions into supporting the economy, while the disorganisation of supply chains and the closure of China have led to supply disruptions and relocation to more expensive areas.
If you want to understand how to get through a period of inflation safely, the most obvious recommendation is to talk to your parents.
However, several of these phenomena are in the process of being absorbed, and central banks are beginning to talk about a slowdown in inflation. As a result, if the situation goes into reverse, you need to be careful not to perpetuate your cost increases, particularly salaries, which could become a problem if prices fall. Rather than offering pay rises, which are by their nature irreversible, pay generous but one-off bonuses.
In the 1970s, our economy went through a period of inflation far more virulent than the one we are going through now, but that didn’t stop many businesses from thriving, and the people who were running them at the time can certainly give you some valuable advice. In fact, if you want to understand how to get through a period of inflation safely, the most obvious recommendation is to talk to your parents.
This was previously published in French by Xerfi Canal.
This post gives the views of its author, not the position of ESCP Business School.
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