How does inflation hurt businesses?

In May of 2022, professional networking site Alignable released survey results that found 51% of small business owners were concerned that rising inflation rates may cause them to close their doors in the next six months.  

That’s a grim statistic, but one that illustrates just how much inflation rates can hurt a business. In this article, we take a deep dive into this topic, and explore just how bad inflation is for business.  

What is inflation?  

Inflation, simply put, is when the cost of goods and services rises over time. Business Insider explains it best when they write, “inflation causes your buying power to erode, meaning that the same dollar today buys less in the future.” 

Inflation has several main causes, some of which are more concerning than others: 

  • Demand-pull inflation – this is when the demand for a good or service outweighs the supply, causing the prices to rise. 
  • Cost-push inflation – this occurs when the cost of materials and labor rises, and those costs are pushed onto the consumer by raising the prices of the good or service.  
  • Increased money supply – if an economy’s money supply increases faster than the rate of production, this could result in inflation, because there will be too many dollars chasing too few products. 
  • Devaluation – this is downward adjustment in a country’s exchange rate, resulting in lower values for a country’s currency and higher prices on importing goods from other countries.  
  • Rising wages – simply, when wages face a legislated increased, many businesses will have to increase their prices to accommodate.  
  • Government policy/regulation – policies and regulation can result in a cost-push or demand-pull inflation, such as tax subsidies, building regulations, rent regulations, etc.  

Inflation is normal. 

For the most part, inflation is to be expected. It’s the reason an ice cream cone doesn’t cost what it did in 1950. In fact, you can typically expect an inflation rate of about 2% a year. It’s something you can plan and account for, under normal circumstances.  

Right now, inflation is not normal.  

In 2022, inflation rates are reaching heights we haven’t seen in forty years. While economists have several theories on why this is, most agree that this is fallout from the impact of COVID-19 on the global economy. Here’s how: 

  • Shutdowns at factories, ports, and other crucial checkpoints in the supply chain created huge shortages in a variety of industries. 
  • Waves on online shopping, and decreased expenses in areas like commuting for the consumer, resulted in higher demand for products.  
  • Turmoil in the labor market – such as the ‘Great Resignation’ – led to a labor market and a significant number of empty jobs.  

Right now, inflation also feels very dramatic, because at the beginning of 2020, prices dropped in many areas, such as gas, that have this year seen all-time highs.  

What does this mean for businesses? 

As previously mentioned, businesses – especially small businesses – are incredibly concerned about rising inflation rates. In the same survey from Alignable, 60% of small business owners said inflation has been worse for them than COVID.  

Some of the reasons they cited included: 

  • Reduced revenue 
  • Increased operational costs 
  • Increased rent  
  • Inability to raise prices to meaningfully cover inflated costs 

It’s true that inflation puts businesses in a difficult position, balancing the increased cost of operating with the reduced purchasing power of their customer base.  

Wages become complicated during periods of high inflation.  

Businesses may contend with the difficult decision to raise wages during periods of high inflation. If labor wages can’t keep up with inflating rates of retail prices, your workers may not be able to afford the cost of living. Especially if your employees are living paycheck to paycheck.  

Workers may demand a wage increase or choose to leave. In either case, businesses are seeing lowered profits. Especially with today’s labor shortages, this is an incredibly difficult decision for many business owners to make.  

Not all businesses hurt equally.  

Not all industries are going to see the same damage from inflation as others. In particular, restaurants, hotels, salons, tourism businesses, and other industries that consumers may consider luxuries or unessential will be hit hardest, as they find themselves with less disposable income.  

In May, NPR published an article looking at the fate of restaurants that had survived COVID, only to find themselves in danger because of inflation. In particular, one Boston pizza shop  found that while “sales over the last two years rebounded to about 75% of what they were pre-pandemic… they’ve now slumped back down to about half” due to customers cutting their spending habits.  

What can businesses do to combat inflation? 

If your business or organization is among those concerned about closing due to rising costs, there are some measures you can take.  

The best thing you can do to combat rising costs, is reduce expenses wherever possible. Instead of layoffs or further price increases that might drive away customers, reducing operational expenses wherever possible – by strategies like eliminating paper waste, auditing your invoices for billing errors, or ensuring you’re paying the correct merchant services rates – will free up capital you need to weather the inflation storm.  

Deloitte also advises businesses to proactively address the causes of inflation, such as supply chain disruptions by focusing “on building a diversified supply chain with enough slack to ride out uncertainty.” 

In conclusion… 

While inflation is normal, we are currently experiencing historical highs. This presents many challenges to businesses, but there are strategies that can be taken to combat it.  

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