If you’ve watched the news; or visited your local grocery store; or filled up your car with gasoline, you've noticed that we are experiencing inflation. If you own a small business, you may feel overwhelmed with employees asking for more money; and customers leery of price increases. In this post, I will illustrate what's happening; and what you can do to proactively retain your employees and charge your customers a fair price.
Causes of Inflation
There are several causes to the inflation that we see currently in the U.S. This is post is not intended to point the finger at Democrats or Republicans. The fact is that many of these causes of inflation have happened under both political regimes. Here are the major contributors to the increases in our Consumer Price Index from the modest 2% that it was in 2019, to the whopping 7.5% that it is today.
Pandemic Response. The response by our government was to close businesses that had any public pandemic spread risk. The businesses that were allowed to stay open had onerous restrictions that increased costs, in most cases. To make this close down less painful, the government injected trillions of dollars with grants, unemployment benefits and other funds into the economy. The combination of reducing productivity, decreasing the supply of goods, and increasing the cash supply is a recipe for inflation that started in April 2020 and has not worked its way through our economy.
U.S. Oil Exploration Restrictions. Stopping the Keystone XL pipeline along with increasing public land lease rates, and other restrictions on fossil fuels created a spike in gasoline prices in 2021. The average price of a gallon of gasoline rose from $2.40 to $3.40. Another driver of this quick increase in gasoline prices is the low demand in 2020 due to the pandemic followed by many people returning to the workforce in mid 2021. On top of all of this, Russia is threatening to invade Ukraine as I write this blog post which will increase gasoline prices further in 2022.
Supply Chain Disruptions. It is hard to find the exact culprit for the supply chain disruptions. However, these disruptions are real; and they are driving prices higher. The causes have been rumored to be from vaccine mandates, sick employees, trucking slowdowns, dock worker strikes, government work restrictions, disruptions in Asian manufacturing, etc. Regardless of the cause, supply chain slowdowns have limited the growth of home construction, food availability, and other key drivers of the U.S. economy.
Federal Reserve Shenanigans. To help stimulate the economy, the Federal Reserve did two things: 1) kept the Federal Funds Rate to 0%; and 2) increased it’s buying of assets. I don’t want to dig too deep into either of these topics. Suffice it to say, both actions add fuel to an already inflating economic environment. Home prices are skyrocketing as homeowners see a chance to buy more house with low interest rates. Large businesses are borrowing money at the low rates as well. Home interest rates are staying low because the main underwriter of these loans is the Federal Reserve. These are many of the assets they are buying. In 2022, the Federal Reserve will be reversing many of these policies to try to reduce inflation.
Government Spending. Government spending is not as large of a contributor to near-term inflation as it will be to future inflation because most added spending will happen over a longer period. Congress recently approved the Bi-Partisan Infrastructure Bill to add $1.2 Trillion in spending over a five-year period. This bill adds more fuel to inflation fire as the nation implements infrastructure improvement projects.
Low Unemployment: They say when unemployment drops below 5%, you will struggle to find anyone who is unemployed who wants to work. The unemployment rate is currently at 4%. This low rate of unemployment drives wages higher and adds to inflationary pressure.
The reason that I went through this long list of causes of overall inflation is that these events have a direct impact on the actions you take as a business owner. Inflation puts pressure on your employees to desire higher wages and salaries.
The Consumer Price Index (CPI) is 15% over the past three years. This means that $100 worth of goods in 2019, will cost $115 today (2022). At first glance, you may come to the conclusion that you can raise your prices and wages by 15% compared with 2019 and be fine.
Unfortunately, the CPI is understating the true pressure felt by your employees. Food prices have risen by 29%; gasoline prices have increased by 43%; and housing costs have increased by 17%; when compared with 2019 prices. When you look at a weighted average, many of your employees are experiencing a cost-of-living increase of 22.6%. If you add this cost-of-living increase to traditional merit increases in pay, you should be paying your staff 30% more than you paid them in 2019.
Employees & Wages
Inflationary pressure will affect your employees differently depending on their age and current wealth status.
Upper Middle Class: If your employees are homeowners, in the higher middle class earning brackets, they will feel little effect from inflationary pressures. In fact, they may have benefited from increases in stock investments, and their home value giving them a sense of being wealthier. The one pressure that they may feel is in consumable items like gasoline and food.
Minimum Wage to Lower Middle Class: If your employees are renting, they will be experiencing a tight rental market with high rents equal to the spike in home prices in your local area. They will also experience increased cost pressure on food and gasoline. The longer their commute to work, the greater influence gasoline prices have on their desire for higher wages.
In both cases, most people do not fully understand inflation. Especially, since average inflation over the past several years has been near 3% per year. In fact, gasoline prices had been dropping prior to 2021. Your employees will be reacting to what they hear on the news… what they experience at the gas pump and grocery store. They may hear their peers talking about pay increases.
Actions with Employees: Be proactive with your employees. Increase their pay when you see these prices increasing. Communicate to your people that you will be taking action to increase prices so that you can pay them well to keep up with rising costs.
Customers & Prices
You’ve probably figured out that if you are giving your employees more money; and your supplies are costing you more money; you must increase your prices.
Customers will have the same reaction to this price increase that you must giving your employees more money than they’re used to. Let’s face it, people get used to paying a certain amount. In fact, they may have thought your current price was too high. The fact is that price is a mathematical calculation based on your costs, your profit margin requirements and competition.
Your Costs: If you give your employees a 30% wage increase and labor is 30% of the cost of goods sold, you must increase your price by at least 9.0% to cover this wage increase (30% X 30%). Let’s say the remaining cost of your product has increased by 10% due to inflation. This means that you will need to add an additional 7.0% (70% X 10%). The total increase in price due to your cost increases in this example is 16.0% (9.0% + 7.0%).
Your Profit Margin: If your profit margin is 10%, and increases due to costs are 16.0%, then your price must rise by 17.6% ((1+10%) % X 16.0%). Otherwise, you will gradually diminish the profitability you desperately need in a time of inflation when suppliers can raise prices on you at a moment’s notice.
Your Competition: It is highly likely that if you are proactive, your competitors will not react as quickly as you to increase their prices. Don’t worry… inflation is not an optional expense. Everyone pays it and your competitors will need to do the same.
Can I Ignore Inflation?
Inflation has causes that are beyond your control, so there is little to do that you are not already doing to increase cost efficiency.
Here’s what will happen if you ignore inflation or delay acting. Your employees will eventually grumble and complain that they’re not making enough money. You will think it’s a normal complaint and ignore it. Your best employees will leave; and your worst employees will want to be paid more. Since the employment market is tight, you will struggle to find employees at the same price that you were paying your previous employees. You will end up hiring poorer quality people, for the same price you refused to pay your best employees. You will also create a culture of distrust… and in the end, you’ll have to raise your prices and wages. Why not be proactive?
I hope you’ve learned how to act promptly in this new era of inflation. I also hope that you take this advice to heart so that you emerge on the other side of this inflationary event (whether long or short term) a business winner… instead of a business whiner 😊
You can learn more about how I coach my small business clients at www.mmbizcoach.com.