No matter your life path, there are universal truths that apply to us all. One of those is the fact that inflation rates have a huge impact on all of our daily lives. Another important universal truth is that most of us have no idea what the heck the term inflation rate means (even though it is a constant topic in the news no matter where you live). With it being a global issue, it’s only right to conclude that it also has a major effect on businesses, and that impact trickles down to the rest of us. No matter if you're a business owner, an employee or a non-working citizen, inflation is the monster hiding in all of our closets.
With that being said, we at MicroMentor wanted to address those things in this blog. Specifically, we want to answer the question, “What is inflation and what is its impact on business?". To be clear, those are two huge topics that need to be covered. So let's break them down a bit and discuss. Starting with the question….
What Is Inflation?
As mentioned earlier, the inflation rate is pretty much always in the news (even while doing research for this blog, at least a half dozen news stories came up). To simply put it, inflation is a measure of the continuing price increase of goods, services and cost of living in an economy. It is usually measured over a longer period of time.
To be clear, inflation does not refer to sudden increases in which the price of something skyrockets based on demand and then drops just as quickly within a short period. A good example of this is when Uber prices are suddenly high in your area during a thunderstorm because everyone in that area is requesting rides, only for the prices to go back to normal within the span of an hour or so after the storm. This isn’t inflation. Inflation is both nationwide (and/or global) and sustained.
In terms of why inflation is happening, the simple answer is production costs. When it costs more to make a product or produce a service, the provider must also raise their prices in order to continue to make a profit. Another thing that plays a key role is the demand for a specific product or service and the consumers' willingness to pay more. Think of the Uber example from a moment ago, and if the surge pricing sustained over months, years or decades. We’ll delve more deeply into this point in just a moment.
Again this is a brief explainer on a very large topic. A perhaps more simplistic and cynical view on inflation is that it’s an economic equivalent to a snake eating its own tail. But now we know about what inflation actually is, let's take a look at…
What is its impact on businesses?
Inflation can impact virtually every aspect of a business, so the short answer to this question is everything. This is one of the most frustrating things about this topic from both a business standpoint and a consumer standpoint. With this in mind, we are going to take a look at inflation for both of those angles. One of our most important goals at MircoMentor is to empower entrepreneurs, so we want to especially focus on how it affects you directly as well.
Impact on businesses…
Earlier in the blog we mentioned Uber's surge pricing. Their prices tend to surge when two things happen: demand is very high and less drivers are available. Opinions on surge pricing aside, when it happens it can be almost fascinating (if not extremely frustrating) to watch in real time. A $5 ride might suddenly rise to $10, $20 or $50 within the span of a half an hour.
This usually happens in the case of an event, such as a sudden rainstorm when everyone suddenly wants a ride, or a public transit outage or if there is a major event like a concert or baseball game happening in your area. As demand for rides cool off, e.g. the storm ends, transit service is back up etc., the prices will plummet back to normal. In that way it’s almost like watching the stock market. As demand for a stock grows, so does its price. Also keep in mind, those surge prices generally only affect a specific city or section of a city at a time.
So how does this example affect the average business? First off, to reiterate a previous point, inflation rates don’t spike and valley within the span of a few hours in a small area. They tend to be sustained and national. Well say you own a construction business that builds houses. If the price of concrete rises by 6% due to the cost of the material itself, you are now paying 6% more for that material. That also means that by default you have to raise the prices on the houses you’re building to make up for it.
The same could be said if you own a grocery store or a restaurant and the price of lettuce goes up, or if you run a small coffee house and the price of coffee beans goes up. Your costs and the costs of a cup of coffee or a salad at your store goes up as well. These are broad examples of inflation impact on business mind you, but they are no less true.
Now factor in those few examples across every business in your city. Seems pretty straight forward right? Well here is where the snake eating its own tail thing comes in. Another example using the construction thing is this: if the inflation rates cause the costs of houses in a major city to skyrocket, fewer and fewer people can afford to buy or rent homes there. So those potential homeowners start looking for a smaller city nearby where homes are cheaper. As people leave the big city for the smaller city that has now become popular, those prices also rise. If you’ve ever thrown a rock in a standing pool of water and watched the waves ripple from the center outward, think of those ripples like smaller cities becoming more expensive.
But in a way, that is kind of good for businesses like construction right? That means they get to charge more for their product due in part to the sustained demand. Wrong. The problem is that as costs overall rise, people need to be paid more. Meaning that Inflation rates will cause your business to spend more to keep their employees. To be clear, businesses should try to keep up with inflation. Some businesses may not be able to, but if they can, they should. A company's best asset isn’t a product, it’s its staff
It mat be easy to think that the solution to inflation is simple. “Okay, so my costs go up, I can just charge more so that my businesses can continue to thrive”. While this may be true, there is one thing that this solution does not factor in…
Impact on consumers…
Now we’re getting to the other side of that coin. In a very basic sense, as a consumer, prices have now gone way up. That house or office space you were looking at renting or buying? Due to the increased inflation rates, you and many others may now decide against buying/renting that property because it’s now out of your price range.
On top of that, you may decide to spend money on other important things. Your groceries also cost a lot more, your utilities cost a lot more, transit costs a lot more. As mentioned before, inflation rates affect everything. So having said that, the cup of coffee you enjoy on your way to work may not seem like a worthy expense anymore. Especially if it's a decision between a cup of coffee or something from the grocery store.
In short, consumers will generally spend less as prices rise. Unless it’s absolutely essential, things that are considered as “luxury items” will generally be the first to feel the hit. Hopefully this point helps you see how it all ties back together. If you sell a product that now due to inflation rates people can no longer afford, your business may suffer. Those houses you built might sit empty. Those coffee pots may go dry. I know I keep using those same analogies but again it's like a snake eating its own tail.
Inflation is a complicated economic topic, but we hope that we could provide you with a basic understanding of what it is and what it looks like in action. We also hope that the next time you hear about the inflation rate on your local news channel, you’ll know a little more about what’s happening. Just remember, it affects us all in some way. BUT, if you’re a business owner, it doesn’t mean you’re looking at a financial apocalypse. It may just mean shifting gears a bit. That, however, is a topic for another blog at another time so stay tuned in!