Although inflation in the U.S., based on the U.S. Consumer Price Index, was reported at only 1.5% last year, many businesses have experienced much higher inflation and it could get worse. 

Imported petroleum is up 21% over the past year- driving up transportation, raw materials, and commodities.  The U.S. dollar has depreciated 5% in the last year which generally tends to drive up prices for imported goods.  Import prices were up 1.4% in February, the fifth straight monthly increase in excess of 1%. The U.S. federal debt and budget situation may create more inflationary expectations.

One of the biggest problems with controlling inflation relates to inflation expectations. Once these expectations begin rising, inflation becomes much harder to control.  The bulk of the inflation concerns are currently in food, imports, raw materials, commodities, and transportation- a pretty big slice of our economy.  And, if that’s not enough, inflation expectations could spread to our labor markets.  Although currently constrained by high unemployment, the more prices rise, the higher the probability inflation will spread to labor- a huge slice of our economy.  Finally, as domestic suppliers see foreign producers raising their prices many of them will follow suit. 

So, what should we do to manage our businesses in an inflationary environment? 

·         Start at the top.  You need to strive to grow your sales faster than inflation.  You need to decide if you can or will pass along your price increases to your customers. Do you compete on price or quality/service? What will increased prices do to your current customers, future customer prospects, and your market strategy? What are your competitors doing?  If you raise prices, will you still be competitive? How much do you need to increase prices to maintain your margins and how much will the market bear? All tough questions with potentially huge ramifications.  

·         Manage your margins.  What inflation have you seen and what do you think will follow?  For cost items, think hard about substitutes.  Are there things you can avoid purchasing by incorporating substitute materials? If you believe key items will continue to go up, consider buying larger quantities now- you may be able to get additional volume discounts.  Can you combine your buying requirements with others to get volume discounts?

·         Stay flexible.  If you decide to raise prices, how will that affect your sales volume?  Rather than rushing out to hire employees and adding another fixed cost, think about using temporary staff until your sales demand becomes clearer.  Are your customers buying more now anticipating a price increase?  Is your top line increase sustainable? 
 

·         Understand your cost structure.  Are your fixed costs so high that if your sales fall, will your profit fall faster? 

·         Manage your product offerings.  Know what margins you make on your top customers and product offerings.  Evaluate your product margins, it might be time to get out of low margin products or expand and promote your higher margin offerings.

·         Contracts- Try to negotiate inflation escalation adjustments in your sales contracts.  On the other hand, try to avoid inflation escalation clauses in your purchasing contracts.

·         Hedging- For some companies, there may be opportunities to hedge your commodity or other key material expenses. 

·         Get more aggressive on your cash collections.  The time value of money will likely increase along with inflation and interest rates.  On the other hand, negotiate longer payment terms if possible from your key vendors.   

·         Inflation is good for debtors because the loan will be paid off in ever-cheaper dollars. If you’ve been thinking about borrowing for a project, now may be a good time.  Interest rates are still near historic lows.  As inflation goes up, interest rates will rise.  Lock into a long-term fixed rate loan now if possible.

Not managing inflation effectively is a major re-distributor of wealth, plan now.