Updated on September 20, 2021
Inflation is rising at a troubling rate in some industries. Does your business management reflect this?
In order to safeguard against the impacts of inflation, you need to ensure better control over your costs to protect your company’s profit margins.
What causes inflation?
After rising 3.7% in July, the Consumer Price Index (CPI) rose 4.1% in August 2021 compared to August 2020. This is its fastest increase in 18 years.
The increase in inflation is largely associated with the decline in prices (particularly gasoline) seen in the spring and summer of 2020. It is also due to significant imbalances between supply and demand for many goods and services. More than half of the components of the total CPI basket showed annual price growth above the Bank of Canada’s upper inflation target (3%) in August.
Supply chain disruptions
Much of the inflation is attributable to disruptions in the supply chain. The pandemic has interrupted production or reduced the available workforce, and the transportation of goods has also been affected in various ways over the past year. As a result, there is less product available in some sectors at a time when demand is booming.
Higher demand in some industries
Household spending has shifted. Because they are unable to travel, many people have decided to renovate, decorate, garden or equip themselves for various outdoor activities. Suddenly, demand in these sectors has outpaced the available supply, which causes prices to rise.
Moreover, savings are relatively high and deconfinement may stimulate spending. Any significant increase in demand is likely to drive prices up.
Other factors contribute to inflation: the workforce shortage is pushing up wages. The restaurant industry, for example, is strongly affected by this situation.
Cost of health measures
In some areas, the health measures resulted in extra costs. Staff had to be added to enforce these measures and businesses needed additional supplies (medical masks, disinfectants). Mandatory distancing reduced production capacity, while demand remained stable or increased.
How does inflation impact businesses?
Inflation erodes profit margins by increasing the cost of purchasing inputs.
In the construction sector, for example, contractors sold houses at prices set long before the materials were purchased and now have honour their commitment, even if the project is no longer profitable.
The erosion, or even disappearance, of margins, puts the financial health of these businesses at risk.
How can you protect your profit margins in an inflationary market?
Have a clear view of your cost
Only a minority of SMEs have a good knowledge of their costs. Many set prices according to market prices, without checking whether this makes sense in their own business. At a minimum, businesses should know their contribution margin, which is total revenue minus variable costs.
You have to make sure you cover variable costs when you sell your products or services. In today’s market, many variables are changing simultaneously (wages, inputs, cost of health measures) and it is important to have a clear view of the costs.
Secure your supplies
It is important to do everything possible to secure supplies. Can you sign longer-term supply contracts to guarantee your purchases at predictable prices?
You should also cultivate your relationships with your suppliers, because in the current context of shortages, some of them may choose to stop serving you in order to prioritize more profitable clients. A good relationship can potentially avoid this type of setback.
Before passing on price increases to consumers, it might be better to consider your operational performance. So far, few companies in Quebec have invested in a digital transformation. Optimizing processes generally increases productivity by 15% to 25%.
You can generate more services or products with less waste using the same work force, thereby reducing your costs. You are not responsible for inflation, but you have the power to adapt by taking action on this aspect of your activities.
Rethink the business model
Sometimes this is the only option remaining. In more vulnerable industries, rethinking the approach and being open to new business opportunities in a fluctuating market can be beneficial to keep margins at an adequate level.
In order to avoid taking the wrong approach, let our experts assist you. They can provide guidance and save you time and money. Moreover, many subsidy programs are available to allow entrepreneurs to benefit from such expertise.
16 Jun 2021 | Written by :