The phantom of stagflation

Inflation typically occurs when an economy is growing and strong demand push prices higher. In this case the central reason why inflation is going through the roof in Europe, has little to do with demand and much to do with supply shocks.

So why am I speaking about stagflation? Stagflation occurs when there’s high inflation in an economy that is stagnant or contracting. In stagflation, demand isn’t strong, while inflation is sparked by a sharp increase in commodity prices often brought on by a supply disruption. I believe that we have all the right ingredients to be entering a period of stagflation and the rise in interest rates will likely push us further into that direction.

Let’s rewind the tape a bit – well not just a bit but to the early 1970s.

Stagflation occurred in the 1970s when the Organization of Petroleum Exporting Countries (OPEC) imposed an oil embargo that reduced the supply of oil to the US from October 1973 to March 1974. The price of oil surged and led to price increases throughout the economy. Higher oil prices meant consumers had less money available to buy other goods, which hurt companies’ revenue and the economy’s growth. Inflation also meant consumers’ wages couldn’t buy as much as they had in the past. Consumers’ purchasing power was eroding. Workers responded by asking for wage increases. At the time, unions were strong and many contracts included automatic wage adjustments for inflation. Companies facing higher energy prices, higher input costs and higher wages responded by increasing the price of their goods and services and laying off workers. It all resulted in a nasty wageprice spiral. The result was a global economic recession between 1973 to 1975.

Once stagflation arrives, it creates the dual challenges that squeeze businesses as they have to deal with softening customer demand, while costs rise from inflation – making it a very tough environment to run a business. However, those businesses that successfully adapt to stagflation may find themselves better positioned for the economic boom times that normally follow.

The European Central Bank recently outlined its monetary policy which will be based on a number of increases in interest rates in response to the increase in inflation across Europe.

So below are some pointers that businesses can consider to help their business survive the possible tough stagflationary times.

Improve productivity

The best way to survive stagflation is to improve your company’s productivity. Consider investing in software or machinery that can automate processes and reduce human input to produce the same amount of product or service. New software or machinery may be able to produce items faster, with fewer defects and less waste.

Look for ways to cut costs to offset rising prices for materials and wages. Can business operations use less energy? Are there ways to improve the supply chain and reduce shipping expenses? Can the business receive discounts by ordering in bulk or by being flexible about delivery dates? It’s important to find ways to cut costs and offset inflationary pressures.

Cut costs Evaluate prices

Stagflation is an opportunity to reassess pricing policies. Observe whether other companies, particularly those in your industry, are raising prices. If they are, consider raising prices as well to offset increasing costs. Consider offering products or services in a bundle or change packaging in a way that increases price per unit sold. Doing so may allow you to offset rising costs and remain profitable without alienating customers by a blatant price increase. Food companies are known for reducing the contents in bags while leaving prices unchanged. Reducing the contents of the bag allows food manufacturers to reduce one area of cost while keeping revenue unchanged. Another alternative may include offering a new line of more affordable products – reducing quality in a way that customers won’t notice. Or if you have to raise prices, think of ways to improve quality without adding as much cost so customers feel like they’re getting something in return for the higher price. It may also be the time to consider a new pricing model, perhaps selling your product as a service.

Strengthen your sheet Preserve your balance

In stagflation, revenue may not grow while costs keep increasing. Prepare for tough times by building a cushion. That means keeping debt at a minimum. If interest rates are rising, consider replacing any debt carrying floating interest rates with debt that has fixed interest payments.

cashflow

Tighten up accounts receivable and payable. Try to improve cash flow by reducing late accounts receivables and ask your own vendors for the longest terms to make payments. Keep track of inventories, accounts payables and receivables on a very frequent basis.

Keep a watchful eye for opportunities

It’s sad to say, but tough times during stagflation may force many small and medium-sized businesses to go under. If your company is among the survivors and has the financial flexibility, consider bargain acquisitions. Companies that are going out of business or need to raise cash may sell property or equipment at firesale prices. Consider acquiring property, equipment, assets, brand lines or staff with needed skills. Likewise, consider merging or acquiring a competitor if doing so allows both companies to reduce overhead and expand into new markets or offer an expanded array of products or services.

Stagflation is a tough environment in which to operate a business. Costs rise and wages increase. Meanwhile, sales may stagnate or drop due to low economic growth or contraction. Business leaders can use stagflation as an opportunity to take a hard look at their business and make changes to grow stronger. Companies can adopt productivity-enhancing technology that saves time and money. They might change pricing mechanisms, consider merging with or acquiring competitors and strengthen the balance sheet. Businesses that take such steps to survive stagflation may find themselves positioned well for growth when the economy recovers.

Silvan Mifsud is director of Advisory at EMCS Tax & Advisory