Over the last year, consumer prices rose 7.9%, according to the latest data from the U.S. Bureau of Labor Statistics. The Consumer Price Index covers the prices of food, clothing, shelter, fuels, transportation, doctors' and dentists' services, drugs, and other goods and services that people buy for day-to-day living. This is the highest 12-month increase since 1982.
Increases in the price of consumer goods will affect most businesses, sooner or later. For example, if you operate a restaurant, spikes in food prices directly affect you. If you operate a fleet of delivery vehicles, you're already feeling the effect of rising gas prices. And manufacturers have been hit with higher energy, commodity and shipping costs.
Meanwhile, the producer price index (PPI) is up 10% over last year. This is the largest increase on record for wholesale inflation. PPI gauges inflation before it hits consumers. The U.S. Bureau of Labor Statistics reports that whole energy and food costs were up 33.8% and 13.7% in February 2022 compared to February 2021.
Inflation impacts profits. Although you might be able to absorb some temporary cost increases, at some point, you'll probably need to raise prices to remain profitable. But, if your competitors hold out on increasing their prices, they might gain an instant competitive advantage, which could lead to turnover and reduced market share.
The decision to raise prices by how much and when depends on demand for your products or services, market trends, customer loyalty, and how long high inflation rates persist. Even if you're able to implement a successful price increase, there's a limit to how far you can go. Then what can you do to stay profitable?
Link Pay to Performance
The next step is taking a fresh look at your cost structure for savings opportunities to offset cost increases. Unfortunately, this may be challenging for companies that have already cut costs during the COVID-19 pandemic.
A logical starting point is payroll. It's the largest cost category for most businesses, and many companies have been forced to raise wages to attract and retain workers during the so-called "Great Resignation." If you've raised the pay for certain key positions, you'd probably expect a corresponding increase in those employees' productivity. Review those workers' productivity levels to determine whether there's indeed a connection between pay and performance.
Next evaluate whether your performance assessment process is effective. That means having clear and detailed job descriptions in place, including performance indicators and annual objectives. Performance reviews need to be performed regularly against those objectives. Document the results. Accountability for productivity is the best way to achieve it.
Optimize Staffing Levels
The performance review process can help identify opportunities to reduce headcount. How? Before giving existing workers a raise, discuss whether they'd be willing to take on additional responsibilities. These discussions could open the door to some tactical downsizing.
Also, when evaluating payroll costs, look for perks you're providing but aren't valued by employees. Some benefits, such as occasional free lunches and company parties, can be suspended without significant pushback from employees.
While generous health benefits are usually a good way to attract and retain employees, consider whether you might be being more generous than you're legally required to be. For example, are you paying more to subsidize health benefits than other employers in your area?
Other Savings Opportunities
Payroll and benefits aren't the only areas that can be scaled back to counter inflation. Consider these popular savings opportunities:
Using independent contractors: Labor laws tend to discourage companies from converting employees into freelancers. In fact, under certain conditions, the IRS may reclassify independent contractors as employees — a potentially costly scenario for a business.
However, you might be able to use contractors to augment your staff or replace workers who've left. Generally, using freelance help is more flexible than employing workers — you use contractors only as much as you need them, at a cost that's negotiable.
Renegotiating service contracts: Make a list of all your service contracts. Examples include phone, Internet, software licenses, equipment leases, landscaping, cleaning, security, insurance and professional services. You can lower these costs by 1) switching to a less-expensive competitor, 2) negotiating a lower rate with your existing provider, or 3) reducing your level of service.
Downsizing your real estate: In addition to rent, mortgage interest and property taxes, real estate can represent a major expense because of maintenance, insurance and utilities. You can't change the space your business occupies overnight — especially if you own the property. But you can evaluate your current footprint and assess how much space would be necessary if you implemented a flexible work schedule. Some workers might be able to telecommute indefinitely. Others can work from home two or three days per week and use revolving workspaces when they're in the office.
Under the right circumstances, you could sublease some of your excess space. Or you might negotiate less square footage when your lease runs out. If your company owns its real estate, investigate whether you could sell all or part of the space. Alternatively, some businesses lower costs by moving to a less expensive location. Before you decide to relocate, however, consider how doing so would impact employees' commutes and customers' convenience.
Partnering with other businesses: Large groups — such as trade organizations or cooperatives — often have more collective bargaining power than individual businesses negotiating alone. By forming or joining a buying group, you'll likely benefit from discounted supplies and services. Some groups even share certain overhead expenses, such as office equipment, administrative staff and meeting space.
Managing inventory: Over the last two years, some companies have increased their safety stock levels to mitigate supply chain disruptions and to take advantage of bulk discounts. However, businesses that carry excessive inventory levels tie up substantial working capital. They also incur significant costs, including insurance, storage, security, pilferage and obsolescence. Efficient inventory management is essential to staying profitable and maintaining cash flow in today's inflationary conditions.
What's Right for Your Business?
High inflation, coupled with labor shortages and supply disruptions, are creating a tenuous situation for business owners. How can you counteract these trends? Strong demand allows some companies to pass along price increases to customers — up to a limit.
If high inflation rates persist, you'll need to find more creative coping strategies. Contact your business consultant for advice on price increases and feasible cost cuts for your business.