Inflation is much like rust. Left unchecked it can quietly eat away at your buying power and can turn a profitable business into one that struggles and a struggling business into non-existence.
For many of us, you pretty much had to be a Boomer living in an industrialized world to fully appreciate the impact that inflation had during the 80’s. During that period mortgage rates skyrocketed to over 21% and unemployment exceeded 12% in North America.
As bad as that was, there were countries that faced 100% annual inflation back then. To put things in perspective, that meant that the price of goods doubled in a year.
The point of all this is not to provide an economics lesson, because I’d be the wrong person for that. No, this is intended is reinforce the need to be vigilant in managing your costs and pricing.
Regardless of your industry, you are probably facing cost increases in materials and wages. The latter because of the tight labour market, thanks in part to government social programs.
With all the things we must oversee as business owners, being a little more vigilant with all our purchases can become burdensome. However, with inflation starting to ramp up to serious levels, it’s more important than ever review your costs and adjust your pricing to protect your margins.
Too often I find small business owners struggle with increasing their prices because they are afraid of losing customers. Their internal dialogue usually centers around “I can’t charge them that much, that’s expensive, they’ll never pay that much!”
How is it that they won’t pay that much? Everybody is paying higher prices for just about everything they buy now. So, why should you be a martyr? Unfortunately, inflation is a perpetual motion machine that never stops.
The destructive power of inflation
What so many entrepreneurs fail to realize in a high inflation era, is that you need to keep your prices in step with the increases in your costs, otherwise it ends up costing you money and potentially your business.
Inflation can destroy your income statement in short order. When you look at the bottom line of many small businesses, there is not a lot left over after a year of hard work. The typical small business has a Net Income is way below 10% with many running in the 2-4% range. So, on a $1 million business that means your left with $20-40,000 or $10-20,000 on $500,000 and only $6-12,000 on a $300,000 business. Not much of reward for all the hard work.
Now layer on inflation at 4-7% that has recently been reported by various governments over the past few months and you will start to see the potential for margin destruction. But only if you don’t adjust your costs accordingly.
Business is not a charity
Using the previous examples, a 4% increase in inflation can wipe out the profit of most small businesses. Whereas a 7% increase you automatically go negative into a loss.
Look, nobody likes price increases, but it is a reality of our time. For the past 10+ years most of us have enjoyed a low predictable inflation rate below 2%. Even then I have encouraged small business owners to take annual price increases. Because 2% compounded annually equates to over 6.1% over a 3 year period.
Business is not a charity. You are here to make money. The more you make, the more security you can bring to your firm and your employees. The more money you make, the more you can pay your staff and yourself.
Some options
Being worried if your customers can afford the new price is noble but not realistic. There’s no point of losing money just to avoid increasing your prices. Yes, you can always offer a one time discount to your better customers as a way to ease them into the new pricing. But I stress one-time.
I also know that there always seems to be someone willing to do the job cheaper and to that I say let them. Every industry has someone who offers low pricing but it’s my experience that most don’t last long.
Alternatively, you can do what many consumer goods companies are doing, reduce the size of the product to maintain a price. Offering your customers a “lite” version of your existing product or services may be all you need to do.
Minor tweaks such as a decrease in reporting, a reduced delivery frequency or even quicker payment terms are just some of the examples. These small adjustments can be used to maintain a given price point.
Another thing to always keep in mind is if those customers are only shopping on price, you must ask yourself whether you want them as customers in the first place. Often, they are not loyal and will change suppliers for a nickel.
It has been my experience that profit margins are never high enough. So, increasing your prices to ensure inflation doesn’t destroy your company, is just smart business.
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