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This article was written by Peter Cohan from Inc.
Inflation hit a record not seen in 40 years and it is worrying CEOs. According to the Wall Street Journal, a Conference Board survey found that inflation — which hit 7% in December 2021 — is a top concern for 82% of the 917 CEOs polled. What’s more, over half of those CEOs think inflation will persist until mid-2023.
One CEO thinks that inflation is real and businesses must choose how to deal with it carefully. Honeywell International CEO Darius Adamczyk told the Journal, “Inflation is here. We have to be very, very careful how it gets solved, too, because it’s a little bit like driving your vehicle. If you slam on the brakes too hard, we could see the other side of inflation, which is a recession.”
This raises many questions: Are these CEOs right? If not, what is likely to happen with inflation? What should business leaders do about inflation? Here are five steps I think business leaders should take to formulate the right inflation strategy.
1. Develop inflation scenarios.
Before taking any action, leaders should form their own view of how much inflation will affect their business. To do this, they should interview their customers, suppliers, and partners, as well as economists and industry experts. Questions to explore include:
- What are your optimistic, pessimistic, and most likely scenarios for general consumer and wholesale price increases over the next five years?
- What are the most significant factors driving the increase in consumer and wholesale prices?
- How likely are these factors to persist, increase, or decrease over the next five years?
- How is the Federal Reserve likely to respond to each scenario?
- How much are suppliers likely to increase the price of inputs to your business?
- How much are salaries likely to increase across the industry in order to retain talent?
Based on answers to these questions, business leaders should formulate three scenarios for inflation – best case, worst case, and most likely case. Such scenarios should include five-year forecasts of key input costs and how those increases will affect profit margins depending on whether the business holds constant or increases its prices.
2. Analyze customer sensitivity to price increases.
One of the most important elements of a company’s inflation strategy is that last point – whether to keep prices constant or to increase them. To decide that, business leaders must try to anticipate how customers would respond to a price increase.
To find out, they should hire an independent analyst to answer questions such as:
- How important is the lowest price in the customer’s decision about whether to purchase from your company or a rival?
- How does the company’s current price compare to that of your rivals?
- Are rivals increasing their prices – and if so, by how much?
- Are customers switching their business to the lowest-priced suppliers?
If this research reveals that your customers are highly price sensitive, you should consider keeping your price below those of rivals. If customers are not price sensitive and rivals are increasing their prices, you should consider whether to raise your prices as much or more than rivals.
3. Forecast rate of increase in key costs.
At the same time, business leaders must examine whether their key suppliers are increasing their prices. To that end, business leaders should retain a consultant to examine questions such as:
- What are your company’s largest input costs?
- How much are your suppliers likely to increase the prices they charge you?
- Are there lower-cost suppliers for those inputs who are likely to remain lower cost?
- How difficult would it be for you to switch to those suppliers?
If your suppliers are likely to increase prices to the same level as rivals, you should not switch. However, if reliable suppliers will charge you less than their rivals and your switching cost is low, consider moving your business.
4. Study competitors’ inflation strategies.
Before formulating your company’s inflation strategy, you should try to find out what competitors are likely to do over the next five years. More specifically, investigate questions such as:
- How much, if at all, are competitors increasing their prices?
- Are their customers switching suppliers in response to the price increases?
- How much are rivals increasing wages to retain talent?
- Are rivals switching suppliers to lower their input costs?
- What might cause them to reverse these strategies?
Answers to these questions will help you determine how to maintain your competitive advantage.
5. Test your inflation strategy and roll it out company-wide.
Based on this analysis, you should formulate an inflation strategy that sets future prices, picks suppliers for key inputs, and chooses rates of pay increases. Rather than impose this strategy on the entire company, test it out in a particular location, refine the strategy based on the outcome, and then roll it out across the company.