It’s fair to say that rising prices are the story of the month, if not the year – but what can Australian business owners and leaders really do about it?
Is Inflation Really a Problem Right Now for Australian Businesses ?
Short answer: yes, it’s a big problem. Not only because operating costs are going up, but also because business owners are often really worried before they even start thinking about what they might need to do differently now. When people are worried, it’s more likely they will make a bad decision, or maybe avoid making decisions altogether.
And if economic growth slows because of rising interest rates and declining consumer and business spending, future revenues may soften too. More to worry about.
So Why Are Business Owners Worried?
Its because high inflation impacts businesses owners’ ways of thinking in five different ways, even before they take steps to respond:
- It can’t be ignored – it’s now a daily media story that currently touches everyone, whether they are business owners, employees or not working in paid employment but having to pay more for essentials.
- It’s foreign – it’s been 32 years since annual CPI in Australia topped 5%, so only Boomers and early Gen Xers like me have lived, working experience of dealing with problematic inflation.
- It’s confusing – there are wide variations in price changes by expenditure groups, eg petrol and building materials inflation is much higher than 5.1% but we still have deflation in some areas, eg clothing and communication.
- It’s disrupting – the old solutions to common business problems may not work now, e.g. scheduled salary reviews at the end of the financial year probably have to be done differently.
- It’s lonely – no two businesses are exactly the same, so it’s easy to worry that you are on your own in hard times.
So it’s difficult for many people to even think straight about inflation, let alone take the right steps to deal with it.
What We Hear from Clients about High Inflation
We’ve been helping clients with specific inflationary risks over the past 12-24 months, especially those who have struggled to hire enough highly specialised workers at affordable salaries since borders largely closed in 2020, or to purchase vehicles or other assets that depend on “chips and ships”. But since fuel and power costs started spiking this year, it’s a topic that we’ve discussed with virtually every client, to help them find ways to seize opportunities as well as navigate risks.
Inflation might actually provide an opportunity for some businesses, eg to revolutionise their pricing and procurement practices, or actually invest in a business acquisition. As the saying goes, “never waste a good crisis”.
What Inflation Pressures Are Businesses Experiencing?
The Australian economy is a lot more diversified now than it was in the 1970s and early 1980s, when inflation last ran really hot, so already complex inflationary pressures will affect increasingly specialised and sophisticated businesses differently, depending on their industries and business models, and the responses they choose of course.
Nearly 80% of Australia’s GDP is services-based now, so those businesses are generally more concerned with the cost and productivity of their people, with costs of premises (typically their second biggest fixed cost) being contained over the longer run through hybrid working models reducing commercial real estate needs.
But we also have manufacturers competing on global stages who have had their profit margins smashed by rising power and logistics costs.
Finally there are hybrid industries like construction and hospitality that have been knocked around by both shortages in skilled labour and big hikes in materials costs. We’ve heard war stories of building materials going up in price every two to three months, and annual inflation for some products now exceeding 100%.
What Can Businesses Actually Do to Manage High Inflation?
This is a great time to “get back to basics”:
- Firstly, know your business model and financial results and resources well, so that you know what your current inflation exposures and relevant strengths and weaknesses look like.
- Be prepared to update your Strategic Plan for inflationary risks – and opportunities.
- Stress test your forecasts – what happens to your costs and net assets if expenditure goes up at forecast inflation rates, with no or low increases in your sales prices for 3 months? Or for 12 months? “Forecasts beat budgets for breakfast” when inflation takes off.
- Deploy your precious working capital wisely – eg are you collecting debts as quickly as you should, which a lot of smaller business owners struggle to do? With more cash you might be able to invest more in inventories or prepayments that help you to avoid future price hikes, or survive logistics interruptions.
- It might be time to look at alternate suppliers for key goods and services – are you sure you have tested the market? In our experience most private businesses have pretty unsophisticated procurement practices, so even small investments there can make a big difference. Learn how to run agile tenders well.
For example, a new market entrant attracted by rising prices might be willing to give you a great deal to win your longer term business – and an existing supplier might hold off passing price increases on to you, if they can keep your business.
- Don’t be afraid to pass on increases to your more sophisticated clients, who know what you are dealing with. But give them plenty of notice and make sure that you are still giving them real, easily explained value, or otherwise you might convert a highly strategic relationship into a transactional one and cause long term damage to your operating scale and brand value.
- Don’t forget your marketing, although you might need to find less costly ways to do it – maintaining and even growing market share is arguably even more important in tough times, especially if we do have low growth or even a small recession in the coming year.
- Monitor your competitors, in case they are now offering better value than you.
- There may be some low hanging fruit in your discretionary costs, but it’s our experience that deep fixed cost cutting can actually start a business on a downward spiral. But we certainly wouldn’t be recommending that people fly for business if they can genuinely do the same work on a videocall, for example.
- If your suppliers do have to increase prices and you can’t avoid paying them, ask for extended credit terms. If they have good working capital reserves they might be able to support you that way, while maintaining their own margins. Or ask for valuable benefits or extras that won’t necessarily cost them cash, eg getting privileged access to their R&D program, or favoured delivery times or customer support services.
- In the case of your people, limit wages-based competition as much as you can – there are around 16 drivers of “employee value”, so maximise non-financial talent attraction and retention assets like a strong business purpose and genuinely flexible working practices where you can.
- Also make sure that you are sending the right remuneration signals – if you have “high performance, high potential” people you must keep, who might be targeted by competitors, get ahead of CPI… but if you have people who are chronic underperformers that you can replace or even do without, ration your pay increase budget where you can.
- Where you can, use proactive talent strategies to build a pipeline of great talent so that you don’t need to pay high recruitment agent fees for reactive, urgent new hires.
- Look at every sales contract you have to see if you have leverage to pass on price increases, suspend work or even walk away from jobs or relationships that are underwater on gross margin. You might be able to put up with low margin business for a little while, to cover at least part of your fixed costs, but zero or negative margin jobs can kill some businesses very quickly.
- You might also want to revisit any “force majeure” terms in your contracts – they can be used for unexpected macroeconomic conditions as well as natural disasters, strikes, pandemics and the like. Maybe that won’t help you now, but in the future they might encourage clients to renegotiate bad deals for your business.
- Ask for help – but be careful who you ask. Remember that “hammers see every problem as a nail”, so some very specialised advisers may offer simplistic solutions and will not usually have the full range of skills to help you with the broad range of problems that high inflation might cause.
Finally, have courage – we are all a bit nervous right now, but inflation is already showing signs around the world of abating, as we learn to live and work with COVID and new suppliers enter markets, and as overdue interest rate increases cool some overheated demand drivers.
I remain confident that our current inflation problem in Australia is more of a supply side issue than driven by long term, baked in demand side problems, which was the real problem with late ‘70s inflation when we had more rigid economic systems and less experience with agile monetary policy. The message is clear from the RBA: yes, they waited a bit too long to raise interest rates, but they are on the job now. And they have a much improved inflation fighting playbook than they had in the 1970s, or even in 1990, so they will do what they can to ease off inflationary demand while trying to keep employment levels high and Australia out of a recession.
Should Businesses Consider Absorbing Rising Costs?
As I mentioned earlier, switched on clients and consumers are currently geared up to expect price increases – that’s half the battle won. But they may have limited capacity to absorb multiple rounds of increases, so maybe ask sooner rather than later.
If you choose to absorb a squeeze, make sure you can reasonably expect some upside or other return down the track, like a longer term contract with a key customer, or find a smart way to cut back or alter your goods or services inclusions so that they cost you less to buy or make without unduly impacting the real value that your clients prize.
So whatever pricing decision you make, always focus on the customer loyalty and value implications – to them, and to you.
What About Opportunities from High Inflation?
I’ve made a fairly long list of what we advise most clients to do, as a matter of common sense – we don’t believe in “magic bullets” at the Advisory Collective.
But there is one potentially counterintuitive strategy I have recommended in the past: look out for undercapitalised competitors with good customers, people, products or supply chains that you might be able to buy out cheaply, to add economies of scale, improve business resources and reduce longer term competition. If you have good security and make out a strong business case, its still possible to get historically low interest rate business loans – its not 1990 again. Some really stressed business owners may even just give away a normally valuable business – yes, we’ve seen that happen.
What’s the Outlook for Different Sectors?
The current problems for the construction industry are already starting to ease, through better customer pricing, new supply sources and some smart thinking about product substitution. We’re seeing the same in food services and hospitality – KFC set the pace there by actively promoting their use of cabbage instead of lettuce in burgers and wraps, making a marketing virtue of a cost saving (just think of how much all that free media coverage was worth !).
On the manufacturing side, our biggest concerns are for gas dependent industries – there is no way long term gas prices are coming down, especially now that their full greenhouse gas emissions will increasingly need to be priced in, from extraction through to consumption. And fuel substitutes are not always feasible for many of those businesses.
It’s also going to take years for inflation in highly skilled, highly mobile worker salaries to drop away, and we will have to do better to attract those people vs our global competitors in other developed countries. A lot of us have forgotten that as highly skilled Boomers and early Gen Xs increasingly leave the paid workforce, we can’t replace them with later demographic “waves” without also attracting migrants. So we need to think hard about “our national EVP”, at a policy level.
We’re also hopeful that in the medium term we will see more smart investments in childcare and the like, to increase the participation rate of highly skilled workers, especially women who have been fully trained but work reduced paid hours after starting families.
Any Final Advice?
It’s wise to remember this: when inflation takes off, it’s actually most important to make “good enough” decisions that remain focused on customers, people and solid business models, rather than worrying about getting absolutely everything right.
A lot of worried SME business owners across every sector who panic and don’t get the right advice will make really bad decisions that could cripple their businesses for the long run, so don’t let that happen to you. So if you do need help, book a chat today.