What is inflation

 

What is inflation 

Inflation is the gradual loss of purchasing power, reflected in a broad rise in prices for goods and services.

Annual inflation in a healthy economy normally ranges between two percentage points, which economists view as a sign of pricing stability. When inflation is within acceptable limits, it can also have a good impact. For example, it might stimulate spending when the economy is slowing down and needs a boost, which will increase demand and productivity. On the other hand, when inflation starts to outpace wage growth, it may be an indication that the economy is in trouble.

Consumers are the ones who are most immediately impacted by inflation, but businesses are also impacted. Here’s a simple overview of the variations in how inflation impacts consumers and companies:

When the cost of goods they purchase, such food, utilities, and fuel, goes up, households or consumers have less purchasing power.

When prices rise for production inputs like raw materials like coal and crude oil, intermediate goods like grain and steel, and completed machines, businesses lose purchasing power and run the danger of seeing their margins erode. Companies often increase the cost of their goods or services in reaction to inflation, with the result that customers pay the higher costs. The challenge for many businesses is to find a balance between boosting prices to cover increases in input costs while also making sure that they don't go up too much and decrease demand, which is covered later in this article.

What are the primary factors causing inflation?

The two main forms, or causes, of inflation are as follows:

When the economy's ability to create goods and services cannot keep up with the demand, demand-pull inflation results. For instance, the automotive industry struggled to keep up with the resurgent demand for new cars when it increased more quickly than expected following a severe decline at the start of the COVID-19 pandemic because to an interim shortage in the supply of semiconductors. Prices for both new and used cars increased as a result of the ensuing lack of new vehicles.

Cost-push inflation happens when the cost of raw materials and labour drives up the cost of output goods and services. For instance,As a result of drastic changes in demand, purchasing patterns, cost of service, and perceived value across industries and value chains, commodity prices surged during the epidemic. Industrial businesses were compelled to take price increases that would be passed on to their end consumers into consideration in order to counteract inflation and limit the impact on financial performance.

What impact does inflation have on prices?

Companies often spend more for input commodities when inflation occurs. Consumer price increases are one way for businesses to cover losses and maintain gross margins, but if price rises are not implemented carefully, businesses risk harming customer relations, suppressing sales, and reducing margins. Companies can make better decisions by using an exposure matrix that evaluates which categories are exposed to market dynamics and if the market is expanding or contracting.

When done properly, recovering the cost of inflation for a particular product can improve ties and overall margins. Companies can ADAPT (Adjust, Develop, Accelerate, Plan, and Track) to inflation by following these five steps:

Reconsider other parts of sales unrelated to the base price, such as extended production timetables or surcharges, and shipping fees for urgent or low-volume orders. Modify discounts and promotions.

Improve the science and art of pricing change. Don't change prices uniformly; instead, adjust them to take inflation exposure, consumer willingness to pay, and product qualities into account.

Decisiveness should be accelerated tenfold. Create a "inflation council" of committed, cross-functional decision-makers who are focused on inflation and are nimble and quick to respond to customer feedback.

Consider options other than price to cut costs. Rethink your portfolio using "value engineering," and provide cost-saving alternatives to pricing hikes.

Keep a close eye on the execution. To address revenue leakage and to strictly regulate performance, establish a central support team.

In addition to pricing, there are several commercial and technical tools that businesses can use to combat price increases in an inflationary environment, although other industries may need a more specialised approach. The following five actions can be taken by category managers in the chemicals business, for example, to reduce costs and combat rising commodity prices:

Comprehend the dynamics and outlook of the supply-market in depth. Rectify price increases after those drivers are no longer present by understanding and monitoring the factors that cause them.

Make sure that suppliers can define the effect that market price increases have on their prices. When prices are under pressure to rise, sellers frequently exaggerate the proportion of raw materials in input costs in order to boost their profits. It's crucial to recognise and confront these issues using the cleansheet process.

Consider inevitable price hikes as one-time extras rather than the new normal. Because it shifts the burden of evidence on the seller, this mechanism, which is partly psychological in origin, is particularly effective in addressing the stickiness of price rises.

Give cross-functional projects top priority. The effects of increased yield, decreased waste, or substitutes may be more noticeable when costs are high. If there are any, this is the moment to give them top importance.

To pass on price hikes, cooperate with sales. To shed light on pure market effects and their impact on the pricing of items sold, category managers collaborate closely with the finance and commercial teams. They also make sure that the proper justifications are put out to pass market-price hikes to customers.