Brazil12 strategies for protecting margins and profit during high inflation
Inflation may be falling through much of the global economy, but it remains high, and while the Middle East has seen less of it, it is also on the rise across the region. A new white paper explores 12 ways through which companies can insulate their profit margins from spiraling prices.
The global economy saw inflation explode throughout 2022. In the US, the general increase in prices and fall in the purchasing value of money was gaged at an average of 8%, while in the UK this grew to 9% (though for some essential products this was even higher).
This was in stark contrast to 2019, when both countries saw a rate of 1.8%, according to Strategic Gears.
Even though inflation has slowed in 2023, it still remains at its highest point in decades. Even if it were reduced to a ‘normal’ rate, it would not mean prices were shrinking – especially as wages have not risen in line with inflation.
At the same time, even countries which previously saw low inflation are now being hit. Saudi Arabia, which had -2.1% inflation in 2019 – as the market adjusted to the introduction of VAT from the year before – that rate has since climbed consistently. Even though it had the lowest inflation of any MENA market in 2022, Saudi Arabia’s rate hit 2.8% in May 2023, and remains a key point to address by the kingdom’s policy makers.
In a high-inflation environment, businesses face a challenge of how to balance their financial needs, with those of their customers. While the temptation may be to simply pass the buck to consumers, that may not be sustainable as a model of economic growth – especially if competitors find a way of under-cutting their prices. Meanwhile, implementing price increases and margin protection initiatives are easier said than done.
Countering inflation
To help organisations plan their response to inflation, Strategic Gears has published a new report outlining 12 potential avenues of action:
Cost pass through
Reflexively, when companies encounter higher costs for materials and costs of goods sold, their first instinct is to pass the cost onto their customers – ramping up prices. While this might provide a healthier balance sheet in the immediate and short term, however, it may well be a counterintuitive practice in the long haul.
Cost-pass through has regularly been connected to corporate profiteering – where businesses raise prices above their growing production costs to try and increase profits. Companies that have been found to adopt corporate profiteering practices run the risk of being named and shamed in media, with numerous examples worldwide seeing those companies even boycotted.
In addition, corporate profiteering can contribute to the virtuous cycle of inflation, which at a macro-economic level, can boomerang back at companies. When prices rise faster than wages and real income drops, consumer spending power falls, and companies down the line see a decline in their sales.
This was a major contributor to the economic slowdown of the last year – and also runs the risk of competitors eventually finding ways to undercut pricing, and eat into a cost-passer’s customer base.
Reduce costs
Another reactionary impulse employers often have when dealing with inflated costs, and falling rates of profit, is to execute a stringent cost-cutting drive. The most applied measure is to downsize headcount, which reduces salary costs. Other classical examples include cutting back on luxuries such as office parties, implementing pay-freezes, or closing down offices.
The immediate impact of such and other austerity measures can deliver short-term gains for the company’s bottom line. But in the long-term, Strategic Gears highlights that cost cutting policies can pose a series of challenges. If the market returns to health, and suddenly the company experiences a glut of demand, it will find it has less capacity to take advantage of those opportunities – while if a tight labour market persists, it will struggle to fill out the roles it has previously shed.
Research by Bain & Company found that the winners in a post-crisis period are those that followed a bold strategy during the crisis, which includes sticking to talent and investment in future opportunities.
Recalibrate salary and recruitment
Like workforce reductions, companies also tend to moot hiring freezes and pay-caps during crises. Such recalibration can serve as a key contributor to maintaining financial health and ensuring headcount is aligned to the actual workload requirements of the business.
Pushing such policy requires caution, however. Having well-defined reward structures can actually help a firm get ahead of the competition, boost productivity, and improve profitability in the process. And aligning recruitment to processes which companies need to accelerate to get out of a crisis can also help accrue talent to forge ahead once a return to financial health is realised.
Eliminating non-value added
A sustainable way of living with inflation comes by examining a business’ processes, and trying to streamline them – allowing for a firm’s talent to concentrate more on value-adding activities instead. Proponents of automation often suggest this is exactly what applying machine-labour to repetitive, labour-intensive processes like administration and finance operations, can help with.
By automating the process, workers who previously concentrated large amounts of time on filing paperwork and administrative tasks can apply their talents and creativity to other more important responsibilities.
It is important to recognise that automation is not the only show in town when it comes to eliminating non-value areas of work. Companies can also re-engineer processes, or outsource operational activities, or streamline the entire value chain of goods/services in order to boost efficiency and effectiveness.
Enabling digitalisation
Organisations all around the world have already embraced the challenge of digitising their services and operations – and are reaping the benefits. For example, a report by the Hackett Group found that ‘digital world class organisations’ operate with 29% lower labour costs thanks to >20% higher efficiency.
In recognition of this potential, which is being applied far beyond back office functions, six-in-ten executives of large companies this year expect to increase spending on digital transformation, in spite of economic headwinds.
Other benefits of automating processes to reduce costs can be found in supply chain optimisation, managing inventories, back-office automation, generating financial insights and others. At the same time, equipping employees with the latest technology like generative AI can also help them boost their productivity in creative roles.
Hedging or indexation
Companies can also alter how they leverage investment to try and weather the storm of inflation. Hedging is an advanced risk management strategy that involves buying or selling an investment to potentially help reduce the risk of loss of an existing position.
Meanwhile, indexing is a passive investment strategy similarly helping create a portfolio that tracks a common market index, with the goal of mimicking the index's performance. As a strategy, indexing offers broad diversification, as well as lower expenses, than investing strategies that are actively managed.
This can protect companies against the impact of inflation, especially on input costs. By utilising digital and analytics tools, as well as industry knowledge, companies can negotiate based on long-term expenditure projections, ensuring new contracts have favourable terms – while also reviewing existing arrangements.
Accounting for demand shifts
The experts of Strategic Gears also note that organisations should account for shifting demands in their overall strategy – including pricing and financial plans. Possible factors at play here can include shifting of tastes between demographics – for example, as the baby boomer generation ages, things which they demand will fall, while Gen Z may not have a taste for such materials or products.
In contrast, there may be things the younger generation demands more of – meaning prices for it will increase.
In these cases, it is worth bearing in mind a number of potential factors. These include changes in consumer income and spending power, seasonality of demand, and migration – which may see the amounts of certain materials demanded change in different regions, while remaining the same globally.
Product mix adjustments
The same forces which can alter the demand for certain materials can also impact which products are most successful. Companies expecting to continue with the same level of profit and growth from before the pandemic era, with the same products, need to take stock of the situation, and see how their offering can adapt to the new behaviours and needs of their customers.
Top performers modify their product mix continually. This can including adding or replacing product lines, removing products from those lines all together – helping to reduce costs by only spending on the production of necessary and profitable items, as well as aiding a company to respond to reductions in production capacity, or in government regulations.
Product flexibility
Similarly, Strategic Gears notes that businesses which revise the actual production of their goods in an economic slowdown tend to respond best to adverse conditions. This can help develop manufacturing strategies which could increase their flexibility, quality rate and their profit margins, while also downsizing costs by switching to alternative suppliers or materials.
For example, companies could turn to material processing techniques such as recycling or upcycling to help ensure a steady flow of the right materials for production and development. Meanwhile, some firms engage in customer co-creation, letting customers participate in operations to help cut out areas of waste – particularly when it comes to avoiding materials customers just throw away.
Such practices can provide companies with ways to boost profits that are derived from customers’ preferences and design approaches, shielding their products from the perils of high inflation.
Diversify supply chain
The uncertainties induced by any crisis can disrupt companies’ operations as their suppliers face disruptions throughout the chain. For example, firms which are heavily dependent on lithium to produce batteries should have contingency plans in place, should geo-political or environmental changes jeopardise their access to the trade – something which has happened on multiple occasions.
Supply chain diversification strategies are a key way of protecting profit margins amid periods of high inflation. Sourcing from multiple suppliers prevents a company from being overly dependent on one and becoming exposed to risks such as supply blackout or volatility.
Meanwhile, considering nearshoring – finding countries nearer to a company’s base of operations – can help offer better, more reliable alternatives to supply, even if that comes with moderately higher prices in the short-term.
Restrain dividend payments
A less common mechanism to shore up the liquidity of a company, is to adjust dividends payments. Dividends are regular profit-sharing payments made between a company and its shareholders. A company’s board of directors determines the price per share, as well as when and how often dividend payments are made.
This can prove an unpopular decision among shareholders, but depending on the weight of a crisis, adjusting dividend payments can help keep sufficient cash flow for inside operations – to be spent on things like operations, or acquisitions to drive new growth. In those cases, organisations should take care to also declare a structured dividend plan for once the market begins to recover.
Expand into new market segments
Where possible, expanding into new markets can also be a key way to preserve bottom lines. Indeed, after the initial shock of Covid-19, the second half of 2020 saw a rise in merger and acquisitions manoeuvres to help open up new lines of revenue or move firms into a new national market.
Firms should be careful not to overstretch while doing this, though. Identifying potential market opportunities could be a challenging phase, but looking before leaping is advisable, with organisations weighing up previous failures, as well as how they may adopt new techniques and other measures to meet customer demands; considering future fluctuations in demand which may pose a risk to the launch of new lines or markets; and how they might want to adapt their products and sales strategies according to the cultural differences of the new space they are entering.
The researchers from Strategic Gears conclude: “Rising inflation has been a challenge for economies globally during the last two years. Although inflation is forecast to subside in 2023 from high 2022 levels, price pressures remain, and companies can adopt a range of alternative measures, beyond cost pass-throughs or layoffs, to enhance or sustain profitability.”
