What every business leader needs to know about inflation

We now live in an environment of ugly inflation and a looming recession. Rising costs, persistent shortages, and pricing that is often behind the curve pose a whole new challenge to business leaders, most of whom have never managed through a period like this.

It is your job as a leader to steer the company through inflation, whether or not you have practice at it. That means fully understanding how inflation touches every part of the business and enlisting the help of others in the company to combat it. Hunkering down until the Federal Reserve fixes things is not a viable plan.

Think of the economic shift as a chance to reset the business, and learn from other leaders who are showing a realistic, actionable path to thrive in the new economic context. Some business leaders have moved swiftly, even preemptively, to stem potential damage to the business from shrinking margins, shaky volume, and shortage of cash. Some saw inflation coming and raised prices early on, sometimes by as much as 20%. Chanel raised prices on some of its luxury goods three times in 2021.

The early movers are taking steps to weather the current economic conditions and, more than that, strengthening the business for what will unfold on the other side of inflation and recession some three or four years down the road. They are showing tremendous optimism in accepting the new realities and rethinking the basics of their business—from its compensation plan and pricing strategy to its mix of customers and business model.

Our book lays out the hazards of inflation and how to avoid them so your company will survive this difficult time. It will help you build your confidence to act decisively despite the unknowns by showing how other leaders are stemming the damage and resetting their businesses for a brighter future. It will help you see inflation’s impact through a wider lens and give you specific tools for dealing with it, including simple things like bringing people together from across the organization to address the challenges the new economic context presents. All of those tools and approaches will prepare you to contend with recession or stagflation if and when they come.

The Universal Truths About Inflation

You don’t need charts and graphs to know that costs have been rising. But there’s more to know about how inflation affects a business. You need to understand what inflation does to a company, an industry, and the economy as a whole.

Here are some important facts about inflation that may not be obvious until it is too late:

• Inflation consumes cash. Cash gets trapped in inventories and accounts receivable for the same unit volume. Growth gobbles up even more cash.
• Price increases roll through the value chain to the end consumer like a freight train, disrupting the economics and power balance of players along the way. At some point, consumers will push back and demand drops.
• Aggregate measures like the Consumer Price Index don’t tell you much about how inflation will affect your company. Micro-segmentation across your business and the supply chain is essential.
• The effects of inflation are cumulative. A 7% inflation rate may be manageable for one year but a rate even close to that compounded over several years could ravage the business.
• Inflation trends are partly psychological. When people expect continual price increases, they hoard goods, creating even more demand and exacerbating the imbalance. This pattern can lead to hyper-inflation.
• Inflation can turn well-planned capital expenditures into bad investments. Earlier decisions were likely based on assumptions that are no longer valid.
• Sacrificing customer trust to protect the business from higher costs has long-term consequences. It is hard to restore a brand once it is tarnished.
• Inflation reorders competition. It is an opportunity for businesses that can sustain in the near term and strengthen their position for future growth.

These truths show why many business leaders need a broader and more urgent response to inflation than they have undertaken thus far. They should help you appreciate that the kind of cost cutting many companies have been doing to struggle through the immediate hardships will not get them through a sustained period of inflation above, say, 7%, let alone a spurt of hyper-inflation, recession, or stagflation.

The Bright Side of Inflation

The current disruption to your company may make it hard to appreciate the eighth universal truth about inflation, that it creates opportunities to improve your competitive position. But dealing with inflation’s negative impact on the business will in fact reveal a silver lining.

For one thing, some of the excesses that were tolerated in a zero-cost-of-capital environment will be squeezed out. The business will sharpen its focus and cultivate a stronger set of customers. You’ll find ways to improve productivity and cut costs through more automation, or use technology to serve customers better and with less cash usage. You may be a smaller company in the interim, but the cash you conserve or withdraw from projects that are no longer winners can be used to create new products, or even a new industry.

Look four years down the road and prepare to take advantage of the post-inflation world. The economy will have changed, and your industry and business model might well have changed too. New companies may have entered your space, because technology change doesn’t stop. What will make you better prepared?

The company’s response to inflation will be a differentiator, along the lines of ESG. Inflation will hurt those who can’t manage their cash right, because the demand for cash—and therefore any shortage—is compounding. That creates an opportunity for you to lead an industry consolidation or to acquire critical talent, technology, or patents.

Your psychology will make a difference. Play offense. Take inflation seriously, adapt faster, and bring the rest of the organization with you.

This excerpt is from Leading Through Inflation: and Recession and Stagflation by Ram Charan with Geri Willigan, published by Ideapress Publishing, Nov. 29, 2022.

Ram Charan is a business consultant, author, and speaker who has spent the past 40 years working with many CEOs, senior business leaders, and top companies, including Toyota, Bank of America, Key Bank, Fast Retailing (Uniqlo), and Humana. 

Geri Willigan is an independent content developer and business writer.