Inflation remains a key concern for small businesses moving forward in 2022. Discover tips and best practices for managing inflation and limiting its impact on your company.
If it seems like your money doesn’t go quite as far as it used to when you buy groceries, fill up your gas tank, or dine out, it’s not your imagination; it’s inflation. While the Federal Reserve has managed to keep inflation mostly at bay since the early 1980s, the Wall Street Journal reports that inflation in the United States is now at the highest rate in four decades.1
For small businesses, inflation can be particularly challenging. Rising costs of materials and increased energy prices can directly impact your cash flow, and inflation places new burdens on consumers that could impact your sales. To successfully manage inflation and come out on the other side ready for new growth, it is crucial to understand what inflation is, what the policy response could be, and how your business can adapt in the current environment.
Read on to learn what causes inflation, how it impacts your business, and how you can pivot to reduce its impact.
What is inflation?
Price inflation is the general increase in the price of goods and services. In the United States, inflation has averaged about 2% annually.2 Fed policy, including an overall commitment to curb inflation by managing interest rates, has helped to keep inflation low.
While inflation can be easy to spot in the form of higher price tags, its impact is typically felt by businesses well before that time. Many small business owners have experienced inflation-related challenges like a shortage of raw materials, rising business costs, limited inventory, and delays in their supply chain for at least the past year, in addition to repricing by suppliers, and difficulties hiring and retaining employees.
Higher prices can also impact how your customers interact with your business, as they may be forced to limit discretionary spending and even cut back on essential expenses.
What is causing the inflation we’re seeing in the United States?
The United States is now experiencing price increases across many sectors—costs for gas, food, energy, housing, and cars are all higher than they were one year ago.
While a variety of factors contribute to inflation, much of what is driving the current situation is related to the pandemic. As factories and businesses were forced to change their operations and production cadence, many industries experienced supply chain issues and a shortage of goods. With market demand outpacing supply, the cost of acquiring goods and materials skyrocketed for many businesses.
During periods of pandemic lockdown, spending patterns changed and the additional income from pandemic-related stimulus programs led to increased consumer demand, which also contributed to inflation. On top of these factors, there’s also a shortage of workers in many industries and employees are now positioned to seek higher pay, creating rising employment costs for businesses of all sizes.
From a policy perspective, the Federal Reserve has kept interest rates low since 2018, making loans for large purchases—including homes, cars, and business equipment—more accessible and more common than they might otherwise have been.
How is the U.S. government addressing inflation?
On March 16, 2022, the Federal Reserve announced its new policy: to raise interest rates by 25 basis points (or .01%) in an effort to address inflation. U.S. News reports that there will be six more increases throughout 2022, and three more increases in 2023.3 This will change the short-term borrowing rate, which could lead to higher interest rates and increased financing costs for businesses. Thus, the impact of Fed policy may be mixed for small businesses; further “rate hikes” could help limit inflationary pressures in the long-term, but they could also affect many businesses’ ability to access capital in the coming months.
Ultimately, Fed policy is intended to slow demand, and Federal Reserve Chairman Jerome Powell said he does not believe that the United States is at high risk for a recession in the next year. But inflation is complicated and the real impact of shifting Fed policy for small business may not become clear for a while.
How can small businesses respond to inflation?
Inflation impacts nearly every aspect of running a small business—from labor shortages, to working capital and cash flow, to higher business costs and decreased profitability. These pressures may require that you adapt and change some aspects of how your business operates.
Here are six strategies business owners can use to respond to inflation:
- Consider passing cost increases onto your customers. Higher prices mean that business costs may increase for critical needs like office supplies, equipment, goods and materials, and employee wages. These increased costs can eat into business profitability and more than 60% of business owners say that they’ll raise their prices to respond.4
- Differentiate from your competitors. Increasing prices may help offset some business costs, but it’s just as important to differentiate your business so customers see the value you offer—and have a reason to choose you over competitors. Experiment with new ways to bundle products or adopt different pricing strategies to increase customer-perceived value and drive more sales.
- Make it easier to do business with you. Remove barriers that may keep customers from buying. Look for innovative ways to improve service and expand your customer base. Offering complimentary warranties or product guarantees and removing contracts or additional fees are examples of tactics that can improve the customer experience and increase loyalty to your business.
- Explore alternate supply chain strategies. If you’re facing inventory and supply chain issues, consider how alternate supply chain relationships can benefit your business. For example, pivoting to a regional supply chain strategy that sources a substantial proportion of key goods within the region they’re consumed can reduce a business’s exposure to shipping delays.5 If this solution won’t work for your business, consider the risk-reward of holding additional “safety stock” to ensure you have adequate inventory, especially during critical sales months.
- Make your employees a priority. Nearly 30% of business owners intend to raise employee compensation in the next three months—and more than half already did.6 If you rely on independent contractors, bear in mind that they are also dealing with higher prices—and can easily raise the rates they charge for services. Consider ways to lock in rate commitments or give them other reasons to continue working with your business (like expedited payment).
- Consider if now is the time to borrow. The Federal Reserve is just beginning to increase interest rates, which means it may soon become more expensive to borrow. Consider if there are investment opportunities to take advantage of before rates rise, like real estate, machinery, bulk-discount inventory or equipment for your business. If you foresee potential cash flow shortages as a result of increased prices, explore borrowing options before the new rates kick in.
Inflation can be difficult to manage—both the pressures and the policy response can present new challenges for business owners that require innovative solutions and a willingness to adapt to changing conditions. But there are ways to mitigate the impact of inflation and businesses that are open to adopting new strategies for growth can position themselves for success in this environment.
1. Wall Street Journal. “What Is Inflation and What Causes It? What to Know.” March 10, 2022.
2. Wall Street Journal. “What Is Inflation and What Causes It? What to Know.” March 10, 2022.
3. U.S. News. “Fed Raises Interest Rates for the First Time Since 2018 in Bid to Curb Inflation, Sees Six More Hikes in 2022.” March 16, 2022.
4. NFIB. “New NFIB Survey: Inflation Continues Impact on Small Businesses.” February 8, 2022.
5. Harvard Business Review. “Global Supply Chains in a Post-Pandemic World.” September-October 2020.
6. NFIB. “Small Businesses Start the New Year Raising Prices as Inflation Takes Its Toll.” February 16, 2022.
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