High Inflation Making Business Risky

As the government considers another series of stimulus initiatives, the threat of inflation looms…

Georgia (Oct 20, 2009)

As the government considers another series of stimulus initiatives, the threat of inflation looms larger for small-business owners.
The August reading of the Consumer Price Index stood down 1.5% below that of the year-ago period, but analysts and economists say they are concerned that new spending, combined with a raft of earlier initiatives, will soon trigger higher prices for goods and services.
"When the government borrows a lot of money, at some point, they have to pay for it," says Rob Fairlie, an economics professor at the University of California at Santa Cruz. "One way to do that is print money, and, if they print more money, that printing devalues the currency."
In a sign that inflationary pressures are already taking root, the U.S. dollar has begun to soften. In the last six months, the dollar has fallen more than 11% against a basket of trade-weighted major currencies, the U.S. Dollar Index Futures. Last Friday, that index touched 75.9, its lowest level since August 2008.
Of course, a softer dollar typically helps exporters, as their products and services become cheaper for foreign shoppers. U.S. exports rose in August by $200 million to $128.2 billion, while the trade gap narrowed 3.6% to $30.7 billion, up from $31.9 billion in July, according to the Commerce Department.
However, "most small businesses don't export," says Bill Dunkelberg, chief economist for the National Federation of Independent Business in Washington. Small U.S. businesses are typically service-based and rely mainly on American consumers, he says.
But even without inflation, small businesses tend to pay more than big firms for everything from office supplies to health insurance, says Chad Moutray, the Small Business Administration's chief economist. For example, manufacturers with fewer than 50 employees paid 35% more for electricity than the industry average, while manufacturers that employ a thousand or more workers paid 17% less than the average, according to a 2008 study of energy costs from the SBA's Office of Advocacy.
Bigger firms typically have more room to negotiate lower prices than small companies. In addition, big businesses are often more productive than smaller firms using the same relative resources, Moutray says.
Although most businesses want to boost prices to keep up with higher costs, making your goods and services more expensive during a downturn may not serve your bottom line. "If you raise prices, people will of course buy less. They don't have the income," says Dunkelberg, who says many economists (including him) expect the unemployment rate (9.8% in September) to worsen before it improves next year. As a result, many companies may sacrifice near-term profits as they absorb higher materials costs, he says.

Leaning on a credit line to purchase inventory or pay employees during a slow sales period may seem like an effective solution, but a spike in inflation could also cause a business's cost of capital to surge, says Joseph H. Astrachan, the executive director of the Cox Family Enterprise Center at Kennesaw State University in Kennesaw, Ga. If inflation rises high enough, the Federal Reserve may attempt to moderate prices by raising interest rates, he says. So even if owners have a revolving line of credit that wasn't eliminated or slashed dramatically in the credit crisis, their cost of capital would jump, Astrachan says.
Then, of course, employees will want more money to keep up with higher prices. Although employers have a little more power to withhold raises now because the job market is so poor, to keep quality staff members around, you continually have to pay them more, says Astrachan. However, "when someone says 'I want a raise' and then the boss says 'by the way, I can replace you,' inflation gets nasty," he says.

Five Tips for Beating Inflation
Inflation can be a destructive force — particularly for small businesses. Here are five ways to help improve your odds for survival:
Stock up. If you think inflation is going to heat up, buy as much inventory as possible now, while it's still cheap, says Bill Dunkelberg, of the Federation of Independent Business in Washington. In addition, keep an eye peeled for any closings in your industry, he says. As competitors shutter, consider buying up their old inventories at heavily reduced prices.
Lock down. Many firms were able to negotiate lower-price contracts with their vendors and landlords thanks to the downturn; try to lock down those deals for longer, says Joseph H. Astrachan, the executive director of the Cox Family Enterprise Center at Kennesaw State University in Kennesaw, Ga. But be aware that by locking down longer-term contracts, you're risking getting stuck paying rent or some other cost for as long as the contract — even if your business goes under, he says.
Pay off. As rates often rise during inflationary periods, pay off your interest-accruing debts as much as possible, says Astrachan. However, if you'll need working capital, which is often the case when rates rise, try to lock in loan rates now rather than pay off your line, he says.
Tie in. You might also tie contracts to the Consumer Price Index, Astrachan says. So, as the CPI rises, so too will your prices. To sweeten the deal for vendors, "build in things they want," he says. For instance, include a clause in your contract that stipulates that the linked rate only applies when payment is received on time.
Join together. Big companies can command lower prices, because, well, they're bigger, but your company can also take advantage of economies of scale by connecting with other small companies to make joint purchases, Astrachan says. By joining so-called buying cooperatives like UniPro Foodservice, a foodservice distributor in Atlanta, or an informal group that sprouts in your own community, you can leverage the group's buying power to negotiate lower prices, he says.


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