Article by Sumedh Neharkar, Supply Chain Analyst at River Logic
In today’s fast-changing world of economics, fluctuation in prices is like a rhythm that affects nearly everything we do. It’s not just about things getting more expensive, it’s a sign that our economy is active and evolving. In this article we embark on the journey that will help us understand inflation, its causes, its impact on consumers and businesses and discuss potential ways to sail through it.
In simple terms inflation is a measure of how fast prices of goods and services are rising. This can occur in any goods and services industry including food, utilities, housing, medical care and even automobiles, jewelry, and air travel. It’s important to note that inflation is the rate at which prices increase, not the high price itself. For instance, if energy prices continue to stay high but do not increase with time then it does not contribute to inflation.
Inflation comes into picture if the supply of money grows too big relative to the size of an economy, the value of currency per unit diminishes leading to a drop in the purchasing power and rise in the prices. It is also typically driven by an increase in demand for goods or services as mentioned by the former Fed chair Ben Bernanke in his macroeconomics textbook and due to the increase in the cost of production.
Impact on consumer:
The primary group that has to undergo a huge loss due to inflation is consumers. The reason being that it doesn’t allow the money to go as far as they would expect and restricts the number of goods and services they can purchase. Inflation is usually concerning for a consumer because it makes money saved today less valuable tomorrow. It reduces their purchasing power and makes them more price sensitive. For instance, if you earned 7% on your investment in a year but the inflation was 4%, ultimately you ended up earning just 3%. It adversely affects people with a fixed income as they can’t afford to maintain the same lifestyle as they used to when prices rise to a certain level. Most consumers re-think buying any luxurious item like a good big car or an appliance when inflation is high. It also affects the consumers planning to buy homes, as higher prices imply a higher rate of interest, making borrowing even more expensive.
What we need to know about the state of inflation in 2023:
- Inflation is “real”: Inflation isn’t just media hype, it’s a real thing that people are seeing and paying attention to and aware of. As many as 39% of U.S. consumers say that people in social circles discuss inflation. As inflation truly meddles with their standard of living and purchasing choices they make.
- U.S. incomes not keeping up with inflation: Wages rarely follow the rising inflation making it difficult for the customers to decide on where to spend their money. According to Medallia – Only around one in five U.S. consumers (21%) have experienced a raise or some sort of wage increase that is either at or above the level of inflation. In particular, the portion of individuals whose incomes increased above the rate of inflation is only around one in ten.
- High debt and less savings: As wages don’t keep up with inflation, consumers are forced to use credit cards and borrow money from financial institutions to pay for the goods and services. Research found that finances for the current households in the United States are worse than at the start of 2023. The study found that 30% of consumers have more current outstanding debt as of June 2023 compared to the beginning of the year. In addition, 50% of households are either just barely making ends meet or unable to do so.
- Change in consumers’ preferences: Inflation is affecting the way consumers shop and the brand they choose to do business with. It’s often said that consumers’ belief in inflation is psychological rather than logical. They make subjective decisions based on what they know the price of and what they frequently buy unlike economists who examine a basket of goods and their prices a year ago to get a clear picture. This results in immense change in consumers’ buying patterns in response to inflation. They look out for items on sale which influence their purchasing choices, as various items may be discounted at different times. For instance, one of the noticeable changes is opting for in-store brands over the popular brands which are costlier.
- Expenditure cutting: Since inflation is inevitable – consumers are doing their best to lessen its impact on their pockets. They focus on necessities by adopting alternatives like buying cheaper goods, avoiding eating out at restaurants, minimizing travel, and leisure activities.
Impact on Businesses and its management:
Inflation does not affect all the businesses equally, many essential businesses like healthcare, grocery stores and childcare are considered recession proof. However, with discretionary goods, a purchase that can be put off until next month or longer does get affected. For instance, very high price inflation is a more serious concern to companies. Planning and investment decisions become harder, and at a macro level, inflation may be associated with recessionary tendencies in an economy, leading to cutbacks in consumer spending.
Big and established companies can manage inflation by planning ahead and having enough money to keep their prices stable. Smaller businesses might find it harder, especially if their main cost is for skilled workers who need higher pay, and they can’t save money in advance. To handle inflation, companies can change their tactics without changing the main prices. They might offer fewer discounts or special deals. Sometimes, businesses/companies make their products a bit smaller instead of raising the price, hoping customers won’t notice which is also known as “shrinkflation.”
Demand shaping strategies can be used to overcome inflation that is driven by excessive demand (Demand-pull inflation). Implementing shaping strategies like price adjustments and marketing campaigns, businesses can influence customer spending patterns. They can encourage customers to save and invest their money instead of spending it, which can help reduce overall demand and mitigate inflationary pressures. For example, if a company is experiencing high demand for its products, it might raise prices, which can deter some consumers from making purchases. This not only helps control demand but can also increase profit margins for the business. On the other hand, if a company is struggling with overcapacity or inventory, it may lower prices to stimulate demand and clear excess stock.
How can businesses leverage capabilities of River Logic’s supply chain Digital Planning Twin™
- Demand Shaping: With the use of opportunity values and activity-based costing you will be able to determine what the right product types are for your company not just the quantity.
- Efficient Forecasting: Our solutions enable efficient forecasting and demand planning, considering the impact of inflation on both supply and demand.
- Equilibrium Identification: Our tool helps identify the equilibrium point where marginal revenue equals marginal cost amid inflation’s volatility, aiding companies in making informed decisions and achieving cost savings.
- Incorporating Inflation Rates: River Logic’s capabilities extend to incorporating inflation rates on various production sources, helping companies monitor the impact of inflation on company’s financial position.
- Demand Elasticity: These solutions can assist in determining the appropriate production level based on demand elasticity, ensuring businesses remain responsive to changing market conditions.
- Right-Sizing Inventory: River Logic aids in right-sizing inventory to mitigate the impact of price movements, ensuring businesses remain resilient to market uncertainties.