How inflation impacts different businesses

How are businesses impacted by inflation? Are inflation data and forecasts equally relevant to all types of businesses?
Conjointly Guide to Inflation

Inflation is a key concern for all economic players in the broad sense. However, when referring to the inflation data, there are some points and caveats regarding the usefulness of the inflation data for business planning.

How does inflation affect businesses in general?

Businesses are directly impacted by inflation in two key ways:

  1. When prices increase, businesses experience increased raw materials, manufacturing, and overhead costs. While a business could remain relatively unaffected by transferring all costs to consumers, in reality, businesses will absorb part if not the majority of the increased cost to avoid losing customers.

  2. When inflation rises, the purchasing power of consumers erode - in simple terms, they can now buy fewer goods and services than they used to. This means businesses will record lower sales, reducing the total revenue of the business.

Does inflation affect all businesses the same?

Each business experiences the impacts of inflation differently. Largely their experience depends on the nature of their market, the types of products and services they offer, and their brand strength.

A. Essential goods and services are less impacted than non-essential

In general, consumption of essential goods and services are unavoidable. Thus, consumers will still spend on essential goods and services, resulting in much lower price elasticity of demand. Consumers are more likely to reduce consumption of non-essential goods when prices rise.

Impact of price increase of essential and non-essential goods

As shown above, the same increase in price between essential and non-essential goods results in a considerably bigger drop in quantity demanded for the non-essential good.

B. Markets with fewer sellers see less of an impact

In a market and industry with an abundance of sellers, an increase in prices represents the risk of losing customers to another competitor that is willing to remain at the same prices.

Markets and industries with few sellers have higher pricing power than concentrated markets with many sellers. Simply put, when there are fewer competitors within the market, consumers have fewer alternatives. Thus, businesses that sell within a market with few alternatives may experience a lesser impact than those in markets with an abundance of sellers in times of inflation.

C. Brand power reduces the negative impact of pricing increases

Consumers pay more for branded goods as compared to general goods. Brand power translates into pricing power. Products associated with high brand power have a considerably more inelastic demand, making consumers more accepting of a price increase.

What’s wrong with official inflation data?

1. General inflation data and forecasts may not be relevant to all businesses

Central banks monitor and release inflation data as a tool to guide consumption. However, there are two important considerations here:

  1. Consumers may not respond as policy-makers initially expected. Research has found disagreement among household expectations on future inflation 1. This generally means inflation will boost consumption for some people but keep others away from consumption.

  2. As CPI is calculated to reflect a general basket of goods, it does not reflect the rate of inflation experienced by subgroups of the population 2. Thus, businesses may not know which segments of their consumer base will be the most impacted by rising inflation without appropriate research.

2. Inflation data does not cover the substitutes and alternatives for goods and services

CPI measures a fixed basket of goods and services covering hundreds of product categories. Although the sample may include thousands of varieties available in the marketplace, the index does not account for substitutes and alternatives like store brands and private labelling goods, fruits sold in the groceries and 5-star hotels 3.

3. Inflation data may not reflect the uneven economic development across regions

Previously, we discussed how the varied reopening rates among regions eventually contributed to the ongoing supply disruptions. This may cause a significant gap between economies, as an economy that is more severely impacted will take longer to recover. When an economy’s relative purchasing power is lower than other economies, it will experience a higher inflation rate.

4. Inflation data does not highlight sectoral differences

The pandemic has hit sectors differently, and the general inflation data and trends may not apply to all industries. For instance, sectors still recovering from the pandemic impact, like airlines and hotels, have not seen price levels fully recover to their previous levels 4.

For businesses, it is important to reevaluate the current industry positions and the existing business dynamics within the sector. Some sectors were severely impacted, and now industry players are left with fewer competitors, while others face supply chain disruptions and need to source new suppliers. The impacts of these events generally do not appear under the overall inflation statistics.

5. Inflation data neglect changing online pricing dynamics

Online pricing changes can also be a blind spot of the CPI 5. Official inflation statistics does not always account for the rapid growth of e-commerce. Research prior to the pandemic has found that online prices exhibit similar characteristics to offline prices despite increasing competition and lower costs of changing prices 6.

However, the e-commerce sector has responded rapidly to the challenge of the pandemic, with companies investing in logistics, supply chains and widening their product ranges. Conjointly’s previous surveys found many consumers were likely to continue shopping online after the lockdowns 7. Businesses may need to consider the changes in competition and price dynamism in the e-commerce landscape.

What actions should a business take during times of high inflation?

As covered in this post, inflation has a unique impact on each business. Next, we look at the actions businesses can take during periods of high inflation to maximise their potential for prosperity.


References

[1] Armantier, O., Koşar, G., Pomerantz, R., Skandalis, D., Smith, K., Topa, G., & Van der Klaauw, W. (2021). How economic crises affect inflation beliefs: Evidence from the Covid-19 pandemic. Journal of Economic Behavior & Organization, 189, 443–469. https://doi.org/10.1016/j.jebo.2021.04.036.

[2] Bureau of Labor Statistics, U.S. Department of Labor. (2021). What are some limitations of the CPI? Consumer Price Index Frequently Asked Questions. https://www.bls.gov/cpi/questions-and-answers.htm#Question_22

[3] Bureau of Labor Statistics, U.S. Department of Labor. (2021). What goods and services does the CPI cover? Consumer Price Index Frequently Asked Questions. https://www.bls.gov/cpi/questions-and-answers.htm#Question_10

[4] Hancock, A., & Georgiadis, P. (2021, November. 8). Travel sector braces for post-pandemic world. Financial Times. https://www.ft.com/content/474516a6-6cbf-4d41-9e0b-62a13754e385

[5] Bureau of Labor Statistics, U.S. Department of Labor. (2021). Does the CPI collect prices from online outlets? Consumer Price Index Frequently Asked Questions. https://www.bls.gov/cpi/questions-and-answers.htm#Question_13

[6] Charbonneau, K. B., Evans, A., Sarker, S., & Suchanek, L. (2017). Digitalization and inflation: A review of the literature. Bank of Canada. https://www.banqueducanada.ca/wp-content/uploads/2017/11/san2017-20.pdf

[7] Zhao, H. (2021). COVID-19 Consumer survey: August 2021. Conjointly. https://conjointly.com/blog/covid-survey-august/


Written on 10 December 2021 by:
Chun Hui Lee image
Chun Hui Lee
Insights Writer