With inflation inflicting a lot of damage on small businesses, how does stagflation impact small businesses?
Joanne, a small bakery owner in a bustling city neighborhood, found herself in a challenging situation. Over the past few months, she had noticed the rising cost of flour, sugar, and other essential baking supplies. At the same time, she observed a drop in foot traffic and customer orders, primarily due to the economic downturn and job losses in her community. Her instinct was to raise her prices to compensate for the increased costs, but she feared this would deter her remaining loyal customers even further. Caught between escalating costs and a stagnant market, Joanne was facing the daunting reality of stagflation. This begs the question, how does stagflation impact small businesses?
While all of us are experiencing the effects of inflation, few of us know about stagflation. Fortunately, even fewer still have experienced it. This begs the question, what is stagflation, how do we manage through it, and how can we use it to make us stronger?
What is Stagflation?
Stagflation is a term used in economics to describe a unique and troubling economic scenario characterized by stagnant growth, often accompanied by rising unemployment and simultaneous inflation. In other words, it’s an unusual situation where the economy isn’t growing, but prices are rising. This scenario presents a challenge for policymakers, as traditional methods to combat inflation (like raising interest rates) can further stifle economic growth, while measures to boost growth can increase inflation.
What is inflation?
Inflation is typically a broad measure, such as the overall increase in prices or the increase in the cost of living in a country. It can also be more narrowly calculated for certain goods, such as food, fuel, or services. Regardless of the context, inflation represents how much more expensive the relevant set of goods and/or services has become over a certain period, most commonly a year.
What are the historical Instances of Stagflation?
The most prominent historical instance of stagflation occurred in the United States and the United Kingdom in the 1970s. Several factors contributed to this period of stagflation, specifically:
- Oil Price Shocks: The members of OPEC (Organization of the Petroleum Exporting Countries) imposed oil embargoes and production cuts, leading to a rapid surge in oil prices. Given the world’s heavy dependence on oil for energy, this had a cascading effect on production costs across various industries.
- Supply-side Shocks: Apart from oil, the world faced other supply-side issues, including poor harvests that drove up food prices.
- Structural Changes: The post-war global economic landscape was changing, with increased competition from countries like Germany and Japan affecting industries in the US and UK.
- Monetary Policy: In the years leading up to the 1970s, expansionary monetary policies might have contributed to inflationary pressures.
All of these factors seemingly came together at the same time, creating stagflation.
How Does Stagflation Impact Small Businesses?
Now that we know what stagflation is, how does stagflation impact small businesses? What kind of challenges does stagflation impose on small businesses? Stagflation impacts small businesses in the following ways:
- Rising Costs: As seen with Joanne’s bakery, inflation results in higher costs for raw materials and other inputs. For businesses operating on thin margins, this can significantly impact profitability.
- Reduced Consumer Spending: As inflation is increasing, consumers cut back on their spending, leaving no one to pass increasing costs to. As a result, the small business absorbs the increasing costs, reducing profitability. Additionally, businesses may see a drop in demand for their products or services.
- Pricing challenges: To offset rising costs, businesses might consider increasing their prices. However, with demand already reduced, this can be a risky move, potentially leading to a further loss of customers.
- Credit Crunch: Banks become wary of lending during uncertain economic times, making it harder for businesses to secure loans or credit for operations or expansion. However, there are alternatives, such as Zip Capital Group, that can help with much-needed capital.
Stagflation creates a challenging economic environment for everyone, especially small businesses that don’t have much of a financial cushion to begin with. Fortunately, there are things that small businesses owner can do to control its impact.
What are financial management strategies small businesses can use during stagflation?
Does budgeting and controlling costs matter during stagflation?
Effective budgeting and cost controls are essential during stagflation because they are tools enabling businesses to remain proactive in an unpredictable economic environment. Budgeting and cost control strategies to focus on include:
Reducing operating costs
A small business should reduce their operating costs, specifically:
- Review and Prioritize: Start with an extensive review of all operating costs to determine which are essential and which can be eliminated or reduced.
- Regularly conduct efficiency audits: Regularly audit your operations to identify inefficiencies. This could mean optimizing workflows, automating manual processes, or consolidating tasks.
- Outsource: Consider outsourcing non-core activities if it is more cost-effective.
- Adopt a conservation mentality: Sometimes, small changes such as turning off unused equipment or upgrading to energy-efficient models can result in noticeable savings.
- Rethink Physical Space: With advancements in remote work, consider reducing the size of your physical office or switching to a more cost-effective location.
Negotiate better terms with suppliers.
To better control costs, a small business should seek to negotiate better terms with suppliers, considering:
- Bulk Purchasing: Buying in bulk often allows businesses to secure discounts.
- Long-term Contracts: Consider locking in current prices with longer-term contracts.
- Alternative Suppliers: Regularly shop around and consider alternative suppliers to ensure you’re getting the best deal.
- Open Communication: Maintain an open dialogue with suppliers about your needs and constraints. They might offer terms you weren’t aware of or could be open to negotiation in fear of losing business.
- Barter System: In some situations, businesses can exchange services or products with suppliers, reducing the need for cash transactions.
Inflation is painful for most small business owners. Stagflation is even worse. The last time the United States experienced stagflation was in the 1970s. As a result, It is not something that many businesses or people have experienced. However, in this era of high inflation, it remains a distinct possibility.
In this, the first of two blog posts, we defined stagflation, how it impacts small businesses, and strategies a small business can take to prepare for stagflation. In our next blog post, we will cover cash flow management and other strategies a small business owner can take to mitigate the effects of stagflation.