Strategising Through Inflation: A Guide for Small Business in the Changing Economy

December 8, 2023

The Australian economy, like that of most national economies, is heavily dependent on consumer spending.

Australia’s consumer spending equated to 49.8% of GDP in the June 2023 quarter, compared with 63.5% for the UK and 68.3% for the US.

The Australian consumer spending percentage has fluctuated significantly in the last three years as a result of COVID pandemic lockdowns, the post-pandemic release of pent-up demand, and, more recently, inflation and the rising interest rates intended to curb it.

What it means for small businesses

Small businesses need to keep a sharp eye on consumer spending patterns in order to maintain profitability.

Shift: This year to August 2023, consumer spending on services increased by 9.8%, but spending on goods fell by 0.7%.

Opportunity: Diversify and capitalise. SMEs, especially those in the service industry, may introduce new offerings or innovate service delivery for changing consumer preferences.

Shift: In the same period, there was a rise in non-discretionary spending of 9.1%

(mainly on transport +17.1%, health +8%, and hotels, cafes and restaurants +6.9%).

Opportunity: Embed and partner. Small businesses may incorporate services/products from in-demand sectors, or work with other businesses to collaborate on new services.

Shift: Again, until August 2023, discretionary spending was stable overall, although spending on recreation and culture increased by 2.8% while furnishings and household equipment fell by a huge 12.1%.

Opportunity: Adjust and align. Small businesses can attract more customers by adding fun or experiential elements to their offerings. This can help drive revenue and build stronger customer relationships.

These trends are impacting key sectors differently:

• Construction is facing pressure from supply chain interruptions, labour shortages, and escalating costs. However, this presents an opportunity to explore and negotiate contract provisions and clauses to safeguard against unforeseen future costs.
• Manufacturers are navigating energy price surges, complex supply chains, a distinctive labour market, and changing consumer spending towards experiences. However, they can consider adding new features to their products, focusing on the end user experience and meeting current consumer trends.
• Transport is encountering rising operational costs and sustaining profit margins amidst inflation. Businesses can trial new, creative ways to enhance customer value, increase satisfaction and remain competitive.

Inflation pricing strategies

The CPI first began to show an annual increase beyond the RBA’s 2%-3% comfort zone in the June quarter of 2021, when the annual rate rose to 3.8%. The inflation rate peaked at 7.8% in December 2022, but remains at 6% in the latest June 2023 figures.

The impact of inflation is pressuring businesses to elevate prices to sustain profit margins, while consumers grapple with financial allocation due to static wages and rising living costs.

Beyond price increases, there are other pricing strategies to help businesses achieving sustainability throughout inflation:

1. Maintaining Profit Margin: Add a consistent profit margin percentage to your costs, utilise cost-reduction and enhanced customer service, and transparently communicate price changes.
2. Pricing Competitively: Use market research to strategically price products either minimally above cost or at a competitive mid-range point.
3. Shrinkflation: Reduce the size of products or services while maintaining existing prices, bearing in mind the risks of customer perception.
4. Discounted Pricing and Loss Leaders: Entice customers with discounted key value items and potentially underpriced loss leaders to promote additional, profitable purchases.
5. Fluctuating Pricing: Implement pricing strategies that adapt to various factors, including supplier costs, demand, competition, and external circumstances.

Cost control measures

One of the best responses to inflation is to examine your costs with the aim of eliminating inefficiencies, waste, and non-competitive suppliers. These cost control suggestions may allow you to maintain profit margins without increasing prices:

• Negotiate with suppliers for better terms or bulk discounts.
• Investigate alternative suppliers with lower prices for utilities and services like insurance or travel. Your current suppliers may also price match.
• Refinance loans to get better interest rates if possible.
• Embrace technology. Online tools can automate accounting and inventory management. Cloud-based solutions can be more affordable and scalable than traditional software.
• Review inventory. Dispose of obsolete and slow-moving items. Just-in-time inventory methods may help avoid overstocking.
• Reassess your premises needs. A remote or hybrid workforce may mean you can downsize.
• Adopt flexible staffing levels to meet fluctuations in customer demand.
• Consider outsourcing some of your business functions if they will cost less than in-house processes.
• Concentrate on being a good employer to retain staff and avoid expensive recruitment and training costs.

Focus on customer preferences

Understanding your customers and paying attention to their specific needs may pay dividends, but never more so than in times of high inflation.

A recent consumer survey by McKinsey highlighted some significant differences in how inflation is impacting the behaviour of different consumer demographics:

• Gen Zs (5% of consumer market) who have recently started work , may be struggling to afford their free-spending lifestyle and will need to change their purchasing habits. Retail and consumer packaged goods (CPG) will be at the top of their spending cut lists.
• Millennials (11% of market), the most financially stretched consumers, generally have higher salaries but a family and a recent mortgage. They are cutting back on discretionary spending and delaying major purchases, with the lowest brand loyalty as they chase cheaper options.
• Gen X (17% of market), with above average salaries, a family still at home and a mostly paid-off mortgage, have relatively high brand loyalty. Inflation doesn’t yet seem to be precipitating a lifestyle change for most of them.
• Baby boomers (13% of market) may have a paid-off mortgage but a lower, fixed income. They are most likely to be prepared to switch brands to secure discounts on retail, CPG and telecommunications.

Small business owners need to consider whether they are providing the right products, prices, sales channels, convenience, promotions, loyalty boosters and overall value for their market demographics in inflationary times.

Enhance core values for a competitive edge

There’s much to be gained from a focus on the core values of your business – the defining principles that define your company culture and mission.

Emphasising core business values that resonate with customers and employees not only solidifies company identity and decision-making but also bolsters success metrics.

Companies see a 4x revenue growth and teams experiencing a 17% performance hike when a robust culture and shared purpose are present.

Strong core values and a positive company culture may also enhance your reputation and help you to build a connection with the community, especially if you participate in and sponsor local events.

Adapt your business strategies to thrive during inflation

Small businesses can better weather periods of high inflation by monitoring both the CPI and consumer spending patterns published by the ABS. They should also , choose appropriate pricing strategies while striving to contain or cut costs,. It’s important to focus on the preferences of their specific customer demographics, and fostering company culture can help promote the loyalty and retention of both customers and employees.

This information is for general information purposes only. The information contained herein does not constitute financial or professional advice or a recommendation. It has not been prepared with reference to your financial circumstances or business and should not be relied on as such. You should seek your own independent financial, legal and taxation advice as to whether or not this information is appropriate for you.