Preparing For Inflation. What must you do in the next 6 months?

Contributed by Monty Houdeshell

Preparing For Inflation

Is the prospect of hyper inflation keeping you up at night?  Is inflation even on your radar? Maybe your business is relatively new or you have never operated in a period of higher inflation.

The last time annual inflation in the US, as measured by the CPI (Consumer Price Index), was more than 4% was 1991.  Since then, for the last 20 years, from 1992 through July of 2012 the CPI averaged an annual increase of just 2.5%i. Contrast that with the prior 24 year period from 1968 through 1991 when inflation jumped more than 6% annually. These are two far different worlds in which to operate. Are you ready for it?

Of course not all economists agree that we are facing a period of higher inflation, or if we are, what the primary trigger will be. As someone once said, ask three economists a question and you’ll likely get five different answers.  Many have suggested that the large amounts of liquidity and high monetary base provided by the Federal Reserve recently will lead to high inflation. Former Fed Chairman Alan Greenspan predicts in his new book, The Age of Turbulence, that the flow of people into the workforce in developing countries such as China will slow, leading to stronger wage pressures and higher prices. And he says the impact will be global.ii Bill Gross, manager of the world’s largest bond fund for Pimco, has warned investors that higher inflation lies ahead after stimulative central bank policies created an “ocean of credit”. Mr. Gross suggests this will happen gradually and will likely continue for years to come.

High inflation can cause irreparable damage to your business, dramatically reducing profits and valuations. How can you be preparing for inflation? What can you do about it?

Preparing for Inflation: Here are ten actions you can take now to protect yourself from higher inflation in the future:

1. Adjustable rate debt.  If your term loan or other debt has an adjustable or variable rate, convert now to a fixed rate while interest rates are still low. If inflation starts to rise, interest rates will skyrocket as the Fed tries to combat the trend.  In his book, Greenspan predicts double digit interest rates in the years aheadii .
2. Supply contracts. Review your supply chain relationships and contracts and lock in good quality suppliers now with extended long-term fixed price agreements. This is especially true if you are buying commodities as these tend to react first and fastest to inflationary pressures. Don’t agree to inflation rate adjustments.
3. Customer Contracts. Review your customer contracts to make sure you have the ability to adjust pricing as required to pass on your higher costs or better yet that you can raise prices at will with minimal notice.
4. Price Increases. If the market and your contracts give you the ability to raise  prices now, consider modest increase, even a fraction of a percent every six months or so to get you ahead of the curve. If you have a custom business, start re-pricing each new job now.  If you bundle products, consider an unbundled strategy for the future  to help ease the price increase burden to your customers.
5. Cost reductions. Redouble your efforts to take costs out of the business. You probably have been doing some of this already over the last few years, but now is the time to take another look at those investment projects you passed on earlier because “you didn’t want to spend the money”. Future year’s savings will be multiplied in a period of high inflation.
6. Buy assets. Consider borrowing to buy core productive assets or another business today and pay the debt off with cheaper dollars in the future. Long-term leases with today’s inherent low rates are an alternative to borrowing.
7. Rent. If renting your facilities is still best in your circumstance, consider long-term extensions to lock in low rates while you can.
8. Employees. Make sure you have a good mix between full time employees and contingent labor. This will allow you to be more flexible in the future as cost or competitive pressures may dictate. And if you have union agreements do your best to eliminate or minimize the impact of cost of living provisions. For non-union employees move completely to a performance based reward system – no across the board merit increases.
9. Customer Service. When you do have to raise prices make sure your customers have many other reasons to stay with you and are not motivated to price shop. Investing in great customer service can be a very cost effective strategy for retaining market share.
10. Collections. Fix any lingering collection issues you have now. In inflationary times, customers, particularly distributors, will attempt to stretch out terms and use your money to run their business.

It has been said that the only reason we have economic forecasters is to make weathermen look good. So you’ll have to reach your own conclusions about whether or not we have high inflation in our future. But if you are inclined to think that is the case, there is no reason to lose sleep over it. You can begin creating your action plan for preparing for inflation today to maintain the value of your business tomorrow.