Summary: Beating Inflation: An Agile, Concrete and Effective Corporate Guide by Adam Echter and Hermann Simon

Recommendation

Since 2021, inflation has vexed consumers, preoccupied central bankers and dominated headlines. Businesses have responded with a rash of price increases, but what’s the right way for corporate managers to cope with inflation, particularly when many companies have never operated in an inflationary environment? Pricing experts Hermann Simon and Adam Echter weigh in with this brief manual that walks organizational leaders through the calculus of responding to inflation. The authors argue that it’s not as simple as raising prices; you’ll need to consider a host of factors that could likely change your business forever.

Take-Aways

• Inflation has returned, and that’s forcing managers to change how they do business.
• For business operators, inflationary climates are tricky to navigate.
• Inflationary periods catch everyone by surprise.
• Price optimization becomes an important function.
• To manage in inflationary times, leaders must fully grasp “profit mechanics.”
• When prices are rising, companies need to communicate value.
• Determining the proper price increase is a balancing act.
• Managers must be assertive in responding to inflationary pressures.

Summary

Inflation has returned, and that’s forcing managers to change how they do business.

In recent decades, central banks had all but vanquished inflation. Now, though, rising prices are back with a vengeance: The US inflation rate reached 9.1% in June 2022. The price spikes are the result of a variety of factors. The financial crisis of 2008 set the stage, and the next big shock was the COVID-19 pandemic and a massive increase in the worldwide money supply. Other factors include a simmering trade war between the United States and China, hiccups in global supply chains, and Russia’s war in Ukraine.

“After a decade of unusual price stability, we are experiencing the highest rates of price increases since the 1970s.”

The recent spate of inflation forced many companies to adapt in uncomfortable ways. Discount grocer Aldi, for instance, had little choice but to boost prices – a move that ran counter to its brand image of slashing prices at every turn. Because companies have not had to deal with the challenge of an inflationary spiral in decades, many managers are uncertain about how to respond. The natural reaction is to simply pass on the price increases to buyers, but that might not be the right call. It’s important to understand what inflation really means. Yes, goods grow more expensive, but a more insightful way to view inflation is that money becomes less valuable.

For business operators, inflationary climates are tricky to navigate.

During the 1970s and early 1980s, inflation was a constant challenge. In the United States, for instance, the annual rate of inflation spiked to 11% in the early 1970s, then peaked at 13.5% at the end of that decade. Since then, however, inflation has been an afterthought. From 2012 through 2020, the US inflation rate was generally less than 2%, briefly peaking at 2.5%. As a result, managers have essentially forgotten – or never learned – how to manage during times of inflation.

“The return of the inflation specter poses daunting and unfamiliar challenges for companies and managers.”

At first glance, inflationary times seem to bode well for financial results. As costs rise and companies raise their prices, revenues expand. But if managers don’t factor into their reality that inflationary conditions are responsible for their apparent growth, they can be caught off-guard. Inflation creates challenges for consumers, and they often respond by cutting back on spending. And if inflation persists, merchants can also change their habits by, for example, withholding merchandise in anticipation of higher prices in the future. Inflation can further roil consumer spending by boosting financing costs. In the United States, mortgage applications plunged in 2022 as mortgage interest rates soared, just one symptom of how an inflationary reality reverberates across the economy.

Inflationary periods catch everyone by surprise.

Price spikes generally sneak up on everyone. Often, a hard-to-predict shock can jolt prices upward. The Yom Kippur War against Israel, which sent oil prices skyrocketing, spurred inflation in the 1970s. The inflation of the 2020s came after the COVID-19 pandemic and Russia’s invasion of Ukraine, both unpredictable events. While 2020 monetary stimulus clearly created inflationary conditions, central bankers at first dismissed the price spikes as temporary.

“Inflations do not announce themselves, at least not with exact timing, but come as a surprise.”

The unexpected nature of inflation means that companies must be agile in responding. Inflation threatens any company’s profitability and, by definition, its ability to survive. Managers need to “get ahead” of inflation rather than wait too long to respond. It’s better for companies to make frequent, small price increases than infrequent, large ones.

“It will be very difficult for many companies to defend even the nominal profit line at higher inflation rates.”

Companies that operate on tight profit margins are especially vulnerable to inflation. Walmart, for instance, operates on a net margin of just 2%. A simple example illustrates the effects of inflation: A producer generates $100 million in sales with fixed costs of $30 million and variable costs of $60 million. That leaves a pre-tax profit of $10 million, or 10%. After taxes, the margin falls to 7%. But say prices rise 10%, boosting the producer’s fixed costs to $33 million and variable costs to $66 million. Assuming no price increase and no corresponding rise in revenues, the pre-tax profit just plunged 90% to $1 million.

Price optimization becomes an important function.

Managers can’t assume that customers will simply swallow higher prices because costs are rising. Every organization deals with a price ceiling, which is determined by both the perceived value of the product in question and competitors’ pricing practices. If customers are willing and able to pay higher prices and your rivals raise their own prices by a similar amount, then your company’s competitive position will remain unchanged. But that’s a big if. Your rivals could view inflation differently from you.

“Cost increases without corresponding increases in customers’ willingness-to-pay inevitably lead to a profit decline.”

Aldi, for instance, eschewed the normal cost-plus pricing protocol as milk prices soared. The merchant passed on only 70% of the increases in milk costs to customers, a move calculated to trade profit margin for market share. In an inflationary period, the customer’s willingness-to-pay becomes paramount. If you pass on cost increases to defend your profitability, but your customers aren’t willing to pay, then a decline in sales is the predictable result.

To manage in inflationary times, leaders must fully grasp “profit mechanics.”

When prices are rising, the CEO’s imperative becomes defending profits. But profitability can be a surprisingly vague term. In general, “profit” refers to the difference between an operation’s revenues and expenses. But there are many ways to define the same concept. Sometimes managers refer to profit but mean earnings before interest and taxes (EBIT) or earnings before interest, taxes, depreciation and amortization (EBITDA).

“Under inflationary conditions, the aim is to defend profits. The concept of profit is ambiguous.”

One major distinction is the one between nominal profit and real profit: Nominal profit reflects profitability unadjusted for inflation, while real profit takes inflation into account. In periods of high inflation, the difference becomes significant. Another relevant concept is that of the “phantom profit.” This is a profit on paper that’s fattened by historical procurement costs. If inflation were factored in, the phantom profit would disappear. Phantom profits might not represent real value, but they can be taxable. In times of inflation, another concept – that of the “profit buffer” – becomes important. Companies with low profit margins simply have less cushion to absorb the profit-eroding ravages of inflation.

When prices are rising, companies need to communicate value.

When customers are weighing every purchase, it becomes critical for companies to communicate their value. Companies should change their marketing approach during inflationary periods. Instead of their typical “soft” messaging around image, companies should switch to “hard” benefits. These features can include durability, residual value and energy consumption. By focusing on value perception, marketers can positively influence customers’ willingness to absorb price hikes.

“It makes sense to increase value-to-customer in order to mitigate resistance to price increases.”

Providing additional services is another way to cultivate customers’ willingness-to-pay. At the most basic level, an additional service might be just a free cup of coffee in the waiting room. At a more sophisticated level, the service could come in the form of training and continuing education to help customers realize the full value of a complicated product. Another inflation-fighting tactic is to offer more generous product guarantees. This is a way to eliminate risk for risk-averse customers. Of course, additional services and more generous warranties require a tradeoff: They increase the company’s costs, so managers must ensure that the add-ons don’t cut into profits.

Determining the proper price increase is a balancing act.

Any company’s ability to pass on higher costs depends on the competitive marketplace. In many cases, all participants in a market are affected in the same way by rising costs, and all will respond with a similar rate of price increases. However, this isn’t a sure thing. A competitor with a strong balance sheet might opt to take advantage of the turmoil by holding the line on prices or even by cutting prices to gain market share.

“In highly competitive markets, caution is advisable when raising prices, even in times of inflation.”

In inflationary periods, price leadership matters. In the grocery market, for instance, Aldi has been a price leader, and rivals respond to its cues. General Motors was long the price leader in the US auto market. Michelin has set the pricing tone in the tire market. Of course, even a price leader can never be sure how consumers or competitors will respond. One useful tactic is signaling – a company will publicly declare its intent to raise prices and then see how the market responds to the signal. The advance warning also helps customers prepare for and accept price increases.

Managers must be assertive in responding to inflationary pressures.

Here are some strategies for remaining profitable as prices are soaring:

• “Create awareness” – Inflation is new to everyone, and company leaders must clearly communicate the threat it poses. Price spirals require managers to rethink their corporate strategy and to guard against “price illusion” – the misguided belief that rising revenues mean the company is financially healthy. In truth, if all the growth is being eaten away by inflation, there is no growth.
• Communicate clearly – The CEO and other leaders must find ways to warn workers about the threats posed by inflation. Most employees lack a strong understanding of the company’s finances, and they might well be lulled into a false sense of security by growth in the top line.
• Make the inflation response everyone’s job – The easy approach is for companies to assume that raising prices represents the totality of the organization’s response to inflation. In reality, it’s rare that companies can pass on the entire increase in prices to customers. That means that the job of defending profits falls to everybody in the company.
• Get nimble – For decades, companies took their time about imposing price increases. In an era of low inflation, they could afford to wait. But in an inflationary environment, it becomes incumbent upon companies to react quickly. If you absorb higher costs for months without responding, your financial situation will suffer. Agile responses can mean the difference between survival and failure. When prices are rising, companies need to consider price increases on a regular basis — quarterly, monthly or even more frequently.

“If sales are inflated by inflationary prices, but real profit stagnates or economic profit vanishes, then nothing is gained.”

• Defend your pricing power – In a perfect world, a company could protect its profits by passing every penny of cost increases on to consumers. But that works only if customers are willing to pay. For your buyers to absorb price increases, they must perceive strong value in your product.
• “Restructure pricing models” – Raising prices creates a conundrum: Customers don’t want to pay higher prices, but your company can’t survive without imposing price increases. A crisis is the best time to change, and a period of high inflation presents the opportunity to introduce new pricing systems. This is the time to experiment with such tactics as multidimensional pricing and either bundling or unbundling products or services.
• Bolster your sales staff – In an inflationary period, the front-line sales force becomes crucial. Training is more important than ever. In times of soaring prices, companies should become more hands-on and hierarchical in managing their sales teams. At the same time, individual sales producers need more autonomy to negotiate price breaks without seeking corporate approval. In tough times, companies should expect more turnover in the sales staff.
• Get aggressive about cash management – During high inflation, it’s more important than ever to collect receivables quickly and to manage money in a way that guards against inflation. The finance department also must adjust to higher capital costs and discounting of cash flows.
• Cut costs – Depending on your company’s cost centers, you must look for ways to manage costs. For many businesses, inflation necessitates cutting labor costs by laying off workers. Companies also must begin to play hardball with their suppliers during price negotiations.

About the Authors

Hermann Simon is the founder and honorary chairman of Simon-Kucher Partners, a leading price consultancy. Adam Echter is a partner at the firm.

Review

Introduction

“Beating Inflation: An Agile, Concrete and Effective Corporate Guide” is a thought-provoking book written by Adam Echter and Hermann Simon, two experienced professionals in the field of economics and finance. The book provides valuable insights and practical strategies for businesses to navigate and thrive in an inflationary environment. I have carefully read and analyzed the book, and I am excited to share my detailed review with you.

Critical Analysis

• In-Depth Understanding of Inflation: The authors provide a comprehensive explanation of inflation, its causes, and its impact on businesses. They offer a clear distinction between the different types of inflation, including demand-pull inflation, cost-push inflation, and built-in inflation, which enables readers to better understand the complexities of the topic.
• Agile Strategies for Businesses: The book offers practical and implementable strategies for businesses to beat inflation, such as adopting an inflation-linked pricing strategy, investing in assets that perform well during inflation, and implementing cost-cutting measures. The authors emphasize the importance of being proactive and adaptable in response to changing market conditions.
• Real-World Examples and Case Studies: The authors provide numerous real-world examples and case studies to illustrate their points, making the book highly accessible and engaging. These examples demonstrate how different companies have successfully navigated inflationary periods, offering valuable lessons for readers.
• Focus on Concrete and Actionable Steps: The book is well-structured, with a clear and logical flow of ideas. The authors focus on providing concrete and actionable steps that businesses can take to beat inflation, rather than theoretical concepts or abstract ideas. This makes the book highly practical and applicable to real-world scenarios.
• Limited Focus on Economic Theory: While the book provides a solid foundation in economic theory, the authors primarily focus on practical strategies and real-world examples. This makes the book accessible to a wide range of readers, including those without a strong background in economics or finance.
• Lack of Empirical Evidence: While the book provides compelling arguments and examples, there is limited empirical evidence supporting some of the authors’ claims. This may limit the book’s persuasive power and its ability to convince readers of its effectiveness.
• Limited Scope: The book primarily focuses on inflation and its impact on businesses. While it provides valuable insights into this area, it does not cover other economic factors that may impact businesses, such as recession or globalization.

Conclusion

“Beating Inflation: An Agile, Concrete and Effective Corporate Guide” by Adam Echter and Hermann Simon is an excellent resource for businesses seeking to navigate and thrive in an inflationary environment. The book provides practical and implementable strategies, real-world examples, and a deep understanding of inflation’s complexities. While it has some limitations, such as a lack of empirical evidence and a limited scope, the book is highly recommended for business leaders, economists, and anyone interested in understanding the impact of inflation on businesses and how to beat it. Overall, the book is a valuable contribution to the field of economics and finance, and it provides valuable insights and practical strategies for businesses to succeed in an inflationary environment.