Inflation in Europe is at its highest level in 13 years. According to the European Central Bank (ECB), inflation in February was 5.1%. The ECB’s worst-case scenario suggests that inflation could hit 7.1% by the end of the year, as the region struggles with the consequences of Russia’s invasion of Ukraine. Although there have been hopes that inflation would taper down in the second half of the year, the ECP’s worst-case scenario suggests that this may not be the case. Responding to the challenge of inflation will be critical for the survival and success of businesses this year and in the years ahead.
Why is Inflation Such a Problem?
The North Atlantic Treaty Organization (NATO) has made it clear that it will not intervene militarily in the conflict in Ukraine. Instead, the Western allies have committed to a series of sanctions on Russia. The sanctions are not without downsides, especially for Europe. Russia is a significant energy partner. Germany is particularly reliant on Russia, importing 55% of its gas from Russia in 2021. The region’s energy dependence on Russia means that sanctions will hurt Europeans even as they hurt Russia. The consequence is higher energy prices. The region has tried to diversify away from Russia, but there are no easy or quick fixes.
What’s the Worst That Could Happen?
According to the ECB’s worst-case scenario, the Western allies will impose tighter sanctions on Russia, which will disrupt global value chains, push energy prices higher thanks to supplying reductions, cause a sharp repricing of financial markets and lead to other second-order effects.
The ECB believes that growth would fall to 2.3%, compared to 3.7% in the ECB’s base case in which inflation for the year would be 5.1%. However, the ECB believes that the brunt of the effects of the conflict will occur in 2022 and that the conflict will come to some kind of resolution. However, there are possible adverse scenarios that would arise.
What Businesses Are Vulnerable During Inflation?
In every economic scenario, there are winners and losers. Inflation is much more pronounced for businesses that carry a lot of inventories and supplies. Broadly, autos, financial services firms, retail, and manufacturing firms are the most likely to suffer the harshest effects of inflation. This is because the value of inventories falls during periods of inflation, and for financial services firms, loans, and other investments lose value.
What Businesses Do Well During Inflation?
According to Warren Buffett, the businesses that do best during periods of inflation are those that do not require significant capital expenditure.
Other industries that do well are energy, healthcare, utilities, real estate, and essential consumer goods.
What Can Businesses Do to Protect Themselves During Inflation?
The guiding principle during inflation is to reduce your costs and make your supply chains more robust.
Analyze your profit margins to see what segments are performing well and which are not. Focus on cost reduction and think about killing lines that are declining.
Broadly, you want to reduce your overheads and key expenses. Your business needs to be lighter. At Creative Cabinets, there is a focus on doing more with less. Efficiency is everything. This is the era of the lean business.
If your business does not rely on in-person meetings to create valuable synergies, you should consider, if you have not already done so, becoming a fully or largely remote business, to save on costs. Alternatively, your business can relocate to a cheaper location.
Find cheaper suppliers. Costs will go up, you need to assume that they will go up for at least 2 years and that means getting your supply down to the cheapest possible price. This is especially important if you carry a lot of inventory.
Finally, assess your supply chain to see if there are any vulnerabilities and to find ways to make it more robust. Expect supply chain disruption so you can prepare for it.
