The impact of inflation on small businesses

Small businesses are under pressure from inflation to either raise prices and risk losing sales or accept loans to cover some expenses in order to retain their profit margin. Over 80% of small businesses have increased their prices since the pandemic in an effort to stay in business, and some have been forced to make drastic cost-cutting choices.¹

In addition to the poor profit margins caused by inflation, small businesses that operate across borders have also had to cope with the increasing exchange rates as a result of anti-inflationary measures. Anti-inflationary measures also increase cross-border taxes and tariffs, making imports and exports unfavorable for small businesses.

This article explains the impact of inflation on small businesses, especially those involved in imports and exports. We define inflation and discuss its impact on small businesses. Finally, we offer useful tips on how small business owners can cope with inflation.

What is inflation?

Inflation is a continual rise in the general price level of products and services in the economy. Inflationary tendencies can come as a result of an increase in the cost of production, which is transferred to final consumers, or increased money supply — too much money chasing too few goods. Inflation can also be a result of a country’s monetary policy, such as a downward adjustment in a country’s exchange rate or other policies such as subsidies.

Inflation, regardless of its cause, has one effect: it reduces your purchasing power. In essence, your money has less value. This is better explained by the consumer price index (CPI), which is used to calculate inflation. The CPI calculates changes in the cost of goods and services throughout the economy. This change is expressed as a percentage, which becomes the rate of inflation.

Ideally, inflation should settle at around 2% each year to ensure stability in the economy. Experts have found that a lower inflation rate often signifies weakness in the economy as it may be associated with high unemployment, low spending, and minimal investments. However, a higher inflation rate is also bothersome as consumers lose purchasing power much more quickly.

Inflation has been on the rise since the pandemic. The global inflation rate has risen from 3.74% in March 2021 to 9.2% in March 2022, an increase of almost 150%. The inflation rate has doubled in at least 37 countries so far. Small business owners identify inflation as the biggest risk to their business survival, and 22% of them are of the opinion that inflation has reached its peak. The Fed's decision to fight inflation by hiking interest rates also implies doom for small business owners who are thinking about taking out loans to fund their operations.²

The impact of inflation on small businesses engaging in imports and exports

Inflation certainly has a negative impact on businesses worldwide, but what does this mean for small businesses, especially those that are engaging in cross-border trade? According to the National Federation of Independent Business (NFIB), about 90% of small business owners report that the current inflation has an unfavorable impact on their business.³

Here are some of the direct impacts of inflation on import and export businesses:

1. Higher running costs

Small businesses will have to spend more money on the supplies they need for their businesses. For small businesses involved in imports and exports, this means higher shipping costs and tariffs on international sales.

Domestic costs are also rapidly increasing, especially in energy and electricity charges, which are the major drivers of inflation. 73% of small businesses have said that increasing energy costs are negatively affecting their profits to a large extent.⁴

Rising costs also create a cash flow problem for small businesses, making it harder for them to meet their short-term obligations. A report published by SCORE showed that rising costs are posing extreme difficulties for 35% of small businesses.⁵

2. Increased prices

Small businesses are forced to increase the prices of their products during inflation to maintain their profit margin. However, this can have adverse effects as it reduces competitiveness. Increased prices may also discourage customers from buying your products.

This is especially true for businesses selling consumer products. Consumers will always opt for lower-cost goods. As a result, some businesses are taking on the burden of increased costs by taking out loans instead of passing the costs to customers.

3. Fluctuating exchange rates

Exchange rates will certainly fluctuate during inflation. Depending on the anti-inflationary measures in your country, your domestic currency can either weaken or strengthen against that of other countries. If your currency is strengthened, you would be able to import more, but your international sales would likely drop.

4. Higher tariffs and taxes

Increased taxes may be used to reduce inflationary pressures as taxes lower disposable income, which reduces demand. While this is helpful for the economy, it could be horrid for small businesses because they tend to be less stable and have a lower chance of surviving long enough to enjoy the benefits of this anti-inflationary approach.

5. Adverse government policies

Countries like the United States are already implementing stringent policies to fight inflation. The increase in interest rates, which is expected to reduce the inflation rate, will also increase the cost of borrowing and lead to less working capital for small businesses.

6. Costlier goods and services in the international market

The global economy is weakened by inflation, especially one as severe as this one. Products are scarce and labor turnover is rising. Since the effect is global, businesses have little to no protection against price increases in almost all marketplaces.

Some nations are experiencing double-digit inflation of up to 15%, which translates to an increase in the average price of goods by 15%. Those who do not have high inflation are gradually falling into a recession.⁶

7. Lower competitiveness

During periods of inflation, small businesses operate within stringent financial constraints. This is advantageous for companies with sufficient resources since it allows them to increase their market share. Other companies with less financial access will be too preoccupied with keeping their business running to compete for market share.

8. Supply chain disruptions

Supply chain disruptions were one of the challenges during the pandemic, which also added to the increased prices of goods and services. However, these disruptions have been sustained, and the current inflation makes it worse for small businesses, reducing their purchasing power and inventory levels and causing them to slowly wind up.

9. Market uncertainties

Even experts are unable to predict the direction of inflation, whether there will be a sharp increase in line with higher pay demands by workers and consumers seeking to maintain their purchasing power, or a decrease in accordance with lower spending. Your only choice is to plan for potential outcomes and implement strategies to deal with inflation.

How can small businesses survive rising inflation?

Inflation is an external threat to the survival of small businesses. While you, as a small business owner, can’t do much to influence the level of inflation, you can employ strategies or techniques that would help you cope with the rising inflation levels.

Some of these strategies are:

1. Analyze your business cost structure

Inflation causes an increase in running costs and other operational costs, reducing the profit of the business. Thus, to maintain your profit margins during inflation, you can cut some unnecessary costs. One way to identify these unnecessary costs is to analyze your cost structure.

Isolate the variable costs of production (costs that change with production volume) from the fixed costs and identify the costs that have a direct impact on increasing profits, limiting spending to areas that directly increase your profit margins.

However, you should avoid broad, untargeted cost-cutting that would negatively affect growth. These can include cutting technology that helps with operational efficiency, laying off efficient staff, and cutting marketing costs completely.

2. Automate processes to improve productivity and efficiency

Another way to cope with inflation is to improve productivity and efficiency. Small businesses can invest in low-cost automation tools that can automate their recurring processes such as order sorting, handling, and accounting processes to boost their productivity and efficiency. This will not only help them save on costs but will also allow them to cater to more customers, thus increasing their sales.

3. Analyze profit margins

Your profit margin is the difference between the revenue from product sales and the money you spend on manufacturing and delivering those products. To make sure that your costs do not surpass the value of your sales, analyze your profit margin. You can preserve or even increase the profit margin as it narrows due to inflation by either raising the prices of your items (sales value) or cutting production and distribution costs.

Small businesses with price-sensitive customers stand a risk of losing their market share if they increase their product prices. However, they can still strategically maintain their profit margins by lessening the impact of a price increase — keeping the product price but reducing the quantity.

4. Take measures to improve your bottom line

Your bottom line is your profit after all business expenses. In addition to increasing the prices of your products and reducing their costs, you could diversify your products. Since inflation reduces the purchasing power of consumers, they generally opt for lower-cost goods.

You may also consider changing your product mix by discontinuing products that have a high cost of production but contribute so little to the overall business profits.

5. Stock up on supplies

While the prices of goods are rising persistently during inflation, you can save on the cost of raw materials by buying in bulk and stocking up. If you have limited funds to make a bulk purchase on your own, network with other small businesses in the same niche as you to find out how you can pull resources together to order supplies together.

You won’t only enjoy the benefits of bulk buying but also save up on future price increases. According to American Express, stocking up on supplies is a sure way to keep supplies at optimal levels before prices rise even more. However, you should focus on those supplies that have a long shelf life and whose prices are increasing sporadically.

6. Long-term contract with suppliers to lock in the price

This is hedging against inflation. A staggering 77% of manufacturers look forward to raising their prices, with the knock-on effects for small firms being audible. By securing pricing with a dependable supplier, you can stop worrying about price rises in the future. The price of those supplies may rise due to inflation, but since you have set a fixed price arrangement with your supplier, you will be able to purchase them for less.⁷

When it's not possible to lock in a price with your supplier, you should think about renegotiating lower costs or even moving suppliers.

7. Increase your customer acquisition strategies

Customer acquisition strategies help you reach and engage with prospective customers and convince them to buy from you. These strategies include running an affiliate program, improving online visibility, hosting giveaways and offering discounts. During inflation, small business owners should focus on low-cost, high-return customer acquisition strategies.

8. Diversify revenue streams

Diversifying product lines is only a part of diversifying revenue streams. You can also diversify your revenue streams by adding an online store to complement your physical store. Many businesses did this during the pandemic. In addition, you can offer online courses and workshops to your audience, walking them through your production process. This removes the risks of being dependent on a single revenue stream.

Sell on Alibaba.com

The best strategy to deal with inflationary pressures may be to use e-commerce marketing. Online marketplaces make it easier for small businesses to minimize costs without compromising quality. One of these is Alibaba.com.

Alibaba.com is a superb cross-border selling platform known for its inclusion of and support for small businesses. Its sellers receive more than 400,000 sales requests every day and have more than 40 million active buyers from 200 different countries and regions.

Alibaba.com is a business-to-business marketplace. As a result, you could sign contracts with five companies that would each purchase at least ten products rather than attempting to sign agreements with ten clients who would each purchase just one or two things.

Alibaba.com provides small businesses with additional advantages, such as a classic no-code storefront where they can easily display their products for customers to choose from, in addition to helping them to cut operating costs. Open a seller account on Alibaba.com to enjoy these and a lot more.