How Inflation Affects Your Business

Chances are, you haven’t been giving much thought — or any thought — to inflation lately. Those white-hot increases in the cost of living throughout the 70s, 80s and early 90s are largely a memory now. With inflation idling around 2 percent for the last several years, odds are there are other, more important economic considerations in your business life.

Besides, inflation rates are an abstract concept to many security professionals — just a lot of numbers. In truth, inflation, whatever the current rate, plays a vital role in everyone’s life, business owners as well as individuals.

Consider the price of gasoline, which averaged about $1.35 per gallon 20 years ago; however, due to the unforgiving effects of inflation, a gallon of that same gas cost about $3.50 today. If you have been around long enough to remember when McDonalds dished up their 15-cent hamburgers in 1955, you may feel nostalgic when you shell out a buck for that same treat today (and a hamburger in some restaurants today will cost you $9 or $10).

 

The Complex Effects of Inflation 
One of the complexities of inflation is that its effects are misleading. It makes direct price comparisons — from one year or one era to another — meaningless. It makes some of today’s products seem expensive when they are actually cheaper and vice-versa.

The only meaningful way to compare prices from one period to another is to compare them with the general price level of each period or to the percent of average wages necessary to pay for the item during each period.

Money itself takes on a flexible value when inflation rears its ugly head. We have all heard that computer guru Bill Gates is the richest person in America, with a net worth reportedly at $76 billion. But he is a long way from being the richest American ever when you compare his fortune’s purchasing power with some of the great industrialists of a century ago. While the fortunes of John D. Rockefeller and J.P. Morgan were far less than $76 billion expressed in dollars of their day, their purchasing power was greatly in excess of Bill Gates’s today. That’s because a product or service that costs $1 today sold for about five cents a hundred years ago. Put another way, if you paid $1 for a product in 1903 and bought the exact same product today, it would cost you $23.34.

 

Direct Comparisons Can Be Misleading
During the Great Depression, a first-run movie ticket in a neighborhood theater sold for 15 cents — how does that compare with the tab at one of today’s multiplexes? With inflation factored in, a movie ticket should cost $1.90 today. Obviously, with ticket prices now running at $12 or higher, it is costing us a lot more to visit the local movie emporium than it did back in the dark days of the Depression (and don’t forget today’s $2.50 Coke that used to cost a nickel).

Of course, the bargain-price phenomenon evident in such areas as the price of hamburgers and gasoline doesn’t necessarily extend itself throughout the universe of products and services involved in the security business. Any security dealer paying for medical services or health insurance today is well aware that those costs have risen at a pace far in excess of inflation.

So what does all this have to do with your business? Plenty — misleading comparisons of prices can lead not only to a healthy dose of nostalgia, but faulty business decisions as well. Being aware of the true increase in costs after inflation is a necessary part of good financial management.

 

Inflation Never Lets Up
The rate of inflation can vary wildly from one year to the next; however, regardless of the variations, inflation continues its work relentlessly year after year. And, of course, each year’s increase compounds on top of the previous year’s. Even that harmless-seeming two percent or so inflation rate of recent years takes a significant toll over time. 

After ten years of two-percent inflation, that dollar bill in your pocket today would be worth only 82 cents.

Perhaps more important, it is unlikely that the current low rate of inflation will last much longer. An analysis of the long-term trend over the past 70 years clearly indicates that yet another round of stiff inflationary increases is highly likely. Inflation may seem to be a rather tame beast of late, but don’t be fooled. That ravenous predator is poised to come roaring back. When it returns, actions you take now will make it easier for you to deal with it then.

 

How Inflation Affects Your Business
Here’s an example of how inflation has affected your business in recent years: If you paid $15,000 for a van in 1993, the cost for that same model will probably be $24,029 today. In another example, if you paid $500 for a cash register in 1993, it will cost you about $799 to buy a similar model this year.
Of course, these figures assume that the increases in costs for the items mentioned kept exact pace with the rate of inflation. In practice, the inflated price may be higher or lower than the calculated one. Either way, the overall cost of running your business is rising steadily, more or less in step with the annual inflation rate. That’s why it’s so important for you to understand that when you fail to adjust your prices to keep pace with the inflation rate, you have effectively lowered them.

Are your prices keeping pace with inflation? Are you maintaining your markup over the increased costs you are paying to your suppliers and employees? If not, the short-term effects may not be especially noticeable, but over the longer term, the consequences will be unavoidable: Profits will be eroded, your ability to attract and pay quality employees will suffer, and the overall health of your business will enter into a destructive decline.
Yes, raising prices can be a risky business in an uncertain economic climate, but failing to keep pace with inflationary pressures poses an even greater threat. Remember, if you fail to adjust your prices to at least keep pace with inflation, you are effectively lowering them.

 

How Much Do You Need to Increase Your Prices? 
So, how do you go about determining the proper amount by which to increase your prices? If you do it on an annual basis, the calculations for figuring inflation’s effects are simple enough. Just look up the previous year’s inflation rate and adjust prices upward by that percentage.

But calculating inflation’s effects over a period of two or more years can be dauntingly complex, which is why it is difficult to make simple dollar-to-dollar comparisons from one year to another. Check out this easy way to gauge inflation’s effects on some specific costs in the operation of your business at www.westegg.com/inflation. This easy-to-use inflation calculator adjusts any given amount of money for inflation, according to the Consumer Price Index, from 1800 to 2012. Until the site’s publisher updates the chart to include 2013, you’ll have to add that year’s percentage of increase (about 1.5 percent) to the 2012 result to arrive at the latest result.

One type of economic comparison that is comparable from one era to another are figures expressed as percentages. For example, the 25-percent unemployment rate reached at the height of the Great Depression would be just as devastating today as it was in 1933. 
Another economic yardstick that remains valid through the years is the prevailing interest rate. An interest rate of two percent on a passbook savings account would bring the same return today (if you could get it) as it brought 60 years ago.

The complexities of inflation and its effect on your business can be daunting when viewed from a strictly technical perspective; however, you don’t have to be a mathematical wunderkind to benefit from an understanding of the inflation phenomenon and how it mandates periodic upward adjustments in the prices you charge your customers.

Raising prices, especially in a less than vibrant economy, may seem distasteful, even harmful, in view of competitive pressures and skittish customers. Still, an understanding of inflation and how it works leaves little room for alternatives.   

 

William J. Lynott is a veteran freelance writer who specializes in business management as well as personal and business finance. For more information, visit www.blynott.com.  

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