In SA we have seen the repo rate increasing (now sitting at 6.25%). Although these rates are nowhere near the peak of 23.99% that we saw back in 1998, the country is experiencing high inflation with July 2022 inflation in SA at 7.8%. While there are some signs of this easing, it bears watching and needs to be managed. SA businesses have some experience with inflation and higher interest rates, but it is still worthwhile highlighting some of the actions businesses should consider taking:
- Pricing – the most critical lever for businesses to deal with inflation is to increase their own pricing at least in line with cost inflation. If they are unable to do this because of competitive pressure, then they will naturally face a margin squeeze as revenue increases will not offset cost inflation. We recommend businesses get into a habit of increasing their prices semi-annually as smaller, more frequent increases may be more palatable than a larger, shock increase. Also, re-look at your pricing strategy and segment your products/services as different rules may apply in different areas.
- Communication – communication with customers is critical. If you are going to increase prices then also communicate how often this might happen and why, so that customers are able to plan for the future. For bigger customers it may be worthwhile discussing the increase in advance and explaining to them the steps you are taking to drive efficiencies and reduce your own cost pressures (see below). Remember customers hate surprises.
- Understanding your costs – in a low inflation environment, businesses tend to get a little bit lazy and accept their cost base. In a high inflation environment, it is critically important to understand your cost base and specifically:
- Strategic vs non-strategic spend – what costs are avoidable and can be taken out of the business without impacting service/product quality?
- Supplier challenges – what are the key inflationary pressures and which suppliers are likely to face significant cost pressures of their own? Which suppliers are facing supply chain challenges?
- Don’t just accept a supplier’s increase. Understand why they are facing cost increases and what they are trying to do in order to mitigate these. If they aren’t doing enough, challenge them to do so. If you understand their business, you can also look to reduce prices when conditions stabilise.
- It is good practice to go and tender for a material product/service every few years even if your supplier is doing a great job. You don’t need to change, but at least you will get a good idea of market pricing and keep them “honest”.
- Capital expenditure – consider your capex budget and whether non-essential capex can be deferred. But don’t risk cutting into the fabric of essential capex items. If you do defer, then have a timetable to reassess.
- Automation/Changes in business model – inflationary pressure may be the opportunity you need to take some hard decisions and change your business. This might include introducing automation or changing critical processes (particularly if this improves your exposure to the factors being impacted by inflation).
- Outsourcing – consider outsourcing non-essential services. Outsourcing businesses benefit from economies of scale and you can try locking in prices for a period of time putting the pressure on the outsourcer to find efficiencies.
- Diversify your supply chain – use the opportunity to diversify your supply chain to reduce risk. This may include moving your supply chain locally or to other countries. One caveat – make sure you understand where your new supplier is sourcing from so that it is an actual diversification.
- Strategic inventory – consider using your inventory as a strategic tool to weather periods of high inflation. When costs trend upwards, sell from inventory and when costs are stable build up inventory again (link to your pricing and margins).
- Financial engineering – not for the faint hearted – nobody can predict the future and there are different views on whether inflation will increase/decrease going forward. If you are confident in your view, your current gearing is sustainable and your business is sound, you could consider introducing some borrowing. This may sound odd, but what you are trying to do here is get in money today that you will be paying back from cheaper money later (cheaper because of the inflation). The trick is to make sure you are able to meet any short-term liquidity requirements from higher interest rates.
What to do?
If you would like some help working through the challenges posed by inflation and higher interest rates either for your business or your personal life, we are here to help. Our consultants are geared to help you and your business through the good and the bad. Please contact the SAIL team who will be happy to assist.