Five measures SMEs can take to mitigate the effects of inflation

As we move into a more inflationary cycle at a macro level, the pressures are increasing for many businesses. While inflation in Australia isn’t currently at the levels being seen in the US, energy costs are rising, supply remains constrained while demand is soaring, and now the Reserve Bank of Australia has opted to hike the interest rate for the first time in more than a decade from 0.1% to 0.35%. 

For SMEs that have weathered the pandemic and are trying to get back into growth mode, inflation couldn’t come at a worse time. Across all industries, companies are struggling to absorb mounting costs amid labour shortages. At the same time they need spare capital to expand and further digital transformation initiatives. 

So what measures can small businesses take to mitigate the impact of inflation?

1. Renegotiate contracts

Most existing fixed-term agreements were made several years ago with pricing based on a certain set of assumptions. For some projects, such as construction, the cost of stock materials is now so high that projects might run at a loss.

The answer is to go back and renegotiate the contract. There is no sense in keeping going if a contract will put you out of business (which also means your supplier permanently loses a customer). While you need to check the legal aspects, if you don’t renegotiate you may not have a business or be able to pay staff and creditors.

2. Consider alternate pricing 

Consider alternate pricing strategies to supplement the load for your customer base. To what degree can you pass inflationary price rises onto your customer base?

There are different strategies you can adopt. For example, small scale but multiple, frequent increases might be more palatable as people have time to adjust. Quarterly rises rather than annual rises may make sense and allow more flexibility at both ends of the cycle. When benefits swing back in their favour, many businesses don’t relax pricing but just take the gain. There’s an opportunity to build more customer loyalty with variability in exit pricing.

3. Rethink how you manage wage increases

There’s already fierce competition globally for skills across all sectors. Wages are only going to go up further as people seek to bind talent. Raising remuneration rates is a permanent change to your fixed cost base: you can’t go back to a workforce and expect them to accept a pay cut when the market eases again. This means that organisations need to think very carefully about how they manage wage competitiveness. It’s particularly hard for SMEs as larger corporations have a bigger balance sheet to sustain costs, but with around 30% of operating costs in an SME going on wages, a couple of percentage points increase can have a huge impact.

And to add to this, it is becoming apparent that money is no longer a sustainable way to retain staff. A competitive advantage in the recruitment space is increasingly about fulfilment: how well cared for staff feel, what flexibility they’re offered, their opportunities for career advancement, having a better work-life balance, the organisation’s broader purpose and mission and how stimulated they are. SMEs can potentially compete at a lower pay scale by focusing on other benefits of employment and avoid getting sucked down the rabbit hole of spiralling wages.

4. Adopt a loss leader position

Another strategy is to adopt loss leader position. Identify a key product, accept a loss or lower margins there, and compensate by upselling and cross-selling other products in your suite, getting an increased basket size with your customer base.

This is a typical strategy for supermarkets, where customers come in for lower cost staples but are walked past the bakery and meal sections on the way to purchase. Identify your “milk and bread” products and use them to stimulate sales of more profitable products or services.

5. Identify opportunities to diversify supply

Smaller SMEs face more supply chain risk, with their businesses typically built up on one or two key supplier relationships. Diversifying your supply chain may be critical for survival. Can your business procure closer to home? Can you pivot what you had been procuring to manufacturing and become a supplier? This way you can do less front end work and become a supplier to your former competitors, placing your company in the middle of the supply chain instead of being the net recipient of the inflationary costs. 

Alternatively, if you were outsourcing logistics, consider using government incentives to buy vehicles and manage it in-house. The key thing is to question how far you are pivoting from your core business, and how well do you understand the new direction? Ultimately you don’t have to simply accept that costs have gone up 10%. There are usually other options.

Think about how you position your business’ purpose and value to end customers. How important are you to your suppliers? For example, soft drink companies are a major supplier to the cinema industry, although it isn’t a large volume compared to big box retailers. But because the drink manufacturers just deliver concentrated syrup, with carbonating done on site, bottling and logistics costs are reduced. Cinema orders can be delivered using vacant space on trucks already being used for larger retailers. This gives cinema companies a stronger negotiating position than what you may think: soft drink businesses can afford to give a better price as the logistics costs are already sunk.

Inflation isn’t going to be easy for many of Australia’s SMEs. But by having a rethink of strategy now, and preparing for higher inflation later, businesses can put themselves into a stronger and more resilient position for sustained growth.