Options against inflation

Warning! This article will not be short, in exchange, its content is likely to ruin your mood!

However, if you are an entrepreneur or business leader, it might contain potentially life-saving knowledge to help you look ahead and get through the next 18 months – because I believe this time we're in trouble for real.

The last two years have not exactly been a walk in the park due to the impact of the COVID-19 pandemic, but experts say, what's coming now is unlike anything many entrepreneurs have ever seen. All businesses in developed countries – and in the light of the past few weeks, Hungarian businesses in particular – should prepare for increasing inflation and as a result, a serious, prolonged economic downturn.

While a high inflation environment is indeed a serious tactical challenge, it is also a strategic opportunity – typically only for the lucky, well-informed or economically highly educated minority. With almost 30 years of entrepreneurial and business development experience behind me, I have put together a list of what to do in such a situation – but let's not get ahead of ourselves.

A Hungarian recipe for inflation

Before we get to the nuts-and-bolts of how to adapt to soaring inflation, it’s worthwhile to take a realistic look at the Hungarian economic situation as a whole and the factors which are going to lead to the implacably increasing inflation in the coming months. We all know inflation is an economic constant. However, the healthy 2% rate of the pre-COVID era was first increased by the pandemic by a substantial amount. The disruption of supply chains raised prices through a reduction in supply, thus increasing inflationary pressures.

After this, one of the 3-4 risk factors?I had also mentioned?in an article at the end of last year became a reality: in February, Russia invaded Ukraine. The war bumped up food prices, and sanctions imposed by the US and the EU against the military aggression also gave rise to an energy crisis, the inflationary impact of which will be felt by all Hungarians within weeks.

We entered 2022 with inflation expectations of around 10%, but the Central Bank of Hungary?expects inflation as high as 16%?by the second half of 2022 – a whopping 20-year negative record which undoubtedly falls into the category?of?galloping?inflation. Except that at the time of the forecast, the Hungarian National Bank had most probably not yet priced in the two major decisions made by the government last week...

All-in by the Government

Last week, the Hungarian government had to make two decisions which, contrary to their intended effect, will significantly exacerbate the already rather risky situation and further increase inflation:

·??????the complete and final evisceration of the KATA small business tax for SME-s and?several professions, and

·??????- the abandonment of the long-cherished utility cost reduction (the Government is currently working on the detailed rules, but it has little room for maneuver, and utility bill amounts will raise by multiples from next month).

The government is obviously not tightening its belt just for fun; these decisions are both forced and economically justified. If the cabinet had not acted, the country's indebtedness would soon have caused perhaps even greater issues. Except, in my humble opinion, there is one thing that the decision-makers left out of the equation…

Here's what's coming

The KATA-clysm

Indeed, the KATA system has been used by several companies as an alternative to declared employment, providing workers with a higher monthly income in exhange for less long-term saving options. It may have been in the minds of policy makers that, as the subcontractors choosing the KATA tax option before will now be forced to pick options of higher tax percentage, employers (companies) will swallow the extra tax burden and since immediate price raise is hardly an option, the change will actually reduce company profits (which would thus act as a kind of disguised increase in corporation tax). Falling corporate profits equals less investment equals deflation.

I am convinced that the effect will be the opposite: companies will not be able to pass on the jump in their wage bill onto their customers, that's for sure; instead, they will start to lay off workers and terminate subcontractors' contracts. And although investment will indeed decrease, the companies affected by the phasing-out of the KATA tax will also be forced to cut back production due to the reduced workforce, which will in turn cause a reduction on the supply side - in other words, a relative increase of the demand side. The net result of these two effects will still be a?rise in inflation

What’s up with the utility bills?

On top of inflation, which has hovered around 10% so far, suppliers and employees of businesses will also be burdened with the cost of the increase in the price of household energy overnight, which represents?7.5% of the consumer basket, by double digits for some and?multiples?for others. Most employees or subcontractors will not be able to afford this by making the Friday evening Louis Vuitton shopping craze one bit more prudent - in fact, they won't be able to afford it at all. The rapid change in the cost of utility is even more dangerous with regards to inflation, because it also worsens inflation?expectations, a factor highly responsible for how people react on rising prices:

Theoretically - as decision makers might've thought - if utility bills are higher, then household purchasing power falls, which reduces household demand, and the fall in demand reduces inflation – at least in theory. Except that for a large part of the Hungarian society, there is not much to fall back on, and the energy price spike will be so drastic and so abrupt and, above all, permanent that it will force a meaningful wage increase in the market right after a few months' delay, instead of a demanding reduction. (For those who are really interested in the mechanism behind this, I recommend the?fantastic article?on price-wage spirals by Péter Bihari, who is a thousand times more experienced in macroeconomics than I am.)

Companies, after the immediate tax increase caused layoffs will have no other choice afterall, but being forced to incorporate this wage increase into their prices immediately, which will have a further inflationary effect (I hope I am wrong!).?To put simply, Hungarian companies will need to increase their wages and subcontractor fees in the following few months and they will also be forced to cut back on production at the same time - a combination we call a downturn in effectiveness. The result:

The rest of the year will see a rapid deterioration of the Hungarian currency. I hope I’m wrong, but I belive the annual inflation staying below 20% might be an overly optimistic scenario...

Once you've digested all this, get ready for the raising of price-capped fuel and?all other price-controlled products?as well as the increase in the price of agricultural products due to this year’s serious droughts...

This is how most businesses will react

The first reactions of businesses to soaring inflation will inevitably be a panic-driven, across-the-board cost-cutting and layoffs. I’ll soon explain why both are misconceived and suicidal. Most companies will try to delay price increases, so when they do increase prices, it will be too late and too drastic for their customers.

Depending on the given market segment, the artificial elimination of KATA freelancers may even temporarily create extra demand for businesses, but before you, as a business owner get too excited about the fresh market segment, please don’t – many freelancers, while pulling down the price level, typically worked for such a client base that the corporate sector may rather don't want - or be able to serve profitably. In several industries, the loss of freelancers alone will result a reduction on the supply side, which will, again, heat up prices and further fuel inflation.

How long will this last?

It depends on several factors, I'd typically guess roughly until the end of 2023 – if no other crap hits the fan by then. If the Chinese real estate bubble bursts, if Russia suddenly realizes the Finns are not a separate nation and Berlin is just a suburb of Moscow, if a COVID super-variant chimes in, or if the unfriendly aliens stop by to say hello, it could take the whole decade to recover. The next 18 months will certainly be difficult, and I'm not talking about something like the 2008 crisis – we are facing a much, much tougher era.

However, after all the grumpy talk and doomsaying, let's really get down to what options you have as an entrepreneur in a high inflation environment – because there are options.

The Basics

Before we look into the specifics, let's have a quick overview of the basic principles. As a broad generalization, if you want to survive an inflation crisis that is likely to last more than a year, you need to think in terms of microsurgery rather than spectacular amputations.

A scalpel is fine - an axe isn't!

General advice

A high inflation environment is especially tricky, because while you can still buy your way out of a plain crisis having the right amount of capital, a high inflation environment will eat away even the most prudently raised or saved capital. This means being passive and cutting back production is not a viable option in high inflation environments. The overall strategy could be summarized as the Holy Trinity of:

efficiency, profit-maximization and market expansion (the quick one).

9 specific tactics

1. Increase your profit margin relentlessly!

First of all, start analyzing your profit margin by service or product. If you've already invested in reliable business analytics, this is easy-peasy. If not, you're one step behind. Get rid of the low margin activities and focus on the high profit ones. If, for some reason (e.g. due to a previous investment) you can't cut those products and services, try to?bundle?them with high profit goods (products and services).

In a similar fashion, sweep out leftover products by offering bundles and optimize every little component of the margin. Introduce value-added services – these typically have higher profit margins helping you to mask price increases.

2. Automate whatever you can!

Surviving in a high inflation environment is all about increasing efficiency and automation is one of the most obvious ways to do this. Automate your sales, back-office, marketing and production processes as of right now, because, on the one hand, automations mean rising profit margins, on the other hand, by automating processes you also take steps towards the ability for a faster market expansion – and, as a bonus, you are less likely to face the threat of production downturns as well.

Order taking, invoicing, accounting, sales, management, production logistics, HR; there's room for automation everywhere, so get your processes in order and automate everything you can!

3. Increase your productivity

There's always room for improvement in productivity too; and now is the time you need to take advantage of it. My colleague, Krisztián Sulina, CEO?of 7Digits, has been working in the consulting market for years; he can tell you stories all day long about trivial things that can instantly increase production efficiency by even 15-20% in some cases. By increasing production at a low cost, you can make more profit and serve a larger market segment.

4. Stock up!

Whenever you can, stock up on supplies, even well beyond your usual quantities. In a high inflation environment, the only goods you?can’t?sell for more money later is: money. You will never get €110 for €100, but you can sell your products for €100, then €110, then €150, or whatever the market is willing to pay for them.

Stock up on the best-selling products that are sure to sell, and let go of the more dubious ones without a qualm. Don't keep a lot of cash in the bank, as its value deteriorates by the day. Invest it in products, services or even investments and put your cash to work!

5. Cut costs, but be clever about it!

Cut cost items that don't affect profitability or efficiency. Obviously, these means different items for every company, but assess everything and think about whether you need that cost or can operate without it. But don't even think of cutting costs that threaten the Holy Trinity that helps you survive inflation: profitability, efficiency, and market expansion!

6. Raise prices regularly

In a high inflation environment, there is little else you can do, yet many business leaders are afraid to do so, and when they finally do, they are forced to raise prices drastically and lose customers. Price increases are much more bearable for customers if they are done in small, gradual segments. Start with peripheral products and gradually move towards more essential products and services. 89% of US SMEs have already increased their prices this year. In a high inflation environment you have no other option. The question is:?how?

If you have a lot of products, the?Prisync?app lets you automate the process of adjusting prices to competitors' prices, changing purchase prices, or other market factors (also available individually for $99 a month). It automates pricing based on rules, checking competitors' prices and ads every four minutes.

In price-sensitive markets, you can also use pricing tricks such as value-added services. For example: raise the price but give an extra year's warranty. By the time the extra year of warranty becomes a cost item for you, the money will worth 20-30% less or if it's funny money (e.g.: Hungarian Forints) more like 60% less... You can also increase the prices of some services or items, say because of an increase in delivery costs, like Uber, Instacart or Lyft did.

7. Renegotiate your payment terms

If you get your invoices paid in 30, 60 or 90 business days, it's practically worth less by the time you get it than when you became eligible for it. This is unsustainable with high inflation. Push back the due date of payment - in high inflation environments most markets are high demand ones, so you should be able to do that - and preferably switch to a currency that is less vulnerable than the Hungarian Forint. Using Euro as primary currency was already common in many industries and our company, 7Digits, for example, has been using US dollar as currency for 5 years now. This is a relatively painless step and, while its effects might not be that significant, it still provides some immediate protection from losing money.

8. Keep your customers at all costs!

The high inflationary environment is all about optimization, and – depending on which study you read – it costs 5-25 times more to acquire a new customer than to keep an already existing one. Reducing?churn?by 5% can increase profits by up to 30%, so

retaining customers is one of the secret weapons of maximizing profits.

That's why your marketing focus should be on retaining already existing customers, especially if you've been working with a high customer churn rate. Personalization, proactive promotions, gathering customer feedback, loyalty programs; the list of applicable tactics is almost endless. Do not skip on these, because in a high inflation environment, conscious, professional marketing can be a lifesaver for your business both by identifying optimization opportunities and maximizing profits.

9. Speed up investments

Although in the current situation, most business leaders are more likely to be consulting their accountants than dreaming of setting up a new R&D department, the acceleration of inflation makes it obvious that it makes sense to fast-track investments. If you were previously thinking about investments that could increase efficiency, support business development, result in more accurate analytics, etc., then start them?now, because even a six-month delay will make the cost of investment noticeably higher. At the same time, as I indicated above: cut any investment that does not serve the Holy Trinity of efficiency, profitability and expansion.

What NOT to do

As I indicated above, knowing the Hungarian market, most SME decision makers will just roll up their sleeves and spend approximately 60-90 minutes on cutting parts off their companies to enter inflation mode. Don’t be that guy! They'll downsize en masse and cut costs across the board. The problem with that is they'll do the same thing again in two months and then again because this measure doesn't increase efficiency, it just downsizes operation until the company collapses.

Also, the immediate reaction in many companies will be to drastically cut marketing budgets which most decision makers did not really understand in the first place. This decision may even be justified when it mainly involves branding-type activities. However, if it concerns market acquisition that is demonstrably profitable, or the postponement of technological investments that increase efficiency, it is rather idiotic. A lot of decision makers are afraid of marketing because they don't understand it, because it's expensive, because it's tedious work.

In an inflationary environment, you cannot afford the luxury of not understanding marketing - if you want to survive.

Cutting back on wage costs and subcontractor fees is another favorite tool in the underequipped toolbox of clueless decision makers. However tempting it may be to get rid of the responsibility of the livelihoods of X and Y, mass layoffs would be a mistake. Look after your workers and find a way to keep subcontractors on your payroll. It's often cheaper to retrain a loyal colleague than to downsize and find a new one for top dollar when the job market booms.

If any of your competitors are making such wonderfully brainless decisions, you can start rubbing your hands together, because while a high inflation environment is a tough tactical challenge, it is also a huge medium-term growth opportunity simply unfathomable in peacetime. This is a market situation where you?could?have a significant share of your competitors' markets in two years' time – if you can survive that long.

Take one last deep breath before the first utility bills without the price cap arrives in two weeks – and I wish you the best of luck as well as strength, patience and above all, wisdom to hold up until in a year and a half you can grow enormously in market wiped clean of competitors! Good luck in the storm – and if you found this article helpful, feel free to share it or send it to others!