In a time of permanent inflation, firms need to rebuild their brand equity

I like to call the high inflationary period from roughly the second quarter of 2022 to the end of 2023 a vast unplanned experiment in showing just how effective brand equity and advertising (particularly brand advertising) delivers real financial – and share price – benefits to corporates.

Time and time again on results conference calls, company chief executives and chief financial officers highlighted how it was the strength of their brands that enabled them to push through much greater-than-anticipated price increases to their consumers.

The crisis brought home to many board executives just how vital a role brand advertising – and equity – had in enabling them to push through the inflationary impact of cost increases through to their consumers. These benefits are also likely to be long term in nature; prices have now been set at a new, permanently high level and, as input costs come down, firms are likely to bank the profits.?

Yet in this positive story lies a potentially major risk and it comes in the form of complacency. Anecdotally, at least, some businesses have taken the view they can take their foot off the pedal when it comes to advertising investment because they think the crisis showed their brands had enough strength to push through prices increases.

While that is true for the past, it risks not being true for the future. Brand equity is not a bottomless pool and every time consumers are asked to pay more for a product, more and more of that equity is used. In order to keep sufficient reserves, it needs to be constantly refilled.?

There are already some warning signs that, for some firms, the pool is being depleted. McDonald's has had to roll back some of its price increases for products such as Big Mac meals because consumers were refusing to pay the cost.

On a wider level, 2024 was supposed to be the year in which major consumer-facing companies pivoted from price to volume as the main driver of growth. That has not happened. Consumers, particularly at the lower and middling income scale, are coming under increasing financial pressure as they face inflationary pressures on a range of fronts.?

However, this is an issue that is likely to become only more pressing.?

We are entering a phase where inflation is likely to be permanently higher in nature than it has been for the past 20 years or so. The days of zero inflation in major economies have gone.

At the low end, 2-3% is the new norm and it is easy tio see how it could be higher. The reasons for that are varied (the waning of the deflationary effect of outsourcing to China, the growing drive for re-shoring, increased supply chain complexities, a growing international fight for resources and a greater militancy from labour amongst others) but the end result will be the same: higher inflation.

Moreover, the compound nature of these rises (in other words, the effect increases over time because the increases are coming off an ever-increasing base) will have a meaningful impact for firms.?

Consumers, perhaps even more, face even greater calls on their resources both because governments (stand up the UK but also others) are increasing the tax burden and because the cost of services is increasingly, in many cases, far greater than the official rates of inflation.

To give a personal example: my renewal quote from a well-known medical insurance company increased by well over 40% this year. That money has to come from somewhere. I do not expect much sympathy but, to give an example that affects lower-income consumers, utilities such as broadband and mobile operators often base their price increases at several percentage points above the inflation rate figure. Increase the cost of those services by 7-8% per annum, as opposed to 3-4%, and that has a major effect when compounding is taken into account.?

Firms are therefore likely to face a major decision over the medium term: namely do they absorb those costs and reduce their margins, or do they try to push through these higher costs to consumers. If they go for the latter, I would argue that firms need to be investing more heavily in their brand advertising in particular, and they need to be doing this now.

Their success at persuading consumers in 2022 and 2023 to bear the costs was built on the deep pools of equity built up over the years. Consumers may be less forgiving when it comes to accepting further price increases – and investors and the stock markets may also be similarly unforgiving when these companies miss expectations.

As usual, this is not investment advice.