How inflation is eating into your profit and what you can do about it

Inflation has become a genuine concern for consumers, governments and businesses in India and globally. The high level of inflation has been persistent for quite some time, fuelled by increased demand post-covid, an ongoing war in Ukraine, and poor harvests in multiple parts of the world. 

The Reserve Bank of India swung into action by raising the benchmark interest rates from 4% in early 2022 to 5.9% in September. However, even after the multiple increases in interest rates this year, with more increases planned in the coming months, inflation is not showing any signs of slowing down. The recently published figures peg the CPI at 7.41% in September, up from 7% in August and a five-month high.

The inflationary pressures might take months or years to settle: The IMF estimates an inflation rate of 6.9% in 2022-23 and 5.1% in 2023-24. However, these figures could further change due to a weakening rupee and the continuity of the Ukraine war. According to the RBI, inflation could increase by around 20bps for every 5% depreciation of INR.

While consumers feel the pinch of shrinking budgets, businesses have been hit with reduced volume growth and pressure on profit margins.

Let us first understand how inflation is eating into your profits :

As consumers tighten their purse strings, they rethink their expenses and limit their purchases to more essential categories, impacting sales volume across categories and price points. At the same time, companies reduce the overall volume of their products to preserve a fixed sticker price product.

For example, in the FMCG industry, companies have reduced pack sizes by 11g for biscuits and by 29g for washing powders (between Q3 19 and Q2 22 for an INR 10 pack).

On the other hand, consumers start down-trading and buying cheaper products impacting the average price realisation. This effect gets further amplified if a company cannot pass on input price rises, either by fear of demand slowdown or limited pricing power, with a risk of losing market share. 

In sum, inflation impacts both volume and price realisation, putting a company’s sales growth at risk. 

On the cost side, companies have been feeling the pressure with wholesale prices increasing more than consumer prices, clearly showing a gap in passing on price increases to customers. India’s WPI reached 10.7% in September compared to CPI of 7.4%, meaning that most companies reacted to inflation by reducing their margins. 

The red-hot talent market has led to higher payouts in salaries and wages, with salary increases of 9.3% in 2021 and 10.6% in 2022. These increases are comparatively higher than Brazil’s 5.0%, Russia’s 6.1% and China’s 6.0%, as per the Aon survey.

Given the entrenched nature of inflation driven by supply and demand factors, companies need a comprehensive strategy to ensure growth and protect their profit margins. Broad-based actions for cutting costs and increasing prices would have given short-term respite, but more needs to be done with surgical precision as inflation is not going away anytime soon. 

So what can companies do to deal with inflationary pressures effectively? Four steps can help in driving growth and achieving better margins:

Segment and serve

First, a better understanding of customers through practical segmentation approaches is necessary. The impact of inflation is non-uniform, with higher-income customers spending money (e. g. on car purchases and international travel) while those severely affected by COVID and inflation cut down on their spending to buy essentials.

Higher-income customers spend a lesser proportion of their income on staples and are less affected by inflation but directly benefit from an increase in salaries and other income and are thus willing to spend more in discretionary categories. 

A recent research report shows that revenue from high-ticket, discretionary products increased by 15.5% YoY in the quarter ending in June, while revenue growth for staple products grew only by 8.8%. 

At the same time, in the B2B business, companies in some sectors face supply challenges rather than demand compression. 

These consumers must be adequately identified and targeted, with a potential price increase.

Segmenting your customer base with a fresh lens and new data can help you develop more targeted strategies.

B2C and B2B customers now demand a seamless experience and are willing to pay for it. In the B2C segment, it is especially true for younger cohorts, as Millennials and Gen Z consumers are much more sensitive to the overall purchasing experience rather than just the value proposition of the core product. 

Companies that better understand customers’ expectations and offer top-level customer experience in support, personalisation, and convenience can better differentiate themselves from the competition and ensure repeat business.

Decide with data

Thanks to digital transformation, companies now have a wealth of data to inform their decisions. According to IBEF estimates, Indian company expenditures in data analytics have increased by 11.5% in FY 2021. 

For example, Grasim recently identified an opportunity to launch an e-B2B platform and plans on investing 2,000 crores in this new business over the next five years. The new platform will generate big data to help develop marketing, pricing and promotion strategies. 

However, not many companies use the data to drive business growth and cut costs. Conducting a data audit and building a data-driven culture can help you reap dividends.

Companies must learn to analyse and use that data to get actionable consumer insights, which can help determine the products to promote, and categories to target to accelerate sales. Practical data analysis can also uncover early trends and reveal future profitable markets.

Transform costs

Costs are sticky once they become part of the business model. However, with a large number of automation opportunities available, across all business functions, companies can identify the waste in developing and selling their products to customers and automate processes, cutting costs and improving quality. 

For example, implementing an automatic replenishment system can augment the availability rate while optimising the inventory levels by considering the seasonality of demand and other factors driving sales. 

Automating routine tasks and assisting the workforce/salesforce through technology can also help achieve higher productivity and reduce costs in the long term.

Build scenarios

COVID has taught everyone that markets are dynamic rather than static. Even as the pandemic started to fade, new clouds emerged on the horizon - the war in Ukraine and increasing inflation with a looming risk of a global recession. 

As a result, static ‘once-a-year’ approaches to strategic planning are no more sufficient. Instead, companies need to build a system of scanning trends, identifying critical uncertainties in their market and then building future scenarios to take appropriate actions as the future unfolds. 

Scenario planning can help CEOs and business owners make better investments, resource allocation, and risk management decisions. 

Inflation is not a short-term issue that companies can wish away. As it silently eats into your profit, your company needs to brace itself for the long haul by taking action now. Thinking ahead and creating adaptive strategies would be the key to ensuring growth and protecting margins.