Business leaders must always adapt to changing economic environments. But for more than a decade, they have enjoyed a mostly growing economy with low inflation. The “stagflation” of the late 20th century is long forgotten. Economists, though, have long memories. Some suggest stagflation, an extended period in which the economy is stagnant or in recession and unemployment and inflation rise, may make a comeback.
Businesses operating in stagflationary times face two large headwinds: rising costs and declining customer demand. During stagflation, managers should search for ways to improve productivity, often by harnessing technology. They can also reevaluate pricing schemes, improve supply chains, reduce debt and consider acquisitions. Those who successfully adapt to stagflation may find themselves better positioned for the economic boom times that inevitably follow.
What Is Stagflation?
Inflation typically occurs when an economy is growing and strong demand combines with tight supplies to push prices higher. Stagflation occurs when there’s high inflation in an economy that is stagnant or contracting and unemployment is rising. In stagflation, demand isn’t strong, while inflation is sparked by a sharp increase in commodity prices often brought on by a supply disruption.
For example, stagflation occurred in the 1970s when the Organization of Petroleum Exporting Countries (OPEC) imposed an oil embargo that reduced the supply of oil to the U.S. from October 1973 to March 1974. The price of oil surged and led to price increases throughout the economy. Higher oil prices meant consumers had less money available to buy other goods, which hurt companies’ revenue and the economy’s growth. Inflation also meant consumers’ wages couldn’t buy as much as they had in the past. Consumers’ purchasing power was eroding. Workers responded by asking for wage increases. At the time, unions were strong and many contracts included automatic wage adjustments for inflation. Companies facing higher energy prices, higher input costs and higher wages responded by increasing the price of their goods and services and laying off workers. It all resulted in a nasty wage-price spiral.
The result? A U.S. recession from November 1973 through March 1975, with unemployment peaking at 9% and inflation, as measured by the Consumer Price Index (CPI), rising to 12.2% for the 12 months ending December 1974.
Stagflation poses a conundrum for the world’s central banks, including the U.S. Federal Reserve. The Fed normally cuts interest rates to boost economic activity and reduce unemployment. But doing so during stagflation would theoretically send inflation higher. The Fed finally contained the 1970s inflation by raising interest rates sharply from 1979 through 1983, but their actions also pushed the economy into another recession.
Once stagflation arrives, that conundrum causes it to linger, creating the dual challenges that squeeze businesses large and small: low or negative economic growth, which means softening customer demand, while costs rise from inflation.
- Economies in stagflation experience high inflation, growth that is flat or shrinking and rising unemployment.
- Companies often have a tough time operating during stagflation because their costs are rising and their customers are pulling back as they, too, face price increases.
- Some things businesses can do to combat stagflation include raising prices, increasing productivity, reducing costs, reducing debt and making acquisitions.
8 Ways to Beat Stagflation in 2022 and Beyond
Stagflation is a tough environment in which to run a business. On one hand, inflation is driving up expenses, with the price of raw materials and wages often jumping sharply. On the other hand, the economy isn’t growing quickly — if at all — and unemployment is rising. The difficult economy makes it tough to pass on higher costs to customers. Revenue may fall as consumers pull back their spending. Many small businesses go out of businesses in an economy besieged with stagflation.
But here are seven approaches managers can consider to help bolster their business and survive tough stagflationary times.
Improve productivity. The best way to survive stagflation is to improve your company’s productivity. Consider investing in software or machinery that can automate processes and reduce the number of employees needed to produce the same amount of product or service. New software or machinery may be able to produce items faster, with fewer defects and less waste.
Perhaps the largest difference between the 1970s and today is the technology that exists to improve processes across an enterprise. Software is making everyone in a corporation more productive, robots are getting smarter and able to do tasks once reserved for humans, and artificial intelligence is accelerating these changes.
Cut costs. Look for ways to cut costs to offset rising prices for materials and wages. Can business operations use less energy? Are there ways to improve the supply chain and reduce shipping expenses? Can the business receive discounts by ordering in bulk or by being flexible about delivery dates? It’s important to find ways to cut costs and offset inflationary pressures.
Evaluate prices. Stagflation is as an opportunity to reassess pricing policies. Observe whether other companies, particularly those in your industry, are raising prices. If they are, consider raising prices as well to offset increasing costs.
Consider offering products or services in a bundle or change packaging in a way that increases price per unit sold. Doing so may allow you to offset rising costs and remain profitable without alienating customers by a blatant price increase. Snack companies have been known to decrease the number of chips in a bag but keep the size of the bag and its price unchanged. Reducing the contents of the bag allows the manufacturer to reduce one area of cost while keeping revenue unchanged.
Another alternative may include offering a new line of more affordable products or a new line of higher-end products. Reduce quality in a way that customers won’t notice. Or if you have to raise prices, think of ways to improve quality without adding as much cost so customers feel like they’re getting something in return for the higher price.
Finally, consider a new pricing model, perhaps selling your product as a service. Software companies used to sell their software once and, in a year or two, update the software and try to upsell customers. Today, most software companies sell software as a service, in which customers pay monthly for software that’s automatically updated.
Boost quality. If a company is going to ask customers to pay more for a product, it should be sure the quality is as good or better than it was before the price increase. This might involve an increase in research spending to improve the product. Consumer product companies are often able to raise prices on products that are new and improved. A new laundry detergent that fights stains better is likely to fetch a higher price than older detergent options. New computers or cellphones that can process information faster either have higher price points or lower costs than items from competitors featuring slower processors and older technology.
Fortify the balance sheet. In stagflation, revenue may flatline while costs keep increasing. Prepare for tough times by building a cushion. That means keeping debt at a minimum. And if interest rates are rising, consider replacing any debt carrying floating interest rates with debt that has fixed interest payments. Floating-rate debt has an interest payment that often resets every month, quarter or year at some spread above a specified benchmark, like the two-year Treasury note.
In a rising interest rate environment, interest expense on floating-rate debt can jump very quickly. For example, a floating-rate bond might have an interest rate that is set every quarter at one percentage point above the two-year Treasury note. In January, if the two-year Treasury note yields 1.95%, the interest rate on the debt will be 2.95%. When the interest rate resets in March, if the two-year note yield has risen to 5.95%, the interest on the debt jumps to 6.95%. But payment on a fixed-rate note doesn’t change during the life of the debt. A 3.95% fixed-rate note will have the same interest payment on day one as it does on its last day. Fixed-rate debt may initially be more expensive than floating-rate debt, but it reduces the risk of interest payments rising in the future.
Tighten up accounts receivable and payable. Try to improve cash flow by reducing late accounts receivables (AR) and ask your own vendors for the longest terms to make payments. Management can keep track of inventories, accounts payables (AP) and receivables more easily and efficiently with software like NetSuite Enterprise Resource Planning.
Become a landlord. During stagflation, rents may increase and your business’s revenue might not. If you have extra cash available, consider buying the building in which your business operates.
Be opportunistic about acquisitions. It’s sad to say, but tough times during stagflation will force many small and medium-sized businesses to go bust. If your company is among the survivors and has the financial flexibility, consider bargain shopping. Companies that are going out of business or need to raise cash may sell property or equipment at fire-sale prices. Consider acquiring property, equipment, assets, brand lines or staff with needed skills. Likewise, consider merging or acquiring a competitor if doing so allows both companies to reduce overhead and expand into new markets or offer an expanded array of products or services.
Stagflation is a tough environment in which to operate a business. Costs rise and wages increase. Meanwhile, sales may stagnate or decline due to high unemployment and sluggish or declining economic growth. Management can use stagflation as an opportunity to take a hard look at their business and make changes to grow stronger. Companies can adopt productivity-enhancing technology that saves time and money. They might change pricing mechanisms, consider merging with or acquiring competitors and fortify the balance sheet. Businesses that take such steps to survive stagflation may find themselves positioned well for growth when the economy recovers.
How to Beat Stagflation FAQs
What assets do best in stagflation?
Commodities often offer investors strong returns during stagflation. That’s particularly true if stagflation is being caused by a disruption in the oil market as occurred in the 1970s. Companies producing commodities or providing services and equipment to the companies producing commodities should benefit. Investing in technology companies that produce software or robots that enhance corporate productivity should also perform well during stagflation. And in the past, defensive companies outperformed cyclical companies. Defensive companies often produce essential items like food and medicine. Consider buying Treasury Inflation Protected Securities (TIPS) because their principal value is indexed to the rate of inflation as measured by the Consumer Price Index (CPI). When inflation rises, the principal value of TIPS increases. Traditional Treasury notes have a fixed interest rate and principal amount.
How do you survive stagflation?
Small business owners can survive stagflation by improving their productivity, cutting unnecessary costs, producing products for which customers are willing to pay a premium, opportunistically buying equipment or expanding through mergers and acquisitions. Companies may also consider buying their office or manufacturing facilities if rents are climbing quickly. And reducing debt and fixing any floating-rate debt is also prudent.
What happens to house prices in stagflation?
U.S. home prices and home sales rose sharply during most of the stagflation of the 1970s. But every cycle is different. If stagflation occurs in the future, the direction of home prices will depend on whether home prices are low or inflated when stagflation begins, how many homes are available for sale and how easy it is to obtain a mortgage.
Are TIPS a good investment during stagflation?
Treasury Inflation Protected Securities (TIPS) should act as a hedge against inflation. Their principal value is indexed to the rate of inflation. When inflation rises, the value of TIPS increases. Traditional Treasury notes have a fixed interest rate and principal amount and typically decline in value as inflation and interest rates increase.