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Strategy and innovation
Strategies to fight inflation in companies.
This is no longer transitory inflation. We are unable to moderate it but can adapt it to our business model and draft contingency plans with mixed strategies, even by creating an inflation management office led by the CFO.
Never in our career have we faced a period marked by such high inflation. In Spain, the CPI is above two-digit figures. It had not been this high since the mid-1980s. In addition to the 40-year gap, as it has happened with the United States and our neighbour economies, Spain in the 1980s was very different from Spain in the late 2000s. The national currency was the peseta, very weak against the dollar, yen and Deutschmark, and Spain had not joined the EU yet.
Forecasts for the end of 2022 point to 8.1% inflation in Spain (EU and the OECD); or 7.2% (Banco de España). The good news is that 2023 will bring more moderate figures: 3.4% according to the EU and 2.6% according to Banco de España.
How are Spanish companies responding to this scenario? Last year, when the PCI was 6.5%, companies decided to not increase prices and reduce their margins. A temporary strategy that they were unable to maintain in 2022, since business costs shot up even more, particularly commodities and energy.
Everything consumed by companies has gone up in price, but the real headache (and with a strong link to this inflation) is the supply chain crisis. Its management is now key to any business strategy, as we mentioned in the article The success of a good combination between finance and supply chain.
Inflation is the no. 1 concern of Spanish companies
Inflation is the number 1 concern for 77% of Spanish executives, according to the report 'Perspectivas España 2022' by KPMG and CEOE. Paradoxically, around 77% of respondents expect to increase their turnover and 46% expect to expand their workforce, despite the macroeconomic outlook. The most optimistic business sectors showed more resilience to the pandemic or faster recovery: tourism, leisure, pharmaceutical and healthcare industry, technology and telecommunications.
According to company executives, enemy #1 of the Spanish economy is inflation. Next come the global crisis (37%) followed by the tax rise (36%). This is their opinion about the economy but when business executives are asked about their actual business concerns, they mention three variables:
- The volatility of commodity prices
- The demand risk
- The regulatory risk.
According to a recent survey by Gartner, 74% of CFOs list profitability as their no. 1 concern. This is the most important effect of inflation. For this reason, they have taken action and some of them have created integrated offices to fight inflation.
Anti-inflation crisis office chaired by the CFO
The pandemic demanded an agile response from companies, and they had to completely rethink seemingly unmoveable processes and protocols. In the first quarter of 2020, crisis teams were created to save the traditional horizontal silos in organisations. They showed their efficacy.
McKinsey talks about creating inflation management offices within companies, led by the chief financial officer. Companies must offer a cross-function, disciplined and agile response in their relationship with suppliers and customers, their price policy and their reorganisation. But, above all, companies must stay ahead of problems instead of reacting to them.
According to McKinsey, what are the qualitative advantages of this anti-inflation cell?
- It improves the pace and quality of decision-making.
- It allows companies to focus more on strategic action and less on 'putting out fires'.
The keys to setting up this office
- Establish a clear mandate and purpose and share them across the organisation.
- The CFO or a direct report must coordinate the office.
- The office will be made up of a team of function leaders (McKinsey mentions, for example, Talent, Commercial, Supplies, Operations, Technology and Finance) who are prone to action but not necessarily the heads.
- Like during the pandemic, be aware that decisions will be made in a climate of high uncertainty and that errors will be made.
- Data, facts and a systematic approach for transparent tracking of the execution, diagnosis of profit and loss and course correction.
Eight measures to tackle inflation
Companies, led by their CFO, must fight inflation, which is no longer transitory. Well-oiled technology and predictive models, which have been analysing the inflation since last year, could become their main ally. Measures ranging from digitalisation to dynamic price management, analysis of competitors, monitoring of the salary policy and supplier diversification. We summarise them in eight points.
1. Diversifying and strengthening the supply chain
KPMG recommends that companies focus their business strategy on optimising production, minimising impacts and improving product quality. This is achieved by reducing the commodities and time needed for production. Supply chain management is listed as the key factor in the fight against inflation in all analyses. The US CFO forum, sponsored by Oracle, suggests that companies should model possible scenarios to test several potential impacts of inflation:
- The price doubles for certain commodities.
- Supply chain disruptions cause revenue delays of 25% or higher, and stock build-up.
In this inflation crisis, we have seen how predictive models lacked data to feed from, when faced with never-before-seen indicators and situations. But the path of inflation in the last year enables us to train the algorithm.
Several analysts and consulting firms recommend that companies diversify their supply chains as much as possible, even if this results in increased costs in the short term.
The pandemic has taught us about the importance of strengthening and enriching the chain, and making it more sustainable in the long term. The options include searching for national or closer alternatives, storing more inflation-sensitive materials and diversifying the suppliers. About strategic storage, a survey by JP Morgan showed that 65% of medium-sized companies saw it as their preferred tactics.
2. Progressing in digitalisation to reduce costs
Reducing costs is the first instinctive measure in the hyperinflation climate we are currently experiencing. However, and as Gartner stresses, under no circumstances should it affect the ongoing digitalisation processes. Digital initiatives may have a long-term positive effect on costs and, consequently, on product and service prices.
Alexander Bant, Gartner vice chairman, calls it the 'digital deflation': investing in technology to permanently reduce the cost of doing business.
3. Collaboration and the analysis of competitors
What are my competitors doing about prices? Once again faced with such a critical situation, in order to mitigate the effects of inflation, the strategy of companies must consider whether the measures can be taken individually or jointly with other companies. And, as emphasised by KPMG, organisations must not forget competition law. But this must not hinder collaboration, regarded as the new business paradigm in the previous crisis and one of the foundations of the Next Generation funds.
Broadly speaking, SMEs tend to have no influence on prices since they do not hold dominant market shares. As a result, they must carefully analyse the data on demand and market structure. In the opinion of the CFO forum, if your competitors increase their prices, it is perhaps better for you to do it too, unless you have enough margin not to do so and therefore can win market share.
4. Dynamic price management for a better value proposition
In the medium term, companies will have to get used to price variation across the value chain. According to KPMG, this affects the value proposition and commercial model with new dynamic price management. For months, decisions were made with a negative impact on the margins and it is now time to increase prices. However, this entails a strategic reflection on the supporting measures, from improved service to promotions. And companies must bear in mind that they can explore new paths with consumers reluctant to buy: recurring use or consumption.
As per the recent advice of insurance company Allianz, it is about improving the margins by diversifying the product and service portfolio and exploring market segments where customers are less sensitive to prices, with greater added-value and wider-margin proposals, like generic brand products. According to the experts, this is a sweet time for low cost.
5. Reducing the product or service portfolio
In line with the above, many companies are reorganising their product and service portfolio in response to their difficulties in procuring commodities, and to lower consumer spending.
Supermarket shelves no longer have space for the same variety as before. For example, big consumer companies are focusing on basic high-margin products with higher demand.
6. Including contracts with customers and suppliers in risk maps
Breach of contracts by customers and suppliers is one of the effects of inflation scenarios. Companies must incorporate this factor into their risk maps. According to KPMG, this will enable companies to anticipate and arrange financial products that cover these situations and any possible lawsuits against the parties in breach of contractual obligations.
At the same time, companies may reduce risk by increasing the number of futures contracts, especially for commodities, thus promoting cost predictability.
7. Non-salary compensation and teleworking
While a major income agreement between the social agents is still to take place, collective agreements that establish salary rises linked to the PCI are a serious problem for companies. Ideally, they should link salary updates to the company's earnings.
At the moment, it is hard to attract talent for certain jobs, such as technology; but instead of the salary, companies should explore other non-salary-based compensation avenues and stimulate teleworking, as a focus of attraction and cost reduction mechanism.
8. Optimising finance in the face of liquidity stress
The upcoming interest rate rise may be the last straw for companies dragging financing problems since the pandemic. KPMG recommends that organisations consider whether they need to refinance their debt and apply for additional finance and review hedging against interest rate instability.
The liquidity in the private market is boosting mergers, acquisitions and capital increases. In fact, according to the 'Perspectivas España 2022' report, 34% of Spanish companies are planning partnerships, joint ventures or some type of agreement for the next 12 months, 29% are planning purchases or acquisitions, 22% debt refinancing, 16% divestments and 10% a merger.
