Most managers today lack any experience dealing with high inflation. Sure, they can handle the drumbeat of low inflation, a percentage point or two a year, but the current situation presents a dangerous new challenge.
“Leaders have to change their priorities,” Ram Charan and Geri Willigan write in their timely new book, Leading through Inflation. “Many have been in hot pursuit of revenue growth and market-share gains through their career. Now they may need an abrupt shift to become a smaller, financially sturdy business. They have to focus on the balance sheet, especially cash, and get the entire organization on the same page.”
Mr. Charan, who criss-crosses the globe advising top CEOs, has been here before. During the runaway inflation of the early 1980s, Jack Welch, then chief executive officer of General Electric Co., asked him to train executives through a program called COIN (for Coping with Inflation.) His book stresses that inflation affects nearly every part of your business, so the entire organization must confront it.
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Inflation consumes cash, as accounts receivables that linger are paid in money worth less than the purchase price. Price increases roll through your value chain like a runaway train, from suppliers to consumers. You can zealously watch the consumer price index to guide you in adjusting your prices, but it may not reflect the severity with which your sector is being hit. Price increases that don’t keep pace with cost increases can severely reduce your margins. And finally, the effects of inflation are cumulative. “A 7-per-cent inflation rate may be manageable for one year, but a rate even close to that compounded for several years could ravage the business,” Mr. Charan and Ms. Willigan write.
To tackle the problem, each company should establish a war room – a frequent gathering of knowledgeable people to collate and consider early warning signals, develop policies and drive action. It’s a combination of firefighting and strategy. The early-warning signals can come from customers, your supply chain, industry statistics, and macroeconomic indicators. Develop a dashboard of metrics to keep tabs on the situation.
Pay attention to cash, because it’s the No. 1 risk to the organization. You need to know where it flows from, and how that changes over time. Mr. Charan and Ms. Willigan note that if you have contracts to sell at fixed prices with no way to prevent inflation hitting you on the cost side, you are heading for trouble.
“And don’t forget that customers consume cash in the form of receivables, inventory and production, some more than others. A customer who pays receivables in 275 days might not be worth having, even if you get a hefty margin,” they write.
You must also strive to keep inventories low while still meeting customers’ needs. Keep in mind that as revenues grow, inventory will grow and consume cash.
To preserve margins, you must change your pricing approach. Mr. Charan and Ms. Willigan point out that pricing has been a relatively low priority over the past decade, but under inflation is central to survival. “It’s not just that you have to raise prices, which you almost certainly do; you may have to revise your whole approach to pricing,” they write.
They stress that the range of options on pricing is likely wider than you have considered. Perhaps you need a subscription-based approach, or have ruled out surcharges in the past but now think they would work better. They point to the approaches taken by two lumber distribution companies. One negotiated prices with individual customers, – a process that proved too slow to keep up with the change in the value of money. Another set prices based on a fixed margin, adapting well to inflation.
Essentially, you must pick up the pace of price changes. “If you leave it to sales and marketing alone, you may never get the price increases you need, let alone be first in line. They may stall because they don’t want to lose the customer or dread getting serious pushback from them,” Mr. Charan and Ms. Willigan warn.
Your goal is dynamic pricing or, at least, more dynamic pricing. Building a cadence of more frequent changes will pay off better than playing catch-up with one big price increase down the road. Automating price adjustments, at least for certain customers, relieves the pressure. One company used dynamic pricing for small accounts to free up salespeople to negotiate prices with the biggest ones.
Cost cuts may also be necessary, but Mr. Charan and Ms. Willigan stress you should find ones that build the business. One CEO told his team to remove costs wherever they could, except those that weakened their business, that of their customers, or that of the subcontractors manufacturing their product. A delicate dance, but this is a new era and it calls for new moves.
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Harvey Schachter is a Kingston-based writer specializing in management issues. He, along with Sheelagh Whittaker, former CEO of both EDS Canada and Cancom, are the authors of When Harvey Didn’t Meet Sheelagh: Emails on Leadership.