Companies can't ride out inflation by raising prices

Consumer-goods giant Procter & Gamble says consumers are switching to premium brands. Burberry has said it expects to have to put up the price of its coats and bags as costs increase. According to a Which survey, Waitrose has been putting up prices faster than rival supermarket chains and yet sails on regardless. Meanwhile, BT is pushing up broadband prices way ahead of inflation and even the mighty Greggs, hardly anyone’s idea of an upmarket brand, has put up the price of its sausage rolls. Companies are complacently assuming they can ride out a bout of inflation with higher prices. But is that really true?

Inflation: back to the Seventies?

Most of the developed world is witnessing a burst of inflation on a scale that it has not experienced for 30 years or more. In the US, prices are going up at an annualised rate of 7.2%. In the UK, inflation has hit 5.2% and, with energy price rises still to come, will probably go above 6% very soon. Of course, this might not be sustained. If oil and gas prices start to level off, and if supply chains that were snarled up by the pandemic straighten out again, prices may start to steady. But if wages start to rise more rapidly as well, and if central banks misjudge what policies are needed, then we may well find ourselves right back in a 1970s-style wage-price inflationary spiral.

For companies, that poses a real problem. Many of them seem to be assuming that, if costs are rising, they can just put up their prices. Everyone, from coffee chains to fashion brands to streaming services such as Netflix, has been putting up their prices. Costs are going up, they explain to anyone who might complain. We don’t have any choice but to charge a bit more. That is, of course, the easiest option. But there are two big problems with complacently assuming that prices can always be lifted at the same rate as inflation.

MoneyWeek

Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE

Get 6 issues free

Sign up to Money Morning

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Sign up

First, we are about to see a real squeeze on living standards. Take the UK, for example. Wages are now rising by 4% a year, but prices by 5.2%, and are set to rise even more steeply quite soon. It doesn’t take any great mathematical skill to work out that lots of people are getting steadily poorer. Once the energy-prices cap is lifted, and the ill-judged tax rises announced by the government come into effect, many households are going to be struggling to make ends meet. They will have to start making choices about what to cut out of the weekly budget. True, they will get rid of the luxuries first, but they will also cut out any items that have risen sharply in price.

Second, price rises open up space for lower-cost, smarter competitors to emerge. Every price rise creates an opportunity for a rival to come into the market. If they can find a way of offering the same product or service at a lower price, perhaps by finding cheaper suppliers, or operating more efficiently, then they can very quickly undercut you. And consumers who are feeling squeezed will notice very quickly.

A naive generation of managers

There is a generation of managers in charge that has never experienced inflation on a serious scale before. Prices are now rising at the fastest pace since the early 1980s. Warren Buffett is probably the only CEO who has been around for long enough to remember what that was like and how to deal with it: it is brutally hard to navigate; firms have to be vigilant, lean, efficient and move very quickly if they are to survive.

Many companies are very naively raising their selling prices. Perhaps even worse, many shareholders are assuming that the businesses they invest in can maintain their margins and perhaps even improve them while inflation is escalating. Over time, they will pay a high price for that. Consumers will notice and start to abandon businesses they feel are overcharging them. And competitors will see a space in the market and start to move in. The real winners from this bout of inflation will be the companies that hold their prices, offer value for money and, if necessary, take a hit to their margins. They will do a lot better over the next couple of years than those who think they can push up prices at the same rate as costs