Ways Small Businesses Can Fight Inflation

In this session for the Amazon Business Small Business Summit 2023, Professor and Economist Tyler Cowen discusses coping mechanisms for inflation and recession. Read highlights from the transcript of the session below. 

Inflation versus Recession

To give a very simplified take on inflation and recession, you can think of inflation as something which happens when the demand for goods and services are too high. Most typically, that happens when the monetary policy of the Federal Reserve has created too much money and consumers and businesses are spending too much. Sometimes it happens because oil or energy prices are too high. But in general, think of inflation as being a problem of excess demand. Now, recession in this sense is the opposite coin of inflation. Very often recessions come about when there is not enough demand. If there's not enough demand, businesses will produce less. They might lay off more workers. They will be less interested in extending their economic activities and the economy enters a downturn.

How are inflation and recession related?

If inflation is too high and the central bank, the Federal Reserve tries to limit inflation, very often it moves to a state of affairs where then demand is too low and you end up with recession. So often, but not always, inflations are followed by recessions. 

When is the best time to prepare for recession or inflation?

The answer is pretty simple. The best time is now. And it doesn't matter exactly when I'm speaking, but the best time is now because inflation, when it arrives, can come pretty suddenly. When inflation in the United States spiked in early 2022, this was not widely expected. All of a sudden we had inflation of almost 9%. As I'm speaking now in 2023, some economists are suggesting we're due for a recession. No one quite knows for sure. But when the recession comes, a lot of people will be surprised. Now to consider some costs of inflation, why is inflation a bad thing?

Why inflation is bad 

When inflation is going on, we don't always know how to read economic signals. Sometimes we just see a lot more dollars coming in the door and we think, “Hey, this is great, I need to expand my business.” But it's not really that your business is doing better, the more dollars are coming in the door just because there's inflation and that can be bad for your business. So, one possibility is that you end up expanding your business when you shouldn't, and that makes inflationary environments riskier. It can also be the case that your accounting is harder to interpret or will confuse you because you have revenues and you have outflows, and they're defined across different periods of time. Another problem has to do with interest rates. Inflation makes interest rates more volatile. So, if you run a small business and it in some way depends on interest rates, for example, you're a realtor; when interest rates are more volatile, your business is riskier. You could get an interest rate call wrong and the housing sector could be shrinking when you would otherwise be hoping that it is expanding.

Overall, when inflation comes along, it's easier to make bad decisions. And furthermore, inflation very often is followed by a recession, which is yet another problem.

How to cope with inflation

Diversify product lines

Start selling some things you weren't selling before. Get a fresh start. Diversify your risk more and give yourself some more protection.
Examples:

• Pet shop that start selling more pet health and wellness products
• Rapper who used to just sell music but starts selling T-shirts, swag, and other products
• Music store that used to sell compact discs, then moved to long-playing records. Now that store could start selling books or T-shirts.

Engage in creative discounting and price discrimination

Keep in mind your customers might be feeling a pinch. They might have less money to spend on your products.
Examples:

• If you are managing a travel property, you might need to be more flexible in your price to get in some groups in a down time when otherwise demand might not be there
• If you're selling a service, let’s say you're a dentist, you might need to be more flexible with your billing or when you collect your bills. Give more generous credit terms. It's simply the case as your buyers experience more hardship. You need to be more flexible.

Seek out new markets.

Look for new customers because the old ones may not be as profitable as before.
Examples:

• If you're selling something in one state, consider marketing it in other states as well. A lot of businesses are doing this right now.

In the country of Ukraine. There's a farmer I know. He was selling organic produce in Ukraine only. Ukraine now has a war and high inflation. So, he's also started selling to Poland. So be creative. Look for places you can find new customers.

Cost-cutting

It may be necessary for you to look at your costs more carefully. We've seen this in its most pronounced fashion with a lot of tech companies, whether they be large or small, and they've simply decided that they're not going to hire at the earlier pace.

Be cautious about long-term commitments and contracts

There’s isn’t a good example of this as it’s a case of not doing something rather than doing something. But just think before you commit.

Consider that you might need to raise your prices

A lot of merchants, people with small businesses, they're reluctant to raise prices because they fear it will alienate their consumers. But it may be the case you simply have to. What I've seen happen is a lot of restaurants, there's one Chinese restaurant in particular I know, and they've decided to make the bold move of raising prices to a kind of luxury level. And they just tell their customers, ‘look, we're producing excellent Chinese food for you. We think you're willing to pay these luxury prices.’ And when I go to that restaurant, actually, it's still quite packed. This strategy has worked for them.

How to cope with recession

Now, let's consider how you might cope with recession. Some of the strategies are the same that you use to cope with inflation, such as finding new product lines, looking for new ways to price discriminate or discount, charge people different prices, and look for new markets. Since inflation is often followed by recession. sometimes the inflation actually prepares you to deal with the recession that is coming. And again, as I've noted, recessions tend to come suddenly and they're not always announced much in advance.

A key principle in recessions is to simply avoid debt. Try to keep your net worth high. Debt payments can put a small business out of business very readily. This is common sense, but it cannot be stressed enough. Be prepared.

A general point I would note and returning to the theme of opportunity. Recessions, in fact, can be very good times to pick up talent or to start new businesses. If the economy is in a boom and all of the major corporations are paying super high wages, it can be very hard for you to hire people with your small startup or if you want to expand your small business. If everyone has a job, is being paid a lot, and they're pretty happy, it's very hard to put together a talented team. So, just to continue with this theme of opportunity is always present, there are green shoots in a recession. Inflation is painful. A recession is painful. There are not good things to have. But eventually, we do come out of recessions and in part they come out because people who run small businesses and also large businesses, they find talented people who are unemployed or underemployed, and they hire them to do something new and creative. So it's just like a setback in your life. It's a bad thing to have, but if it causes you to rethink what you're doing and go back to these key ideas: finding new product lines, coming up with new ways of pricing your product, and expanding your markets, opportunity is indeed present in all economic circumstances.

Current state of inflation

Most economists believe that right now the underlying rate of inflation in the U.S. economy is probably somewhere between 4 and 5%. That's come down from its maximum of 8 to 9%. But typically, it's a little below 2%. So it still feels pretty high. The big debate at the moment is to get down from 4 to 5% back to 2%. Will we need to have a recession? And that economists disagree. And I see opinion as pretty much evenly divided.

I'm somewhat in the optimistic camp, but we will see. The core point is you need to be ready now for both inflation and recession. Please do not be too discouraged. Try to do your best and turn things around because indeed, opportunity always is present.
 

Amazon Business Small Business Summit 

Check out other small business sessions presented at the Amazon Business Small Business Summit 2023 and Amazon Business Small Business Summit 2022. 

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