The Price of Change: Tips for managing inflation

In my previous column, I wrote about what inflationary expectations will be in 2023 and beyond. To reiterate, inflation will start easing but will stay well above most of this century to date. Whether a franchisor, franchisee, or supplier, we all have lost purchasing power and experienced declining margins since 2021—and will continue to do so next year. The result is continued pressure on margins that have already had a lot of pressure. What can we do about it?

For most businesses, operating costs are largely driven by labor, cost of goods sold, energy, and overhead expenses such as rent, insurance, and capital costs. Understanding how each of these four categories of expenses will behave in 2023 will help inform our strategy for taking pressure off margins.

Labor. There are 50% more job openings today than at any time before the pandemic. Yet there are 755,000 fewer people employed today than at the start of the pandemic, despite an increase of 4.2 million in the population of people ages 16 and older. The unemployment rate is near a half-century low. So how did this happen? The big story is a 9.2% drop in employment among workers ages 65 and older and a 3.0% decline among workers ages 20 to 24. The Baby Boomer demographic is nearing its peak, which means they are permanently leaving the workforce in large numbers.

The next three demographic groups aren’t able to fill the gaps. How did we do so historically? Immigration. We simply must solve the political impasse and allow immigration of low- and non-skilled workers into the workforce. If that can’t be done, we will see a rapidly accelerated substitution of capital for labor, eliminating the very jobs that allow most workers entry into the workforce. 

The second statistic, a decline in workers ages 20 to 24, has a silver lining for franchising. One of the strengths of the franchise business model is entry-level job training that leads to career growth. As I’ve written many times, we must make this a marketing hallmark of franchising. Perhaps relabeling some of the positions as apprenticeships focused on fundamental job skills like teamwork, customer service, POS, accountability, and so on will appeal to the 20-somethings on the fence about their future.

Cost of goods sold. While commodity prices always experience price swings as weather and other factors influence the supply/demand balance, recent increased prices were in large part the result of global supply chain distribution issues. Those are working their way out, and we should see (and already are seeing) a reversion to historical pricing trends.

Energy. There is every indication that fossil fuel energy costs will remain elevated for years to come. One of the consequences of pushing into greener sources is less investment in traditional energy production. That, in turn, keeps supply tighter and prices higher.

Rent, insurance, interest rates, etc. One of the most significant longer-term impacts of the pandemic is playing out in the retail/office/commercial space. The permanent patterns of changed consumer behavior will change the demand requirements of space and likely take pressure off the historically constant rising cost of rents. Other overhead costs, such as insurance, are likely at a permanently higher plateau. And as long as the Fed views the unemployment rate as the root cause of inflation, we can expect elevated interest rates well into the future.

What to do

If we are likely to experience continued input cost pressure (labor, in particular, is sticky upwards, i.e., wage rates go up and don’t go down), capital for labor substitutions may be part of the solution but can’t compensate for all of the margin loss we will be encountering. We must also deal with price increases. Consumers are more accustomed to rising prices than they were pre-pandemic, but that doesn’t mean you can hike prices without being careful not to end up losing more than you gain. 

Recently, I had a conversation with a franchisor CEO that was enlightening. With considerable franchisee pressure, he went along with testing a modest price increase. The result for the franchisee testing it was a significant loss of weekly revenue, which even with prices lowered to the previous level took many weeks to recover from. The lesson is to proceed with caution, but if the cost pressures noted above are accurate, you must proceed or see serious margin erosion. Here are some ways to do so.

• Adjust discounting and promotions and differentiate which products or services can be adjusted with the least consumer reaction.
• Reengineer processes. The capital for labor substitution trend is real and needs your attention.
• Develop the art and science of price change. This starts with a solid base of detailed product or service cost and margin benefit. Across-the-board price changes are very risky, but adjustments to specific products or services can have a much better outcome. Which ones to change, and by how much, requires data.

My email signature contains a quote from W. Edwards Deming that we all should remember: “Without data you’re just another person with an opinion.”

Darrell Johnson is CEO of FRANdata, an independent research company supplying information and analysis for the franchising sector since 1989. He can be reached at 703-740-4700 or djohnson@frandata.com.