Retail Inflation

Perspectives

The big squeeze: How to fight inflation

Considerations for retailers on the costs of inflation

With inflation rising to historic levels, retailers and consumers alike are scrambling to adjust their responses and chart a course forward. We dove into recent data to better explain the effects of inflation and add important context to the costs that continue to bear down on retailers, manufacturers, and their customers.

Not all inflation is created equal

Transitory turned to persistent. Persistent is now looking chronic.

What started as a squeeze on producer input costs now extends up and down the retail value chain, with an increasingly significant impact on households up and down the economic strata. According to a recent UBS survey1, a rising number of consumers indicate their standard of living has decreased in the last four months, and they’re feeling insecure about their financial health.

In recent months, the most persistent and widely felt inflation in decades has companies shifting from the question of, “Is it real?” to “What now?” This shift now requires a more nuanced answer. Inflation’s effects aren’t created equal. By understanding the effects of inflation on different product categories and consumers, along with the root causes of rising input costs on margins, companies can navigate the coming months with faster, agile responses that meet the demands of the moment.

To better understand the effects of inflation today, we dug into the latest Bureau of Labor Statistics (BLS) data for April 20222. Excluding certain categories like utility energy, shelter, and medical care services, we categorized available data into discretionary vs. non-discretionary purchases and analyzed the average weighted consumer price index (CPI) of each (see chart below). Inflation is hitting non-discretionary categories hardest at an annual CPI of 13.1%, compared to 5.6% for discretionary categories. When comparing these figures to the overall inflation rate of 8.3% for April 2022, you can start to see why it is important to understand the nuance in how to fight inflation.

Discretionary vs. non-discretionary inflation

Even within these two groups (discretionary vs. non-discretionary), there can be vast differences in inflation on specific items. Take the apparel category, for example. Inflation for women’s dresses rose to 8.3%, while inflation for women’s suits and separates has remained relatively low at 5%. Similarly, prices for men’s shirts and sweaters increased 9.6%, compared to only 0.1% for men’s pants and shorts. The demand for shirts is outpacing that of pants perhaps because of the realities of work-from-home attire.

We also see substantial differences in inflation’s effects in other areas—notably by geographic region and purchase size. Annual CPI stood at 7.2% for the Northeast region, compared to 8.8% for the South. After bucketing BLS categories into low-, medium-, and high-spend categories, we discovered high-spend categories like food away from home, motor fuel, and household furnishings had the highest average annual CPI at 13.8%. Low- and medium-spend categories were at 6.3% and 7.1%, respectively.

The squeeze on consumers

In the years leading up to 2021, wage growth had exceeded inflation, thereby minimizing the cost of inflation across most categories. That trend reversed in early 2021 as inflation began its steep climb while wage growth remained relatively constant across income quartiles (see chart). Combined with particularly high inflation on non-discretionary categories, this trend has eroded purchasing power across a majority of consumers. During the pandemic, the savings rate increased significantly3. Now, consumers across all cohorts are either saving less or dipping into pandemic savings to fund increased costs associated with current standards of living. The subsequent tempering of consumer demand perhaps hasn’t happened yet due to accumulated savings—potentially the most concerning effect of inflation.

Change in CPI vs. change in income (by quartile)

How to fight inflation

With inflation affecting both spending categories and consumers differently, what’s that mean for manufacturers and retailers? Navigating these shifting dynamics is more difficult than ever, and companies can’t rely on traditional playbooks or past experience. Case in point: most brand managers and retail merchants weren’t even born the last time inflation was this high.

So, how can companies mitigate the costs of inflation? In our view, companies need to evaluate where their products and customers sit across the inflation spectrum to inform a more targeted response. Some responses include:

Manufacturers: What started for manufacturers as price increases (or more likely multiple rounds of pricing increases) is broadening to include other responses. Pricing efforts are being combined with operational improvements related to supply chain productivity, supplier lead times, and new or different network partnerships. In some cases, companies are also forming new “inflation councils” to bring together commercial and operational teams for more coordinated, cross-functional responses based on a holistic understanding of the business and the potential financial implications of their decisions.

Retailers: For retailers, similar emphasis is being placed on pricing, promotions, and new forms of accountability for manufacturers in the form of service levels, penalties, requirements for inbound compliance, and adjusted in-stock service levels based on vendor profitability. Emerging practices in retail are putting more of an emphasis on personalization and assortment. Companies are personalizing product recommendations, tailoring placement in digital channels, and improving localization of assortment. Several companies are revisiting the mix of in-store vs. national brands, with an emphasis on margin in category placement. They’re also thinking about how to “shield” store brands, or value engineer those products via certain attributes.

Companies may not be able to accurately forecast inflation or just how long it will last, but by understanding its nuanced effects on their products and target customers, they can take steps to pull the right response levers and better manage their performance.

If you’re interested in discussing inflation with us and explore the implications for your company, give us a shout.

Endnotes

1 UBS Evidence Lab inside: Industry Outlook: Data Less Bad, but Our View Remains Bearish
2 BLS Data Link Consumer Price Index for Detailed Categories
3 Savings Rate https://www.nytimes.com/2022/02/25/business/economy/economy-savings-rate.html

Special thanks to Tristan Kowalski, and Lauren Stefenson for their authorship, support, and research throughout the development of this article.

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