The big squeeze: 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.