Wisdom Without Waiting: The Age of Partnerships
© John L. Mariotti 2001
For most of my business life and probably for yours, there has been one constant--inflation. Things always cost more tomorrow than today, more next year than last year. Because of this, wages and salaries were always rising too, either slowly, like the past few years, or rapidly as they did in the early 1980's. Getting price increases has been the typical problem. This period of prolonged inflation is not normal in the longer view--it is abnormal.
Over a longer time frame, much lower inflation, no inflation or even deflation has been the norm. Price increases are very unlikely--price decreases are very likely. As we enter the new millennia, your concern must be to arrest the decline of prices or to reduce costs to keep up with the decline if profits are to be maintained.
Inflation occurs when more money is created than there is tangible value to support. When the same value in goods or services just cost more money, that is inflation. Deflation is a more dangerous phenomenon. At least one of its causes can be massive global over-capacity, which drives prices down regardless of monetary policy.
Another cause can be a local excess of capacity, combined with a collapse in demand. This cause feeds on itself. With inflation expected, there is a motivation to buy before prices go higher. When facing deflation, the assumption that prices will be lower in the future causes postponed buying and fuels the collapse in demand.
There are also positive causes for deflation--like increased productivity. New technology is also a positive reason for deflation--consider PCs for an example. If a deflationary spiral starts, it can lead to recessions and worse--collapses of whole economies. As demand falls, prices decline as producers chase sales, and the postponed buying decision is reinforced--consumers wait longer, and buy cheaper, keeping the spiral going.
Even monetary policy (increasing the money supply or lowering interest rates are the most common forms) can't break this kind of spiral easily. Since most readers, like me, are not economists and cannot influence such things as monetary policy, let's focus on what you can do.
You can manage the part of the business you control better, and react to changes faster and more intelligently.
Several of my clients have expressed concerns about continually declining prices and what to do. A couple of different solutions can help. The first is an early warning system, which is responsive to changes in the prices of commodities--I call it "CIA", (Not the government agency) -- a Cost Impact Analysis. This CIA allows a company to track the commodity prices and exchange rates that are its major cost drivers and quantify how changes in those will hit the bottom line if left unmanaged. Once the effect of changes in commodity costs is quantified, strategies can be developed about how to deal with changes--before the impact hits.
The second tool is decades old, Value Analysis & Cost Improvement (VACI). This is a 1950's process, originated in General Electric, but updated to fit current business conditions. VACI breaks down costs and assigns them to the functional or esteem value provided. This is a complimentary approach to CIA since cost breakdowns are necessary for both. Both approaches also involve suppliers, since purchases are usually the largest component of costs.
Most businesses benefit in two ways from a CIA-VACI process. First, there are usually large cost savings or cost avoidance identified. Second, the result of training in CIA-VACI forever changes the way people think about cost and value, which is a long-lasting benefit.
Tools like Kaizen "Blitzes", Continuous Improvement Programs, and good old-fashioned cost management will also help in deflationary times. Since prices of most things are falling, inventory has to be carefully managed, and buying done as close as possible to the time of sales. This requires finely tuned supply chains if customer service is to be maintained.
The first step to dealing with any business issue is to have a good understanding of the underlying causes, and early warning via timely information. Then you need to consider all of the things you can control and work on them--let the competition wring their hands and blame their bad fortune on the economy.
Managing in a deflationary environment will turn all the things you learned for years upside down. Albert Einstein admonished us: "The world we have created today has problems which cannot be solved by thinking the way we thought when we created them". Only if you manage differently, use new tools to gain insights and then act fast, can you stem the tide of deflation and its potentially damaging effects on your business.
