Is deflation a risk? Yes. That’s the simple answer. However, understanding deflation’s drivers is important for deciding whether to change your business model strategy to address that risk.
I’m trained as an economist, but the older I get, the less faith I have in economists, and their decades-old unresolved policy debates. But some of their stuff is worth paying attention to, in particular, monetary policy findings.
Increase the money supply, and you’ll get inflation. This is mathematically true. The issue is that our Federal Reserve Bank is having a terrible time increasing the money supply, which is what’s caused deflationary risks and fears. There’s been some recent growth in bank deposits, a key component of the money supply, but I suspect the increase is more about businesses and consumers hoarding cash rather than the simulative impact of monetary policy.
My prediction is for deflation as the mechanism for reducing prices during a period of weak monetary policy effectiveness.
- Consolidation across so many industries has given business buyers Herculean buying power. When Walmart says “Jump, as we want to lower our prices across thousands of SKUs to hold market share against Aldi”, Kraft jumps.
- Consumers are looking for a better deal given what’s happened to their balance sheets and job security and the Internet helps them find it. The WSJ’s recent cover-page story on P&G, the model of competing on benefits, using price cuts to preserve market share should send deflationary shivers down every leader’s back.
- Excess supply abounds across markets with many suppliers quite happy to use price to gain market share or build a toehold in a new market.
- Disruptive innovation is the strategy of the day, lowering prices across many categories. Who’s paying for his news these days?
- We live and work in a copycat economy in which elements that once delighted are now a requirement to be considered. The speed with which markets commoditize makes shopping on price easier than ever, as there is little lost when selecting lower priced alternatives. No wonder store brands are 20 to 25 percent of grocery store channel revenue, and that’s without Walmart’s numbers included.
Offsetting the deflationary risks are increases in the prices of raw materials and imported goods. A client who uses stainless steel powder is in shock at what’s happening to input prices in his business. As the business cycle increases the economic juice, we’ll see more commodity price increases.
The big unknown in my book is whether China is en route to a major economic downturn as government-financed leveraging reverses, a parallel to what happened earlier in the U.S. private sector.
So what do you do? If you are selling products or services that are little different from those of your competitors, and your customer has the motivation and ability to shop on price, stop everything and rethink your business model.
The probability that you’ll be able to reduce costs fast enough to stay pace with falling prices is small, which is why federal policy makers are so concerned about potential deflation. Once it starts, it’s hard to stop.
Rethink your company’s core business model strategy questions to find a set of answers that carve out a unique and attractive market space where you have some pricing authority. Some questions to ask yourself:
- Who is our target market and how do we reach and communicate with my target?
- What business are we in?
- What’s our value promise that leads our target select our offerings over alternatives?
- Why can we deliver on this promise in ways competitors can’t easily copy?
- What are our revenue and cost models that give rise to attractive profitability?
