How Inflation Affects Startups

Posted on May 30 2014 - 9:26am by Cristina Beltran

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Inflation can affect a lot of people and businesses – startups included. For businesses that have just begun, inflation can make things more challenging. To explain, inflation is what happens when prices for products and services increase. Inflation therefore has a big impact on the value of money. The value of a dollar now will not be the same after a period of time due to inflation. When prices rise and the value of money drops, consumers will see a decline in the purchasing power of their money.

There are several factors that can cause inflation and these include market power, demand pull, supply shock, and asset market boom. As an entrepreneur, you need to consider inflation as one of the risks to your business. Inflation can hinder or delay your current and future business plans. You must have knowledge about this so you know what to do when it happens because it WILL happen.

The mindset of a new entrepreneur is naturally focused on all the positive aspects but entrepreneurs must also anticipate challenging situations in the business environment. After all, the business world is at the mercy of the economy. Let’s look at the many challenges that your startup can face due to inflation:

Margin of profit decreases and expansion becomes harder

When the price of raw materials and labor increases, your startup can be in a lot of pressure to maintain its profit margin. Sure, you can increase prices but this carries with it a risk that your customers can go to your competitors. Your startup can suffer profit-wise due to inflation and this makes it harder to expand. Making more investment to expand your business during a period of high inflation is harder to justify so expanding your business gets more challenging.

Changes in consumer behavior

Instead of spending, consumers start saving once their spending power drops. Consumers avoid purchasing unnecessary items and services when prices become too expensive. They are less likely to spend when the economy is uncertain. When demand declines, the price and quantity of goods also decreases. Your startup may be forced to cut production if consumer demands falls. Sudden price hikes can also cause fear so people may resort to bulk buying. This kind of consumer behavior can create unnecessary shortages in the markets.

Funding and Investments stop pouring in

As a startup business, you want every financial support you can get from investors and financial services. But when inflation gets too high, this increases uncertainty in the economy and this equates to higher economic risks. The same as with consumers, this triggers a change in the behaviour of lenders and investors. Financial companies and investors become more picky when it comes to providing loans or investments and are likely to cut investments and loans to startups as they would rather lend to or invest in more established businesses. When investors turn you down to help finance your venture, it can be a big blow to your startup.

Management costs rise

Inflation can also increase management costs for startups due to wage and compensation pressures caused by inflation. As a new employer, you need to negotiate salaries with your employees to secure employment. Employees can demand higher wages because of the higher cost of living due to inflation. Your startup may be forced to let go of some people to cut costs if wage pressure gets too high due to inflation.

Not all is lost for start ups when inflation occurs. Inflation can have some positive effects on startups too as you can raise prices to keep up with the overall market. As a start up, do a thorough financial analysis and always expect the unexpected. There are many risks that your startup can face and inflation is one of them. Hurdling these challenges requires you to be aware of these risks so you can plan ahead. Make a list of alternate suppliers so that you can get raw materials cheaper to contain costs. With proper cost management, you can minimize the effects of inflation on your startup.

About the Author
Cristina Beltran