People think inflation is bad, therefore deflation must be good. Wrong. Unlessit’s in relation to a Chinese spy balloon, deflation is bad in both macro andmicro economic terms.
Deflation, or negative inflation, brings a fall in the general absolute levelof prices. Outside of food, it can result in consumers delaying purchases asthey wait for the price to fall. This results in falling demand, reduced levelsof output and an increase in unemployment. This is pertinent, as I believe wewill see deflation in at least some food categories in 2023.
Shoppers won’t be delaying the purchase of their baked beans, but I knowretailers will be putting suppliers under pressure to reduce cost prices onceinputs such as raw materials and energy have fallen. The pressure on retailersto reflect that to shoppers through lower in-store prices – generating the goodPR they crave – will be immense.
But dropping price is not as straightforward as it seems. Some input costs mayhave fallen, but wage cost inflation – which most retailers aredisproportionately impacted by – won’t be falling. These costs are an incentivefor them to hold up prices, even if suppliers lower them.
On the supplier side, many are delaying further cost price increases (CPIs),hoping they may not be necessary. They find CPIs to the retailer such adrawn-out battle that they soak up inflation, hoping for the drop in costs tocome soon. I understand the logic, but I don’t approve. Last time I saw thiswas when they were waiting for Brexit, which was delayed three times.
For these past years at Sentinel, we have been inundated with demand for ourCPI programme. Interestingly, we are now helping many clients with planningcost price reductions (CPRs) as many anticipate a storm of retailer pressurewhen inflation turns. These suppliers know they may struggle to make anargument for holding onto their existing prices – especially if they have givenretailers ammunition via detailed justification for recent CPIs, which will nowbe used against them.
Others, though – particularly those suppliers who sit below the customer’sradar – will opt to take a pre-emptive CPR to demonstrate their fairness. Thisputs pressure on competitors by taking a shelf price advantage – a tactic thatis especially effective for the lowest cost producer. This is dependent,however, on retailers reducing in-store prices ahead of market demands, knowingthey could bank a new higher category margin with which to beat the supplieronce established (in the independent trade, this will be curbed by price-markedpacks).
Many others levers exist, such as ‘reverse shrinkflation’ i.e. offering alarger pack size for the same price. This would enable a reduction in size whencosts go up in a year’s time, without the fanfare of a CPI.
The solutions are category-specific, but the message is clear: whatever you do,start planning your strategy now. Otherwise you might be forced to manage a CPRunder threat of delisting.