Home » Managing Your Money » Difficult times ahead as inflation grips and consumers are unprepared

Dominic Miles

Partner, L.E.K. Consulting

Jean-Philippe Grosmaitre

Partner, L.E.K. Consulting

Soaring inflation has led businesses to experience ongoing increases in costs, whereas consumers have not yet changed their spending habits or felt the impact of the energy prices this season.

Survey findings reveal that while consumer confidence is at an all-time low, people are surprisingly optimistic about their ability to maintain their standard of living.

However, for businesses, the temperature has dropped significantly, as they have already had to deal with a build-up of difficulties linked to post-Covid-19, the war in Ukraine and supply shortages of certain goods.

This has sparked unprecedented levels of inflation — on average, beyond 15% over two years — but wide variations have been seen in some sectors. The knock-on effect has prompted price rises and heightened anxiety within the business community.

The false dawn

To provide clients with a holistic view of the supply and demand positions of the current inflation issues and support them with robust evidence, L.E.K. Consulting, a global strategy consultancy, has just released the results of its research.

The firm interviewed about 3,000 consumers in the UK and France and 1,000 mid-cap companies across four countries in Europe to determine what inflation means for business costs, how price increases are being passed on to consumers and how consumers are managing their spending as a response.

Dominic Miles, Partner, Consumer Global Co-Head, says that there are several possible reasons why consumers felt that their standard of living would be maintained and that they would not need to make major changes to their patterns of consumption.

“Following the pandemic, there is a general sense of having now returned to a much more normal standard of living as people have been able to go out in the evening and holiday abroad again. Having these freedoms are ‘better’ even with higher inflation.

“It also seems that consumers are not acknowledging the financial squeeze until their actual cash costs go up. Whilst prices for food and fuel have already risen, many consumers will only now be starting to experience the impact on their energy bills, the single largest driver of cost increase, as their boiler gets switched back on for the Autumn.”

The situation, however, is set to change as higher bills come through, mortgage payments increase and the job market slows.

Changing landscape

The situation, however, is set to change as higher bills come through, mortgage payments increase and the job market slows.

It’s anticipated that households will have to cut consumption by 3%–4% by October relative to March 2021.

Miles says: “They will respond by cutting both discretionary and essential spending — eating out, recreation, leisure, then energy and water usage. Looking ahead, I think the experience of prices going up ahead of wages will persist; and while cost rises work through, it will continue to be painful.”

Industry response

Jean-Philippe Grosmaitre, Partner and member of the Global Organization and Performance Practice, explains that businesses generally do not expect much reduction in demand volumes, but will experience rising revenues and a weakening in profit margins.

“Companies, on average, expect to lose 25% of EBITDA (earnings before interest, taxes, depreciation and amortization) as a consequence of inflation and limited capacity to pass it through in prices,” he says.

Coping mechanisms

Many firms are taking short-term measures to cope, like promoting more profitable products or cutting their marketing budget and other expenses. It has not yet gone to the point of having to re-engineer products or revisit the make-or-buy strategy, although that will happen eventually.

Grosmaitre points out that one-third of those surveyed had managed inflation by increasing prices, while 20% were really in trouble and already seeing a 50% reduction in EBITDA.

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