By Jessica Tasman-Jones
This article is brought to you by Agenda, an FT Specialist publication that focuses on corporate boards
A generation of business leaders is on the back foot in preparing for a period of high inflation, experts say. At its last meeting, the Bank of England predicted five consecutive quarters of shrinking GDP, with consumer inflation running at 13.3 per cent by the end of the year.
Other forecasts suggest inflation could reach more than 18 per cent. UK consumer inflation is now at 10.1 per cent, its highest rate in four decades. Producer input prices, an important metric for many businesses, hit 22.6 per cent.
Inflation has caught businesses off guard, says Paul Dales, chief UK economist at Capital Economics. Businesses whose energy costs make up a large share of their total costs, such as industrial companies, are most vulnerable, says Dales.
"Everyone assumed that the initial burst of inflation after the pandemic would be transitory. This means it has caught everyone by surprise and businesses were not able to plan for it.”
A generation of business leaders have never experienced high inflation and the rising interest rates that come with it, says Mats Persson, partner at EY-Parthenon, the consulting group. The era of cheap money is over, he says.
Financial markets are betting on interest rates more than doubling to 4 per cent by next May.
Many boards have only put inflation at the top of the agenda within the last few months, and are still relying on planning that was put in place two or three years ago in a different economic climate, says Persson.
Inflation drains cash and reduces margins, says Paroon Chadha, CEO of OnBoard, a board intelligence digital platform. Much of the focus in a period of rising inflation is about evaluating risks, slowing capital expenditures and conserving cash, he says.
Boards should review how inflation affects their previous assumptions, says Persson. He says a minority of companies that he works with have done so.
"That can be as simple as which of your products will go into lossmaking territory if inflation hits 18 per cent, and production inflation goes even higher," says Persson.
Then boards should make a plan, with trigger points related to different economic scenarios, he says.
For example, boards can consider what they are going to do with low-margin or loss-making products once inflation bites, he says. This could include reducing production costs or cutting products.
Maintaining or securing liquidity across various macroeconomic scenarios should be risk committees’ prime consideration over the next 18 to 36 months, says Chadha.
“The depth and frequency of reporting to the board on how the company is responding to inflation needs to strike a balance between keeping the board informed without unduly burdening or distracting management,” Chadha says.
The cost of labour is on the rise alongside capital and production, he adds.
Companies should find creative ways to retain talent, such as profit sharing and more flexible working, says Persson.
A competitive labour market means many businesses are reluctant to reduce headcount for fear of being unable to find suitable labour after the recession, Dales says.
"That means businesses may have to absorb more of it in their profits, cut costs in other ways or pass on more of it in their own prices."
The long-term sustainability of the business should be the priority. Boards should balance short-term financial returns alongside relationships with the workforce, customers and suppliers, says Amy Wilson of investment fund Federated Hermes.
Companies should not just serve shareholders, and boards should explain how the best interests of these groups were taken into account in any capital allocation decisions, such as dividends or share buybacks, she says.
"A clear and meaningful business purpose and strategy should enable boards to identify the right things to do in the short term, in order to fulfil their purpose over the long term," she says.
This article is based on a piece written by Frederic Lee for Agenda.