As a business owner, it is imperative that you pay close attention to the economy: local, national and international. All are interconnected in various ways and all can have far-reaching impacts on your business. We are going to talk here about deflation and how it may affect your business.



What Is Deflation?

To understand deflation, you must understand how money supply impacts businesses. Deflation means that the availability of circulated money is reduced in one or more sectors of the economy. In effect, deflation depresses the costs of money, goods and services, and wages contract. While price deflation is often a side effect of monetary deflation, this is not always the case.

So your vendors may reduce their prices and you may be able to hire employees at a lesser rate, but you will get lower prices for your products.

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For example, this may occur in a time of rising interest rates. As interest rates rise, fewer people are borrowing money so consumer spending is reduced.

With fewer purchases being made at the consumer level, business spending also dries up. Economic deflation means that the purchasing power of money is higher. However, price deflation means that your prices for products and services is reduced. For the purposes of this article, we are discussing economic deflation rather than price deflation.

Understanding How Deflation Impacts Your Business

It is important to note that deflation does not always affect different sectors of the economy in the same way. For example, there may be inflation in the oil sector while there may be deflation in the real estate sector. While deflation can be caused by interest rate changes, it can also be caused by a decline in demand. In many cases, these two causes are related.

Your business may be affected by deflation in a rising interest rate environment if most of your customers use credit or financing to make a purchase. For example, if you are a pool contractor, rising interest rates for home equity loans may make it more expensive for customers to use home equity to finance their pools. This could dry up your pipeline. High deflationary rates can also negatively impact consumer confidence.

5 Steps to Protect Your Business Against Deflation

The reality is that both inflation and deflation can be bad for small businesses. The ideal economic climate has a very low level of deflation or inflation rather than high rates of either one. Below are some steps to help your business weather a deflationary cycle.

1. Reduce Your Overhead

Deflation can signal rough economic times ahead. If you know that the economists are projecting a period of deflation, try to reduce your overhead as much as possible. Identify under-performing or weak areas of your business, and make adjustments now.

During a time of deflation, you may need to reduce your prices or offer promotions or incentives to spur business.

2. Increase Marketing in Cost-Effective Ways

During a time of deflation, consumers generally will spend less money. Unless you provide a critical service, your sales are likely to go down.  Effective marketing can be used to drum up business even during slow periods.

While your inclination may be to reduce marketing to conserve funds, this line of thinking can backfire. Successful businesses will increase marketing in cost-effective ways to create more demand during slow periods.

3. Pay Down Your Debts

You may have debts with adjustable interest rates. As deflation progresses, those interest rates may rise. This means that your debts will generate higher interest charges and higher monthly payments. Paying down the debts before interest rates rise significantly can help you to save money in the long run.

Develop an effective debt repayment strategy now while you still have the surplus funds in your budget to do so.

4. Branch Out into New Markets

To navigate successfully through a deflationary time period, you may need to exhaust all possible avenues for sales. There may be some cost-effective ways for you to tap into other markets. For example, if you have been thinking about targeting a different market segment, you may be able to adjust some of your marketing efforts to cost-effectively tap into a new market.

But you will want to avoid making any high cost, risky ventures during this period of time. For example, now may not be the right time to open a new branch location in an unfamiliar territory.

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5. Prepare to Ride the Wave

Many small businesses may fold during a deflationary cycle. To keep yours afloat, prepare for long term depressed sales by cutting costs and under-performing lines of business. Protect your core business, maintain your marketing and start thinking outside the box.

To Sum It Up

We hope this has caused you to consider how to best shield your company in difficult economic times.

Take time to review your debts, assets, budget and operations carefully. Now is the time to put in place a plan so that, when the time comes, you have a well-thought-out set of procedures and you are not operating in crisis mode. By taking these hard steps now, your business will be better poised to navigate through the storms ahead.

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