Despite inflation reaching its highest levels since 1981, after nearly two years of gradually increasing, only now are its effects starting to seep into the consumer psyche.
While economists and the National Retail Federation still project US retail sales to rise between 6% and 8% this year, the looming uncertainty around inflation’s impact has left both shoppers and retailers scrambling for answers on the retail industry’s future.
Note: This guide is provided for informational purposes only and is not intended to substitute for obtaining financial or legal advice from a professional accountant or lawyer.
What is inflation and why does it occur?
Inflation tracks the rising prices of goods and services in the economy, often measured by the Consumer Price Index (CPI). The CPI is an important indicator of price stability in the economy, measuring the average change in prices over time of all goods and services purchased by all urban consumers.
The CPI covers the data of 21 sectors, including food, energy, medical care, transportation services, and more.
Simply put, when prices of everyday goods and services rise, the money earned and saved by consumers today is less valuable than it once was.
To put these changes into perspective, over the past 12 months:
- The price of food increased 9.4%, the largest increase since April 1981. Meats, poultry, fish, and eggs, specifically, increased by 14.3%
- Piped gas increased by 22.7%, with gasoline rising 48% since the start of the year. The Federal Energy Regulatory Commission advised households to expect up to 54% increases in their gas prices compared to last winter.
- Used-vehicle prices surged over 30%, with a 10% increase in April alone.
While it’s important to note that inflation affects all households and individual shoppers differently, there is no question that these stark price increases are leaving consumers with less money to put toward debt, everyday expenses, and discretionary spending.
Like the past five historic inflationary episodes, this most recent period of inflation is a result of the simultaneous convergence, and the domino effect, of multiple macroeconomic factors.
In this case, a shift in pandemic-induced consumer preferences and extensive stimulus payments contributed to a shocking rise in prices across all sectors. Recent geopolitical conflict has only complicated matters worldwide.
How does inflation impact retail?
To better understand how inflation impacts retail, we must first recognize retailers’ reliance on the global supply chain and its impact on retail prices and consumer shopping habits.
Ultimately, everything boils down to a healthy supply-and-demand curve between suppliers and consumers, which, thanks to pandemic-induced supply-side disruption, has become largely misaligned.
Supply chain issues
With ample savings from government pandemic-relief stimulus programs, consumers have spent much of the past two years looking high and low for ways to spend their money. Since pandemic restrictions took in-person experiences off the table, many consumers turned their attention and demand toward physical goods.
This unprecedented demand for goods like electronics, furniture, gym equipment, and more put a serious amount of stress on an already strained global supply chain.
This, in turn, has placed tremendous pressure on suppliers and port workers across the globe, specifically in China, which was already hampered by pandemic restrictions, including factory shutdowns and understaffed ports.
As the demand for goods increased, so did the need for shipping capacity.
With 90% of the world’s goods transported by ship and understaffed ports more congested than ever, the availability of empty shipping containers dwindled. Driven by a backlog of idling ships waiting to dock and unload, and significantly longer turnaround times back to Asia to reload new cargo, an unprecedented supply squeeze ensued.
As of July 1, 2022, the average shipping container price quadrupled due to COVID-induced shipping container shortages.
Not only has this increase in shipping costs eaten heavily into retailer margins, but it has also led to significant inventory delays. Retailers are now faced with a tough decision: Do we pay even more for airing products or do we accept the shipping delays and wait weeks to months to receive our inventory?
These delayed receipts then lead to shorter selling windows and quicker markdowns to make way for new seasonal products. As the domino effect ensures, retailers are left with decreased revenue and a surplus of outdated inventory.
Outside of product, most brick-and-mortar essentials like hangers, display racks, and promotional assets have also skyrocketed in price and are subject to serious production and shipping delays.
For Feat Clothing founder Taylor Offer, outside of cost increases, supply chain delays have added an additional hurdle to the opening of their first brick-and-mortar retail store.
“Opening up a brick-and-mortar store in this climate has been really challenging,” he says. "There are so many moving pieces that we need to source, from retail racks to couches and hangers, that are all delayed months. We are seeing eight- to 12-week delivery times, and significant price increases on basic items that are usually always in stock. It definitely makes you value the global supply chain and how competitively priced things used to be.”
Ani Sanyal, the co-founder of Kolkata Chai Co., shared a similar sentiment. According to Ani, supply chain issues and rising supplier prices have put downward pressure on their retail margins. On the ecommerce side, these changes have caused the team to postpone new product launches and focus on their core business of chai mixes and accessories.
“To combat these pressures, we've been constantly negotiating with our suppliers, opting to buy larger quantities to retain our margins, as well as exploring new suppliers to find efficiencies for our core products,” added Sanyal. “Supply chain delays are tougher to negotiate, and we've been actively preparing for the fall/holiday season, despite it only being June, in anticipation of shipping delays.”
Price increases lead to decreased consumer sentiment and discretionary spending
Higher production and transportation costs force businesses to either take a margin hit or pass these costs along to the consumer through inflated retail prices. For the health of their business, many companies, especially public companies that have fiduciary responsibilities to shareholders, choose to raise their prices.
As prices increase and consumer dollars lose value, demand for goods naturally weakens.
Consumers are more concerned about preserving the value of their existing cash and covering their debt and daily expenses than investing or splurging on discretionary items. Naturally, this is bad news for retailers, ultimately leading to decreased revenue and inventory forecasting issues.
Executives and analysts expect these trends to continue, as many large retailers are already adjusting their revenue estimates for 2023.
Of the 79 large retailers that reported earnings between April 1 and May 23 of this year, 59% disclosed a decline in consensus revenue estimates for 2023, and 71% saw a decrease in estimates for 2023 earnings before interest, taxes, depreciation, and amortization (EBITDA), according to a report from McKinsey.
Wages and staff retention
Pressured by inflation and a red-hot labor market, many retailers have increased hourly wages at unprecedented rates in an effort to keep employees. According to the US Bureau of Labor Statistics, the average hourly wages increased by 5.1% between February 2021 and February 2022, the most in over a decade.
But still, with consumer prices rising 8% in that same period, the increased wages resulted in less purchasing power. Now, even at $15 an hour (the new de-facto standard that many retailers have yet to meet), this is not enough to make a living.
And with increased competition among employers to hire and retain workers, many retail employees are quitting their jobs to pursue new, more lucrative opportunities.
Even those who want to keep their retail jobs are seeking new, higher-paying opportunities to leverage with their current employers. If the retailers can’t match the pay increase, their talent will walk.
This has left retailers in a tough position. Pay their workers more, further eating into already decimating margins, or remain critically understaffed. Neither is good for brand perception or consumer value.
While larger retailers like Macy’s and Walmart are able to stomach an unsettling combination of slowing sales growth and compressing margins, the same doesn’t apply to local businesses or mom and pop retailers. According to the SBAF Small Business Survey released in March 2022, over 60% of small business owners cited inflation as their top challenge. Similarly, as captured in the NFIB Small Business Optimism Index, inflation has now replaced “labor quality” as the number one problem for small business owners, with 31% of owners reporting that inflation was the single most important problem in their business. This marks the highest reading since the first quarter of 1981.
How retailers can prepare for and stay educated on inflation
Be strategic with price increases
Price increases can be tricky, and when done incorrectly, can erode consumer trust. Instead of implementing broad product price increases across all categories, consider tailoring your response to specific customers and product segments based on category margin performance and customer price sensitivity.
The key here, if possible, is to adjust the prices on “background” items that won’t affect your brand’s ultimate value prop. Not only will this help with profitability, but it is more likely to help keep your customers happier and your brand perception intact.
When you do raise prices, Rebekah Kondrat, founder of Kondrat Retail advises retailers to be upfront and transparent with customers about pricing changes and have retail teams aligned as well.
“Brand loyalists will be much more accepting of a price increase if brands have clear messaging around why it’s happening (i.e., we need to raise our workers’ pay, or our material costs have increased),” she says.
Kondrat also urges all retailers to make sure their retail teams are equipped to handle inquiries about increased costs. “To the customer, the retail employee is an extension of the brand, so messaging undesirable but necessary changes will lead to higher retention and brand affinity in the long term,” she added.
Optimize in-store operations for efficiency, productivity, and resourcefulness
To counteract rising wages, look for ways to improve your stores’ efficiency and productivity. In other words, how can you do more with fewer employees? This may mean hiring fewer but more talented staff or using technology, software, and automation to handle simple data-entry tasks that are now being handled by store employees.
By auditing your existing in-store processes and end-to-end costs, you may be able to find areas for savings and opportunity.
“In these times, it's critical to be practical and unemotional as a retail operator. That means doubling down on the things that are working and focusing on your core, while trimming the fat in areas of excess,” added Sanyal. “Focus on the pushing items where profit margins are solid and cut back on any experiments until the macroeconomic conditions improve.“
Keep an eye on competitors and inventory
In times of inflation, competition can be fierce. According to McKinsey, US consumers have switched brands and retailers more in 2022 than at any time since the pandemic began, with most citing price as their driving motivation. With this in mind, it’s important to closely monitor your competitors’ pricing and promotional strategies.
Separately, it’s important to keep an eye on your inventory levels. This shift away from brand loyalty first started when shoppers’ favorite brands remained out of stock for extended periods of time.
Although many price-sensitive shoppers are choosing to trade down to cheaper alternatives, customer experience still matters. Quality customer service and thoughtful touchpoints have a substantial impact on brand affinity, retention, and future word-of-mouth evangelism.
That’s why it’s more important than ever to know what matters to your customer. Retailers who can identify the key drivers of their NPS can stay better informed on how to tweak their customer experience to prioritize retention in times of turbulence.
In an era of information and content overload, it’s often hard to find accurate and trustworthy data and analysis.
If you’re looking to stay up to date with inflation and its impact on the ever-changing state of retail, here are a handful of quality resources:
- Follow the CPI and Bureau of Labor Statistics Data
- Industry reports from consulting firms like McKinsey and Bain
- National Retail Federation (NRF)
- Harvard Business Review
- Wall Street Journal and CNBC
- Retail Dive, Retail Brew, and RetailWire
Meanwhile, the Shopify Retail blog will continue to provide valuable content to help you grow your business as you navigate the ups and downs.
Ultimately, Kondrat says, the best way to predict the future as a retailer is to listen to what your customers are saying: “Retailers should have robust communication loops with frontline teams. They are the ones who hear what customers talk about—what they’re worried about, upset, or happy about—every day and are attuned to changes in spending habits sooner than anyone else.”