How to run a business at a time of stagflation

FOR the leaders of America Inc, high inflation is unwelcome. It is also unfamiliar. Warren Buffett, 91, the oldest boss in the S&P 500 index of big firms, last warned about the dangers of rising prices in his annual shareholder letter for 2011. The average chief executive of a company in the index, aged a mere 58, had not started university in 1979 when Paul Volcker, inflation’s enemy-in-chief, became chairman of the Federal Reserve. By the time the average boss started working the rise of globalised capitalism was ushering in an era of low inflation and high profits. Their stock rose between the global financial crisis of 2007-09 and the Covid-19 pandemic, a decade of rock-bottom inflation.

Inflation will stay high for some time yet. On June 7 the World Bank warned that “several years of above-average inflation and below-average growth now seem likely”. A new study by Marijn Bolhuis, Judd Cramer and Lawrence Summers finds that if you measure inflation consistently, today’s rate is almost as high as it was at the peak in 1980. As the past creeps up on the future, “stagflation” is preoccupying corner offices. Today’s executives may think of themselves as battle-hardened—they have experienced a financial crisis and a pandemic. However, the stagflationary challenge requires a different toolkit that borrows from the past and also involves new tricks.

The primary task for any management team is to defend margins and cashflow, which investors favour over revenue growth when things get dicey. That will require fighting harder down in the trenches of the income statement. Although a rise in margins as inflation first picked up last year led politicians to denounce corporate “greedflation”, after-tax profits in fact tend to come down as a share of GDP when price rises persist, based on the experience of all American firms since 1950. To create shareholder value in this environment, companies must increase their cashflows in real terms. That means a combination of cutting expenses and passing on cost inflation to customers without dampening sales volumes.