EY ITEM Club special report on inflation

Business implications in summary

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With the NICE decade now a distant memory, businesses are facing the challenge of sustaining revenues and margins in an environment of relatively low growth, subdued consumer spending and continuing inflation. To develop options on how to respond, it is critical that companies understand how a higher level of inflation will impact demand.

The starting point is to identify the effect on real disposable incomes, which will vary across the economy and in different segments. For example, tuition fees impact students as they study, but will also depress graduates’ spending when they start repaying their loans.

The impact by segment can then be mapped to demand for particular products and services, using estimates of ‘elasticity’ or price sensitivity. For example, demand for energy and telecoms services has typically exhibited relatively low price sensitivity, meaning these services will take up a higher share of income – in turn reducing spending in more price-sensitive areas. This effect will also vary with other factors, such as the shift towards in-home leisure spending.

Finally, businesses must examine the extent to which they can use productivity improvements and/or advances in technology to offset the income effect. Technology, media and telecoms (TMT) companies, for example, have been using technology to give consumers more for less, or much more for the same money. Other sectors may have similar opportunities to reposition their offers and thus manage the impact of inflation on demand.

On the supply side too, businesses need to revisit their forecasts and develop a more detailed view of how their cost structure will evolve in light of inflation outlook. A key factor will be the agreement of exposure to international inputs. 

Mark Gregory, EY Chief Economist