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Inflation and Small Businesses: The Varying Effects Across SMB Sectors

4 Mins read

 A record-high inflation rate has largely defined the U.S. economy in 2022—the increased costs come at a time when small businesses are still recovering from the significant hit they took at the start of the pandemic in April 2020, when revenues fell by 22 percent nationwide. Small business owners who spent two years navigating COVID lockdowns and restrictions are now navigating another challenge threatening their bottom line, all while navigating one of the busiest times of the year.

Though the impact of inflation has been felt by business owners for a while (a survey from early 2022 revealed that nearly 40 percent of small business owners claimed the increased cost of materials was having a significant impact on their business), the challenge endured through the summer. Meanwhile, as owners feel the effects of inflation in their stock room, its impact on consumers is beginning to curtail their purchasing power. Although consumer spending has seen a brief uptick as we approach the holiday season (up 0.8 percent in October), consumers are being more selective about where they spend their money, and certain industries are getting hit harder than others.

Despite inflation tightening wallets across the board, the rising prices have had different effects across SMB sectors — here’s a snapshot of how the construction, restaurant and retail industries, in particular, are coping:

Construction costs (and interest rates) are soaring

Contractors are now navigating the severe effects of inflation without a moment to adapt to the ongoing supply chain crisis. According to the National Association of Home Builders, the cost of building materials has increased by over 19.2 percent from last year and at least 35.6 percent since the start of the pandemic. Some materials, like softwood lumber, have seen cost increases of up to 60 percent.

Meanwhile, efforts to curb inflation also pose another challenge for builders. Rising interest rates intended to contain inflation by stifling consumer demand are a big hurdle for residential builders trying to maintain competitive prices without pricing out consumers.

Regardless, the sale prices of new homes are rising. The median sale price of new homes in October 2022 was $493,000, up over $85,000 from October 2021, when the median sale price of new homes was $407,700. Amid the rising interest rates and the need to price homes competitively, new single-family home sales dropped 5.8 percent from October 2021, according to the U.S. Commerce Department.

Food costs are high — for restaurant owners and grocery shoppers alike

As with construction costs, restaurant owners have already seen the cost of ingredients rise dramatically in 2022, with end-of-year estimates further demonstrating the magnitude of inflation’s impact:

  • Farm-level milk prices are predicted to increase between 36 and 39 percent in 2022, and wholesale dairy prices are predicted to increase between 16 and 19 percent in 2022.
  • Farm-level vegetable prices are predicted to increase between 15.5 and 18.5 percent in 2022.
  • Farm-level wheat prices are predicted to increase between 29 and 32 percent in 2022.

As the cost of ingredients rises, owners have had to raise prices for the consumer. The Consumer Price Index (CPI) for food-away-from-home was 7.7 percent higher in October 2022 than in October 2021.

Despite the cost of dining out, grocery prices have increased by 12 percent in the last 12 months — an increase that’s 3.5 percent higher than the increase in restaurant prices. This inflation gap makes it harder for consumers to determine whether eating out or cooking at home is more economical, providing some impetus for consumers to support small businesses. But when factoring in the cost of gas, gratuity, and markups, many high earners still feel that cooking at home is more cost-effective long-term.

Consumers keep spending on retail, but budgets appear to be tightening

While retail owners have not been spared the steep prices while keeping shelves stocked, U.S. retail sales have continued to climb despite the record inflation. Total retail and food service sales for August 2022 through October 2022 were up 8.9 percent from the same period a year before.

However, inflation is affecting lower-income consumers the most. According to market research firm Morning Consult, Americans making more than $100,000 increased their spending by 20 percent between July 2021 and July 2022, while those making between $50,000-99,999 increased their spending by eight percent and those making less than $50,000 decreased their spending by one percent. Though consumers have continued spending, retail sales fell flat in July, despite falling gas prices — signaling inflation’s strengthening grip on consumers’ purchasing power.

As consumer spending recedes, so too is small business confidence. CNBC’s Q3 2022 Small Business Survey showed that small business confidence hit an all time low, with the largest percentage of small businesses citing inflation as their biggest risk. In the face of higher costs across materials, labor, transportation and energy, only 13 percent of owners said now is a good time to pass along price increases to customers.

The light at the end of the tunnel

While the reality is that small business owners are continuing to face unprecedented challenges, there is some hope in sight. Small businesses continue to grapple with the high cost of materials, but some reports suggest that inflation may be peaking for now.

Wholesale inflation fell 0.5 percent in July 2022, — the first decrease in two years – and fell another 0.1 percent in August. President Biden signed the Inflation Reduction Act into law to further support business owners on August 16, 2022, which will fight inflation by investing in deficit reduction. The legislation also delivers economic wins specific to small businesses by leveling the playing field with a modest minimum tax on around 150 of the wealthiest corporations (those with over $1 billion in revenue) and doubling the refundable research and development tax credit for small businesses from $250k to $500k.

Despite the light at the end of the tunnel, the current economic challenges have the most significant effect on the smallest companies. However, small business owners are closer to consumers and can remain more nimble by understanding and adjusting to evolving consumer demand (unlike large corporations like Target, which recently missed its lowest profit estimate).

For small business owners, challenges posed by inflation have compounding effects that come at a time when many expected to see relief from the last two years of the pandemic. As the country continues to navigate this unprecedented time without a clear end in sight, we must remember that small businesses are our economic backbone.

Eric Harnden is the vice president of partnerships and agency distribution at NEXT Insurance. Prior to his role at NEXT, he was a co-founder and managing director of AP Intego Insurance which was acquired by NEXT in 2021. Early in his career, he was co-founder and Co-CEO of Agencyport, a software firm focused on delivering innovative insurance solutions to over 100 P&C insurers globally. Over his 20-year career in insurance and IT, he has worked in a number of leadership and consulting roles to help insurance carriers use technology to help drive business results. Mr. Harnden began his career at John Hancock Financial Services. He holds a Bachelor of Arts degree from Connecticut College.

Inflation stock image by stockwerk-fotodesign/Shutterstock

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