PRO Business MS

Accounting and Finance

How war made inflation explode and what to do

Economic impacts from the war

The impact of the pandemic and the war in Ukraine has driven inflation to surge across the globe. Few C-suite executives have experienced these combined inflationary pressures and navigated their company through such an environment. In a high-inflation context, three imperatives are crucial for success and enduring competitiveness:

  1. Pay close attention to industry specifics. Inflation doesn’t always have broad-brush effects. A nuanced understanding of industry context will influence what levers you need to pull, and when.
  2. Use technology to improve efficiency and agility as quickly as possible to strengthen resilience.
  3. Be intentional about solving issues with stakeholders—customers, partners and employees. Doing so strengthens a company at its core.

After two years of pandemic and a war in Ukraine that threatens modern globalization, many economists, business leaders and policy makers agree: We have entered a high inflation environment that is fundamentally challenging business leaders and the way companies operate. New dilemmas emerge every day, spanning supply chain, manufacturing operations and workforce management to financial management and customer retention.

Are leaders prepared?

Since the global financial crisis of 2007–2009, companies have enjoyed ongoing economic growth and low volatility. However, even before the war in Ukraine, many economies were already experiencing inflationary pressures caused by extensive fiscal and monetary support measures, a shift of consumers buying more goods versus services and supply chain disruptions. As of January, 70% of global C-suite executives were expecting significant inflation in 2022, potentially reaching double-digit rates in select countries.1 As a result, inflation is topping the priority list of many business leaders.

As war compounds issues like supply chain disruption and energy prices, the challenge has become real. Natural resource shortages along with soaring energy and housing costs, and constrained supplies of consumer goods have led to unprecedented inflation levels across major markets. As of March 2022, inflation reached 8.5% in the United States, 7.0% in the United Kingdom and 7.4% in the eurozone.2

Drivers of recent Consumer Price Index inflation

When inflation will peak remains unclear. Economic and business impacts will largely depend on the length and severity of the crisis as well as policy response.3 Few business leaders today have experienced anything similar over their tenure. Now, this new reality is testing their supply chains, their people, their customers and their stakeholders.

The good news

Despite the outlook, leaders may be better prepared than they realize. The operational changes they made to navigate the COVID-19 pandemic helped their businesses survive and thrive: In fact, our research shows the largest 2,000 companies globally grew by 11% between Q4 of 2019 and Q4 of 2021.4

Value generation differed among them, however. The more digitally advanced companies navigated the crisis without compromising profitable growth.5 From December 2021 to January 2022, 90% of c-suite executives reported that their organizations were undergoing rapid digital transformation.6 Some companies—we call them ‘Twin Transformers’—also combine digital transformation with an acceleration of their sustainability agenda.7

Economic cost pressures

Many forces have come together to drive high inflation, and the effects differ by industry. The impact depends on cost structure—including energy, materials and wages—as well as the ability to pass costs on to consumers.

Inflationary cost pressures on profit margin are amplified as they pass through the various layers of the economy:

Round 1 – Energy (direct)

Direct impact on operating costs depends on the industry’s intensity of use of these inputs.

Round 2 – Supply chain (indirect)

Cost pressure passing from upstream industries to downstream industries depends on intensity of use of inputs from industries heavily impacted in Round 1.

Round 3 – Wage and demand erosion

Inflation erodes consumer purchasing power, placing upward pressure on wages. The size of the effect on wages depends on the tightness of the labor market and the negotiating power of employees.

 

To identify your specific challenges:

  • Track market/industry insights
  • Watch for internal indicators that point to the three types of economic cost pressures
  • Consider how location factors in

Remember that challenges also vary by geography and industry. Areas that rely on production from other regions may be more exposed to energy and food inflation. Other geographies may have social, political or institutional constraints that prevent them from handling inflation shocks, resulting in volatility.

The US, meanwhile, would primarily be affected by higher oil prices and their knock-on effect on household wealth and consumer spending. In the event of a protracted impact scenario, Oxford Economics estimates that US GDP could decline relative to pre-war estimates by 1.0 percentage points in 2022 and 0.6 percentage points in 2023.