The Inflation Debate and Business Reality

Last year, there was intense debate among policymakers, economists, and financial-market participants about rising inflation. Some argued it was a temporary issue caused by COVID-19-related disruptions, while others believed it signaled a more fundamental, potentially permanent shift. However, CEOs told us that this debate seemed disconnected from their real-world business challenges. For them, inflation was already “permanent enough” to warrant considering a fundamental change in how they lead and manage their organizations. We agreed with this perspective.

By early 2022, it became increasingly clear that inflation would remain high—well above the 2.0 percent rate that planners had come to expect and central banks had targeted. From March 2021 to March 2022, the U.S. consumer price index rose by 8.5 percent, a 40-year high. The eurozone and the UK experienced similar inflation spikes of 7.5 percent and 7 percent, respectively. Around 60 percent of advanced economies are grappling with year-on-year inflation above 5 percent. Russia’s invasion of Ukraine has further disrupted energy, agriculture, and minerals markets, suggesting that inflation may be higher and more persistent than even revised expectations predict.

In response, central banks worldwide are following a familiar inflation management playbook: raising interest rates to curb demand and regularly communicating to keep inflation expectations in check. This task has become more urgent as markets now expect inflation in the U.S., UK, and Germany over the next five years to be 1.5 to 2.0 percent higher than the 2010–2019 average.

The CEO’s Role in Navigating Inflation

Even if central banks succeed in their efforts, the process will take time—potentially two more years of elevated inflation, which is a long time for business leaders. The ad hoc crisis responses many CEOs have used so far are losing their effectiveness.

How can CEOs guide their teams, employees, boards, and external stakeholders through this period? First, it’s essential to recognize that a CEO’s focus cannot be limited to how inflation impacts profitability. Today’s uncertain environment requires leaders to consider performance in much broader terms. The rapid decisions CEOs had to make regarding operations in Russia recently are just one example. CEOs must lead with the entire business cycle and all stakeholders in mind. While external relations professionals can assist with stakeholder management, there are many conversations and decisions that only the CEO can lead.

Like central bankers, CEOs need an inflation management strategy. They can begin crafting it by asking themselves and their senior leadership teams key questions:

• Where will customers see value in this new environment? How can we design products, services, and experiences to deliver this value?
• How can we quickly stabilize and redesign stretched or broken supply chains? What capabilities are needed to increase resilience and control costs?
• What guidance should be provided to help procurement leaders create value?
• How is the changing talent landscape affecting compensation, benefits, and workplace norms? What can be done to attract and retain employees in today’s labor market?
• How should we approach repricing in an inflationary environment? How can we develop a strategic, through-cycle mindset for customer relationships?
• How can we prioritize and organize to manage all these activities?

The CEO is the organization’s ultimate integrator. Our research on excellent CEOs reveals the pivotal role they play in setting clear direction, aligning the organization, managing stakeholders, and serving as the “motivator in chief.” The best CEOs act boldly but also embrace core mindsets that may contradict the traditional image of a hard-charging executive. They listen first, treat “soft” cultural issues as a significant material advantage, empower employees, and constantly ask questions.

In this article, we draw on our work with hundreds of companies and in-depth research to create an inflation playbook that should help CEOs, regardless of the direction inflation takes. During the height of the COVID-19 pandemic, companies proved their ability to reinvent themselves more quickly and thoroughly than they had thought possible. They can do it again.

Redesign Products and Services for Value and Availability

CEOs understand that design choices for products and services are crucial in responding to commodity price volatility, component scarcity, and higher production costs—all while maintaining the core functionality customers require. Consider these examples of agile approaches that leading operators across sectors have used:

• Rapid Product and Service Redesign: An industrial-technology company redeployed over 50 percent of its engineering capacity to redesign products using available semiconductors. Automotive manufacturers, facing semiconductor shortages, simplified products to maintain production and sales.
• Challenge Specification Norms: A manufacturer redesigned products to meet specifications that overseas manufacturers could reliably achieve, reducing dependence on high-cost regional suppliers and simplifying its product portfolio.
• Service Redesign: With rising transportation costs, efficient truck and container loading has become more valuable. A manufacturer rethought packaging and loading, significantly reducing costs by decreasing freight demand.
• Promote Near-Substitutes: Consumer-packaged-goods companies identify product substitutes, often private-label equivalents, that can be sold at lower costs than branded products. These substitutes maximize margins and increase value for customers.

Mobilizing cross-functional expertise to quickly identify and implement alternative solutions will be crucial for companies seeking to mitigate scarcity and the impact of inflation. Often, only the CEO can break down barriers to innovation and reward risk-taking that goes against typical incentives. Leading the reimagining of product design is an opportunity for CEOs to implement short-term tactics to cope with inflation and seize the longer-term opportunity to build stronger customer relationships.

Rebuild Supply Chains for Resilience

Even before Russia’s invasion of Ukraine, new tariffs and rising shipping and trucking costs had challenged the conventional wisdom that cost optimization should be the primary goal in supply chain management.

In 2021, our research and discussions with hundreds of supply chain leaders revealed widespread problems in global manufacturing and supply footprints. Global shipping costs have increased significantly. In response, many companies increased inventories and sought new sources for raw materials. However, fewer companies have successfully addressed more challenging tasks, such as reducing the number of SKUs and diversifying manufacturing bases. The global response to the Ukraine crisis has further strained supply chains, with air carriers using alternative routes, shipping companies suspending operations near the conflict zone, and multinationals scaling down or halting operations in Russia.

Today, supply chain issues are no longer just for backroom spreadsheet managers but are standard topics in C-suite and boardroom discussions. CEOs should aggressively pursue several critical issues with their teams:

• Make the Entire Supply Chain Visible: Only about half of the companies we surveyed know the location of their tier-one suppliers and the key risks those suppliers face. Astonishingly, just 2 percent understand their third-tier suppliers and beyond, where many critical supply shortages, like semiconductors, originate. CEOs must push for the data needed to map these deeper supply chain tiers and prioritize suppliers by their importance to the business.
• Identify and Manage Supply Chain Risks: Depending on a company’s sector and needs, CEOs must consider various risks, including finance, regulation, reputation, and data security. Operational risk management is especially crucial: examine vulnerabilities in supplier concentration, visibility of operations, labor, manufacturing, and delivery. Are controls in place, and are options available to minimize these risks?
• Make Seamless End-to-End Planning a CEO Priority: End-to-end planning involves managing longer lead times, understanding the financial implications of increased costs, reviewing reorder points and inventory levels of critical materials, and reprioritizing production in anticipation of shortages. CEOs recognize that this requires investment, which must yield a return. Will customers pay a premium for guaranteed product availability? Will suppliers share costs to reduce demand disruption risks? CEOs may need to convince investors that resilience is the new baseline and adjust their expectations for risk-adjusted returns. Digitalization will likely play a crucial role in answering these questions, often paying for itself within 12 months.