Living Well With Low Inflation

Be careful what you wish for. It wasn't so long ago that businesspeople railed against soaring materials prices and hefty pay hikes sought by workers. But now that low inflation seems here to stay, many companies, especially small businesses, are finding that this economic landscape has its drawbacks, too.

No longer can businesses count on price markups to fatten their bottom lines. Low inflation, says Edward Yardeni, chief economist at C.J. Lawrence Inc., is hard on profit growth "because prices contribute nothing." For example, in 1995, it looks as if consumer inflation will finish below 3% for the fourth year in a row. For wholesalers, the news on pricing power is even worse: Producer prices of finished goods are likely to edge up just 2% (chart). Businesses looking for an excuse to raise prices in 1996 are likely to be disappointed: Inflation may actually be lower than it was this year.

Of course, much depends on which industry a business is in. Prices of certain commodities, such as rubber, and industrial supplies, such as paperboard and plastics, have risen by 10% or more over the past year. Meanwhile, the prices of apparel, fabrics, and some industrial machinery are flat or down from a year ago. Why the divergence? Different customer groups. Rising global demand, especially from Southeast Asia, has made commodity price hikes easier to pass along. But businesses selling mainly to the U.S. market face fierce price resistance, particularly among consumers.

Yet even in this brutal climate, many small companies are making price hikes stick. Some companies have entered niche markets that offer stronger pricing power. Others have discovered that their customers will tolerate increases on peripheral items as long as the cost of the main product holds steady. Adding value while upping the price is another tactic. And, as always, companies are keeping an eagle eye on costs.

EXPORT OUTLET. Niche markets have worked extremely well for Waterlox Coating Corp., a Cleveland-based maker of clear and pigmented coatings used on wood, vinyl, and other surfaces. Before the 1990s, Waterlox sold 30% of its coatings to auto manufacturers, which used them on interiors. In the early 1980s, Waterlox was able to pass along the increased cost of raw materials. But by the end of the decade, the auto companies were balking, and Waterlox began searching for new markets. It found one in oiled retro-look wood floors, which were becoming increasingly popular with residential- and commercial-property owners, and began selling its clear finishes aggressively to building and hardware stores. That enabled Waterlox to raise its prices by 10% to 12% in 1992, when the cost of tung oil was last increased--and hold them steady since then. Now, 70% of its sales come from clear finishes, while sales to auto makers have slipped to 11%. Vice-President John W. Hawkins says Waterlox also began selling its products in Europe. That's not unusual: Exports have accounted for 39% of the economy's growth over the past year.

Sometimes, customers will tolerate selective price hikes while rejecting others. Raising the price of a ski-lift ticket, for instance, is considered sacrilegious among downhill racers. So at Loveland Ski Area, an hour outside of Denver, lift-ticket prices haven't gone up in three years. Instead, Marketing Director Scott A. Fortner says Loveland has raised prices of less-visible items--the ski school and hot dogs at the restaurant. "We want to give people value, but we also need to make a profit," he says.

TRENDY TOGS. Carrying specialty items is another way businesses can slip in a price hike. In Hayward, Calif., the Soccer World retail chain faces attack from discounters such as Big 5 and Sportmart. Soccer World Founder Christopher Goumas, a 32-year-old former high school soccer player, has kept his stores and mail-order unit competitive by offering knowledgeable sales help and carrying higher-priced merchandise, such as hard-to-find clothing from Europe. These trendy items appeal to image-conscious teenagers who are willing to accept price hikes. "Everybody would like to buy something for less," Goumas says, "but I'm not running into price resistance." The price of a pair of Adidas' Copa Mundials, for example, rose by $20, to $89.95, last year. Yet Soccer World sold 2,500 pairs of the soccer shoes, more than in previous years. Overall, Goumas says sales have increased 10% annually in the 1990s.

Outside the world of $90 soccer cleats, however, price resistance is still the norm. So executives must hold down costs to keep their companies viable. Larry Friedeman, president of Plabell Rubber Products Corp., is a firm believer in the Darwinian Manufacturing Theory: "The company that adapts the best, survives." So the Toledo (Ohio) rubber- parts maker worked with its utility company to cut its energy usage. Plabell also cut health-care costs while maintaining coverage. Those savings have offset recent increases in the cost of raw rubber. If rubber prices rise again this year, though, employee-owned Plabell may have to pass along the hikes.

The success that Plabell and other would-be price-raisers have in 1996 will depend on finding some cracks in the solid wall of price resistance. A low inflation cycle can be vicious for profit-hungry companies, but evidence suggests that Freideman's theory is right: Many small businesses are adapting--and surviving.

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