Inflation, and Its Link to Business Strategy

 

Strategy Begins With Understanding the Economics Underneath

Strategy, in its most basic form, is about making choices based on an understanding of the environment in which a business operates. That sounds obvious, but it is surprisingly easy to forget when strategy gets reduced to market size, consumer trends, competitive positioning and growth ambitions. Underneath every strategy sits a more fundamental layer of assumptions about costs, demand, pricing, capital, people, productivity and the economics of the business itself. If those assumptions change materially, the strategy has to change too. This is why I believe an underlying understanding of business costs and their interconnected behaviour is not merely a finance or economics requirement; it is a fundamental strategic capability.

 

Inflation is perhaps one of the best examples of this. We have become accustomed to discussing inflation as a number. CPI is at 5%, food inflation is at 7%, core inflation is sticky, inflation is moderating, real wages are rising — and the discussion usually moves on. These numbers are important, of course. They give us a common framework to understand what is happening to the general price level. But there is a significant difference between measuring inflation and understanding its consequences. Inflation is not a single variable moving through an economy in a neat, linear direction. It is layered, interconnected and uneven. It enters through different parts of the economic system, travels through different industries at different speeds, disturbs different cost structures and eventually changes the assumptions on which businesses and households make decisions.

 

Inflation Is Not a Single Number

Consider something as ordinary as a restaurant. An increase in energy prices does not simply increase the restaurant's costs by an equivalent percentage. Energy affects refrigeration, cooking and transportation. At the same time, the cost of food ingredients may rise because of energy, weather, logistics, labour or trade policy. Packaging may become more expensive. Wages may rise later as employees seek to protect their purchasing power. Rent may rise when a lease is renewed. Financing costs may increase if the business has variable-rate debt.

 

The restaurant then has to decide how much of this to absorb, how much to pass on to customers, whether to change suppliers, whether to alter the menu, whether to reduce portions and whether to accept some margin compression. But every decision has a second consequence. Increase prices too much and demand may fall. Change ingredients and the customer experience may suffer. Absorb the costs and profitability deteriorates. Reduce portions and you may damage the value proposition. The original inflationary shock has now travelled through several layers of the business, and the final impact bears little resemblance to the initial price increase that started the process.

 

This is why I find it inadequate to think of inflation simply as an increase in the cost of living or an erosion of purchasing power. Those are certainly consequences, but they are not the whole story. Inflation can change the relationships between the variables inside a business. And those relationships are precisely what a business model is built upon.

 

Inflation Attacks the Assumptions Inside a Business Model

Every business model, however sophisticated, contains assumptions. Some are explicitly documented in financial models and business plans, while many are simply embedded in organisational experience. A manufacturer may assume a certain range for raw material costs. A real estate developer may work with assumptions around construction costs, project duration, interest rates and selling prices. A retailer may assume a certain inventory cycle and gross margin. A SaaS business may have assumptions around salaries, customer acquisition costs, churn and technology costs. A consulting business may have assumptions around utilisation and billing rates.

 

These assumptions do not need to be perfect. They simply need to remain sufficiently stable for management to make rational decisions. Inflation can disturb several of them at the same time. That is when the problem becomes considerably more serious.

 

Take a project that was originally expected to generate a healthy 14% return on investment. Construction costs rise, the project takes longer to complete, financing becomes more expensive and the market becomes more price-sensitive. The project may still make money. It may still show a positive P&L. But the return on capital may have fallen sufficiently for management to question whether the project should proceed at all.

 

Capital could perhaps generate a better return elsewhere, with less risk. The project has therefore moved from being financially attractive to being questionable, even though it has not technically become loss-making. This distinction between profitability and feasibility is important and is often missed when inflation is discussed only through the lens of prices and wages.

 

Framing In Business Terms

Businesses do not merely ask whether something will make money. They ask whether it will make enough money, within an acceptable time frame, at an acceptable level of risk, to justify committing scarce capital and management attention. Inflation can change that calculation without necessarily changing the basic profitability of the proposition. A project that made strategic sense at one level of costs and financing may no longer make sense after those assumptions have shifted.

That is not an accounting problem. It is a strategy problem. The Timing of Inflation Matters as Much as the Inflation Itself: There is another complication which makes inflation even less linear: different prices adjust at different speeds.

 

Energy prices may move almost immediately. Raw material contracts may be renegotiated a few months later. Employee wages may adjust during an annual appraisal cycle. Rents may change only when leases come up for renewal. Interest rates can change rapidly for businesses with floating-rate borrowing. Selling prices, however, may not be adjusted immediately. Customers resist price increases. Contracts have fixed terms. Competition limits pricing power. Sales teams may be reluctant to disturb established price points.

 

A business can therefore spend months operating in a state where its costs have already changed but its revenues have not. This creates temporary distortions in margins, cash flows and investment decisions. Eventually, some prices may catch up, wages may adjust and the business may reach a new equilibrium. But the journey to that equilibrium matters. A company can lose customers, postpone investments, reduce hiring or run into working-capital stress during the transition.

 

By the time the aggregate inflation number begins to look benign, the underlying business may already have changed substantially.

 

The Same Inflation Does Not Affect Every Business Equally

This is why the relationship between inflation and strategy needs to be understood at a much more granular level. The same inflation rate can have completely different consequences for different industries and even for different companies within the same industry.

A software company, a steel manufacturer, a hospital and a restaurant do not have the same exposure to energy, labour, imported inputs, logistics or capital costs. Even two companies making the same product may experience inflation differently because one has long-term supplier contracts, lower debt and stronger pricing power while the other buys in the spot market and operates on thin margins.

The macroeconomic number may be the same. The strategic consequence is not.

This is also why businesses need to understand their own cost architecture rather than rely entirely on macroeconomic averages. Knowing that inflation is 5% is useful. Knowing that 40% of your own cost base is exposed to a category experiencing 10% inflation, while your ability to pass through only 4% of that increase, is strategically useful. The second number tells you what you need to do.

 

Households Are Economic Systems Too

The household provides an equally important illustration. A household is not a miniature corporation with unlimited flexibility. In fact, its ability to respond to rising costs is often much more constrained.

If housing becomes more expensive, one cannot simply substitute housing in the way a business can substitute one raw material for another. If healthcare costs rise, alternatives may be limited. If school fees increase, parents cannot necessarily postpone the expense. Food prices can be managed to some extent through substitution, but even that has limits.

And there is another constraint that is often overlooked: the household has a finite number of people who can absorb the impact by increasing their working hours or generating additional income.

 

Suppose a family's monthly expenses rise by ₹25,000. The family may eat out less, cut subscriptions, postpone purchases, dip into savings, borrow more or increase household income. But every response carries a cost. Additional work means less time. Using savings means less financial resilience. Borrowing moves today's problem into tomorrow. Cutting discretionary spending affects quality of life and also reduces demand for the businesses providing those services.

 

The household has therefore not simply experienced a higher price level. It has experienced a change in its decision-making framework.

 

This Is Where Behavioural Economics Enters

People do not experience inflation as a statistical index. They experience it through repeated encounters with prices and through reference points built over years. If a meal used to cost ₹500 and now costs ₹800, the consumer does not think about the change as an abstract movement in a weighted consumption basket. The reference point is ₹500. The experience is that something which was affordable has become expensive.

 

Wages are perceived differently. A salary increase is generally experienced as a reward for one's work, while a price increase is experienced as something imposed from outside. Consequently, even when wages eventually catch up with prices in aggregate terms, the psychological experience of inflation can remain negative.

 

But this is where we need to be careful. The fact that some of the experience of inflation is psychological does not mean that the underlying economic impact is psychological.Behaviour itself is part of the economic mechanism.

 

When consumers become more cautious, they change their spending. When businesses see weaker demand, they change their pricing, hiring and investment decisions. When employees become uncertain about purchasing power, they change their wage expectations and job-search behaviour. When investors become less confident about future returns, they change capital allocation. What begins as a psychological response therefore feeds back into actual economic activity. Psychology becomes part of the transmission mechanism.

 

Inflation Creates Feedback Loops

This is where inflation becomes much more interesting — and much more dangerous — than a simple movement in prices. Prices affect expectations; expectations affect behaviour; behaviour affects demand; demand affects pricing and investment; investment affects employment and future capacity; employment affects incomes; and incomes feed back into demand.

 

The original inflationary shock may have come from energy, food, monetary conditions, supply constraints or trade policy, but its ultimate consequences are determined by how the entire system responds.

 

This also explains why the effects of inflation can sometimes be considerably larger downstream than the original shock. A business absorbs higher costs, reduces margins, delays investment and cuts hiring. A household faces higher expenses, reduces discretionary consumption and uses savings. Reduced consumption affects another business. Lower investment affects future capacity. Changed expectations influence another round of decisions.

 

The system is constantly reacting to itself. This is why inflation cannot always be understood through a simple cause-and-effect chain.

 

Why Averages Can Hide the Real Story

There is also a distributional problem which makes aggregate measures less useful for understanding lived economic reality. Two households with identical incomes can have radically different experiences of inflation. One may own its home, have little debt and have no children. Another may rent, have two children, carry a car loan and face significant education and healthcare expenses. Same income. Very different economic reality.

 

The same principle applies to businesses. Two companies operating in the same industry can have very different outcomes because their cost structures, contracts, financing, customer mix and pricing power differ. This is why averages can sometimes conceal rather than illuminate. It is not that the aggregate statistic is wrong. It is that the aggregate statistic is answering a different question.

 

Inflation tells us something about the movement of prices across a defined basket. It does not, by itself, tell us how a particular household's financial resilience has changed, whether a particular business model remains feasible or whether an investment still makes strategic sense.

 

What This Means for Business Strategy

For anyone involved in strategy, this distinction is critical. A strategy cannot simply say that a market is growing at 8% or that consumer incomes are rising by 5%. It needs to understand what is happening underneath those numbers.

 

Which costs are moving? Which ones are volatile? How quickly can they be passed through? What happens to demand when prices increase? Which assumptions in the business model are most vulnerable? At what point does a project become unviable? How much pricing power does the organisation really have? What happens to working capital if costs rise faster than collections? What happens to capital allocation if the required return changes? And, perhaps most importantly, how will customers, employees, competitors and investors change their behaviour in response? These are strategic questions, not merely financial ones.

 

This is also why I believe strategy professionals need to be comfortable moving between disciplines. Marketing without an understanding of economics can misread consumer behaviour. Finance without an understanding of behaviour can misread demand. Operations without an understanding of strategy can optimise the wrong variables. Strategy without an understanding of the cost structure can become little more than a set of ambitions. The strongest strategic thinking happens when these disciplines are connected.

 

Inflation Is a Strategic Variable

I increasingly think of inflation not as a number but as a systemic disturbance to the assumptions on which economic decisions are made. It enters through prices, but it does not stop there. It travels through industries, supply chains, businesses and households. It changes margins, feasibility calculations, investment decisions and expectations. Those changes alter human behaviour, and that behaviour feeds back into the economy.

 

The important word here is interconnectedness.

 

What is true for one person does not automatically become true for the population. What is true for the average household does not necessarily describe the household at the margin. What is true for a profitable business does not tell us whether its next investment is financially feasible. And what looks like a small movement in one variable can create a much larger downstream effect when several variables move together.

 

Economics is therefore not an Excel sheet where we change one cell and wait for the answer. It is a system of relationships, incentives, constraints and human decisions. And inflation is one of the forces capable of disturbing almost all of those relationships simultaneously.

 

Perhaps the better question is therefore not simply, "What is the inflation rate?" It is: Which prices are rising, for whom, through which supply chains, at what speed, with what alternatives — and which assumptions does that change? Once we start asking those questions, inflation becomes much more than a monthly economic statistic - it becomes a strategic variable.

 

And understanding that variable — not merely measuring it — is essential to understanding how businesses actually survive, adapt and grow.