By Kevin Phillips
South Africans pay a lot of attention to the inflation rate: whether it’s up, down or stable, which direction it’s headed in and what it means for our wage and salary negotiations.
But in some cases, the official inflation rate is being abused by large companies to squeeze their suppliers — putting the long-term health of many small businesses at risk.
The problem is that when we say “inflation” we actually mean the Consumer Price Index (CPI). This is measured every month by Statistics South Africa (Stats SA), based on changes in the prices of goods and services bought by the average consumer. The “basket” tracked by Stats SA has 12 categories: food and non-alcoholic beverages, alcohol and tobacco, clothing and footwear, housing and utilities, household contents, health, transport, communication, recreation and culture, education, restaurants and hotels, and a “miscellaneous” category that includes insurance and financial services.
The basket is “weighted” to reflect the relative importance of different spending categories in the average household budget. For example, our current CPI weights expenditure on food and non-alcoholic beverages at 15,68% of the total, meaning the typical household spends just over 15% of its income on this category. This weighting used to be higher at 22,09%, but the CPI was revised in 2009 to adapt them to changes in spending patterns.
By all accounts the CPI is a reasonably accurate reflection of the actual price changes experienced by the average household. The problem comes in when people try to use it to determine what businesses should be charging for their goods and services.
Businesses don’t buy a lot of food, or clothing or shoes. They don’t pay doctors’ bills or school fees or taxi fares, all of which go to determining the official inflation rate.
So what do businesses buy? Let’s take the example of a typical small business like a plumber, a beauty salon, a software developer or a graphic design company. These are all service businesses, and for most of them the single biggest cost they face — about 60 to 70% of the total — is salaries.
Salaries, though, have gone up by much more than the official CPI inflation rate in the past year. Last October the government reached a wage settlement with public-sector unions that granted a salary increase of 7,5% — more than double the inflation rate of 3,4% in the previous 12 months. And where the public service goes, others will expect to follow — so there is pressure on all employers to grant wage increases at least above 5%.
What about the other major costs that businesses face? Electricity went up by 27% in 2008, 31% in 2009, 35% in 2010 and it will go by 35% again this year and next year. Travel costs are at the mercy of fuel prices, which have gone up dramatically and aren’t coming down any time soon. Most rental agreements have 10% annual increases built in. The only thing that’s stayed relatively stable is telecommunications costs.
For most businesses, salaries, electricity, communications, travel and rent accounts for about 90% of their total costs. All but one of these costs have gone up by more than double the inflation rate in the past year.
It gets worse. The CPI does include the cost of utilities, so the Eskom price increases will at least feature; but the relative importance of those costs to households and businesses is very different. Businesses spend far more of their income on electricity and communications than do households — but the weighting of the CPI basket reflects only the spending priorities of households.
So, the CPI is a great measure of what’s happening to households; but a terrible measure of what’s happening to businesses. Yet when it comes time to negotiate supply contracts with big clients, many of them point to the inflation rate. “Inflation only averaged 4,3% last year, so you shouldn’t increase your prices by more than that.”
How many of the CEOs of those companies accepted salary increases of 4,3%? Certainly if I was to offer my staff that, they’d be very unhappy; I might lose people I’d very much like to keep.
So those who want their suppliers to limit their price increases to the inflation rate are either ignorant of what the CPI really measures, or they’re abusing it as a bullying tactic. Small businesses are facing increases in their basic costs of way more than inflation — and if they can’t increase their prices to compensate, they won’t survive for very long.
Kevin is an entrepreneur who has built a successful business and so has a solid understanding of the challenges and questions business owners face. He has degrees in commerce and accounting.
Actually, it’s more serious than that at a macro as well as a microeconomic level. Sure, CPI seems to be a myth to almost everyone – households and businesses. The trus inflation rate seems much, much higher just from a simple survey of cost increases. What this means is first that the ‘real’ inflation rate when increaseing wages and prices is more like 10% – nobody believes the 4%. Which means SA’s repo rate of 5.5% is well below the inflation rate and SA has negative real interest rates. Which are a sure recipe for STAGFLATION – low growth but painfully high inflation. Which we now have.
Actually, it’s more serious than that at a macro as well as a microeconomic level. Sure, CPI seems to be a myth to almost everyone – households and businesses. The true inflation rate seems much, much higher just from a simple survey of cost increases. What this means is first that the ‘real’ inflation rate when increase\ing wages and prices is more like 10% – nobody believes the 4%. Which means SA’s repo rate of 5.5% is well below the inflation rate and SA has negative real interest rates. Which are a sure recipe for STAGFLATION – low growth but painfully high inflation. Which we now have.
In addition to the big “rip off” by the large retailers pick ‘n Pay, Checkers, Spar, etc. there is another beinf perpetrated by the same crowd and their suppliers.
Packas are being reduced by as mach as 33% whilst the price reamins the same for a few months. Then the price is increased once again.
Bacon usualy 250 gms packs. Reduced to 200gms in some cases. and 180 gms in others. Price is now about R19,99 for 250 gms.
Tinned goods were 840 gms now 800 gms. But prices have increased bu 80% in some cases.
e.g. Chocolate bars from 200 gms to 180 gms. Price increased from R12,99 to R16,99c
Butter: 500 gms pack ; Prices range from specials R14,99 to R29,99 within a few days.
Bread has reduced from 900 gm to 700 gm (some are 600gms) loaves but prices have increased to R12,99. Just compare prices between major suppliers range from R6,49 to R12,99. Why??
And so it goes on.
Lupercus is correct and what often makes the matter worse, is that some companies design new packaging to make the facts less obvious. The rising costs, it seems, can often be blamed on the new packaging rather than higher production costs or increasing oil prices.
Totally agree. I too run a small business and our prices have had to remain static due to market pressure. This means we have to increase our volumes to stay in the same place. The other burden on us, which we cannot charge for, is that placed on all businesses by SARS. The amount of paperwork and increase regulation that has happened in the past 18 months is truly astounding. This also cannot be factored into pricing of products effectively. Hidden costs, out of order price increases from quasi govt and govt bodies, travel cost inflation etc are slowly but surely stifling the country. Our current situation reminds me of Harold Wilson’s UK where there was serious stagflation. It does not bode well for solving our unemployment problems or anything else
I have spent a chunk of the easter holiday on a ‘fat paper’ exercise… turfing out old accounts and documentation kept for tax purposes… that is more than five years old, and i was disturbed to note that the prices of many routine expenses have risen by more than 100% over the period.
Presumably that is because the CPIX is a [deliberately?] misleading indicator… since it actually [as i understand it] measures the change in the core inflation rate… to which no published data refers at all anymore.
There was a time when the core rate of inflation was widely publicised but as the more fraudulent aspects of our Fiat currency era have become more finely tuned that rate was deemed inconvenient and expediency determined it removal from consciousness..
Economics is however a cruel taskmistress and just because we have stopped publishing the facts doesn’t mean they stop persisting.
Recent reports indicate that Kevin’s closing observation is barely prescient as the rate of small business insolvencies is shifting to pandemic levels: undoubtedly for the reasons he presents.
Given the flood of fake ‘money’ pumped into the global system over the past 3-4 years, we can anticipate a Mugabe style rate of inflation going forward.