Can innovation curb inflation?

The cost of living is rising. Fast. With prices having accelerated to a 30-year high of 6.2% in the 12 months to February, both people and businesses are certainly feeling the pressure.

Despite this, these figures still don’t show the full picture. If you have been feeling hungry after finishing a bag of Doritos recently, it’s because the bags have around 5 fewer crisps per pack. Toilet rolls have also been reduced in size, as well as many other types of food and household products. Restaurants are also reformatting recipes to have cheaper ingredients, hotels are making room service ‘opt-in’ and have stopped providing complimentary toiletry bottles, electrical goods are being made with cheaper designs that wear out more easily… The list goes on. These size reductions are referred to as ‘shrinkflation’, which is another, albeit more subtle, pressure on the cost of living and a way to preserve profits without increasing prices.

Some companies have been open about the profit motivations, with P&G and Unilever proudly boasting boosted profit margins and announcing plans for more. Other companies have insisted that their motivations are unrelated. Hotels have claimed the above measures are purely moves to reduce their environmental impact. Cadbury has insisted its motivation for reducing the size of the Wispa is to “tackle obesity”. How courteous, I’m so glad I can reduce my waistline as well as my bank balance!

Jokes aside, inflation presents businesses with difficult choices. Shrinkflation does tend to be effective and, can indeed come with environmental and other related benefits that are undoubtedly also very important, especially given the growing importance of ESG and Race to Zero initiatives. However, businesses remain careful to strike an appropriate balance between keeping shareholders happy while maintaining customer loyalty. Increasing prices or cutting product sizes risk sparking consumer discontent or even outrage in the case of Wispa, which can spread like wildfire in the age of digital media.

There is no ‘right’ strategy, and businesses must weigh up short term losses with long term gain and base decisions around the behaviours and attitudes of their consumer base. Tim Martin, chair of JD Wetherspoon has opted to absorb the losses for more popular products in the desire to maintain its competitive position and makeup with increased sales. This may make sense, considering the chain’s reputation for being excellent value, and in turn, makes its customers particularly spend-savvy.

In addition to the above, many have proposed that an alternative for adapting business models around inflation is innovation. Innovation is a buzzword that has infiltrated discussion across almost every industry, the virtues of which have become especially apparent following the Covid-19 Pandemic and impending climate crisis. While increasing prices of products or services or employing shrinkflation measures may be effective business solutions in the short-term, inflation-resilient innovations have been proposed to offer a better long-term strategy.

But could innovation really stop inflation, and if so, when might this take effect? This question is contentious and largely speculative with no simple answer. Statistics do show that innovation does enhance competitiveness, market power and survival of firms and sectors. A 2020 report by Boston Consulting Group (BCG) on corporate innovation, which surveyed 1,600 global innovation executives, showed that BCG’s rating of the 50 Most Innovative Companies outscored the average by 3.3% per year in total shareholder return. If this pattern continued, the overall effect could curb inflation levels in a more indirect way.

One area of focus is on economising supply chain processes. A key example of this is through vertical integration. For example, Amazon has introduced a digital freight matching marketplace called Amazon Freight, which is reportedly aiming to act as an incubator for start-up trucking companies to drive for Amazon, with the end goal is to reduce or eliminate its reliance on delivery companies such as UPS, FedEx, and the USPS.

Artificial intelligence, automation, machine learning and robotics are some of the main technological innovations that aim to boost productivity and cut business costs. Amazon also continues to invest in robots for its distribution centres, which help to speed up delivery of products and enable workers to focus on other more productive tasks, with the goal to see fully automated shipping warehouses by around 2030. Administrative-based business costs can also benefit from these technologies, with customer service bots and document-review programmes being key examples.

Another economic pressure that innovation may help to offset is ageing baby boomers. This has been seen through the highly controversial Health and Social Care Levy that recently pushed National Insurance up by 1.25%. Healthcare innovations, such as AI-driven diagnostic tools, could help to offset these costs, with China having put $1.5bn aside for these purposes.

However, with all the excitement around these types of innovation, it is important to consider the limitations and drawbacks. Innovation is not a straightforward incremental process. Innovation is risky, uncertain and failure-prone; as well as expensive! Innovation-readiness is a highly complex topic, and while many businesses may see innovation as a priority, many are not yet in the position to deliver it. The 2021 BDG report showed that, while 75% of businesses listed innovation as a top priority, only 20% were considered to be ready to deliver it in a way that would deliver on value in the way the data suggest. This highlights the overall problem. Innovation is inaccessible for many businesses, and any measures may produce additional costs that could fall on the consumer in the short term. Many have proposed that innovation is a crucial way forward, and government intervention should help to mitigate any short-term increases in costs. However, given the economic pressure from the Covid-19 pandemic, Brexit and the war in Ukraine, amongst other things, this could seem overly optimistic.

This being said, the examples above only provide a snippet of the potential strategies for which innovation could tackle inflation. While there are numerous barriers and limitations to what innovation may achieve in the short term, hopes are high that it will be a powerful disinflationary factor in years to come.