Being an open economy, it goes without saying that Namibian businesses are extremely vulnerable to external factors. Therefore, entrepreneurs have to be mindful of global economic developments to make informed [forward looking] business decisions.
In a bid to aid avid readers of this magazine in this regard, this column will provide insights into factors that impact business profitability, every month starting with this edition.
The first driver of business profitability we will address here is demand. Without its element, there would be no business.
Given a relatively limited local market, exports make a considerable contribution to an economy and thus create meaningful employment opportunities. This, however, means when demand falls in established markets, the local economy is negatively impacted. In fact, the current business operating environment underscores this situation, regardless of geographic boundaries.
Businesses must continuously monitor global economic developments to estimate their optimal output at every given level of demand. This enables a more prudent approach to resource allocation, which reduces the incidence of businesses sitting with idle factors of production. It is critical to understand that debt-funded assets, in particular, cannot afford to “lie idle” without creating a real risk of liquidation.
Let’s consider the demand for Namibian exports as a primary concern. This is because it opens up Namibian businesses to potential increases in their scale of production, which in turn has positive spin-offs for the local economy and ultimately stimulates the domestic component of consumer demand.
The Organisation for Economic Co-operation and Development (OECD)’s composite leading indicators (CLIs), which are designed to anticipate turning points in economic activity relative to trends, continue to show improvements relative to late 2012 in most major economies. In the United States, the CLI continues to point to economic growth firming. In the Euro-zone, the CLIs continue to indicate a momentum gain led by Germany whose CLI shows that growth is returning to trend.
Growth gaining momentum in the OECD area
Source: OECD CLI
The International Monetary Fund (IMF) also reports that global economic prospects have improved. However, the bumpy recovery and distorted macroeconomic policy mix in advanced economies complicate policymaking in emerging economies.
World output growth is forecast to reach 3.25% this year and four percent in 2014. In some advanced economies, economic activity is gradually accelerating. Private demand appears to be increasingly robust in the United States while it is still very sluggish in the Euro-zone.
In emerging markets and developing economies, activity has already picked up steam. This provokes crucial questions when considering export market diversification as it is important to ascertain whether the fast-growing, dynamic low-income markets are likely to maintain their momentum or when the Euro export markets are likely to come to the party.
In the past, companies could easily pass on higher prices to consumers. But because inflationary pressures have wide-ranging financial implications for businesses and households (given their crucial role as consumers), the business operating environment is becoming increasingly competitive.
Inflation being the factor behind the rise in the general price level, it is usually attributed to an increase in the volume of money and credit relative to available goods and services (demand pull) or substantial increases in the cost of important goods or services (cost push). These can be addressed using monetary and fiscal tools, such as interest rates and taxation. However, since some of the major causes of inflationary pressures are not within the ability of our central banks or governments to control, such elements often creep up unexpectedly on businesses.
This invariably dampens demand and may lead to higher levels of household indebtedness as consumers become poorer in real terms. So to maintain the relative purchasing power and welfare of employees, businesses may be forced to increase their wage bills thereby lowering profit margins. It is thus recommendable that all businesses understand and monitor the drivers of Namibian inflation so they may adapt and find ways to mitigate its impact on their profitability.
The negative impact of a recession-led declining demand has come with a silver lining in the form of lower inflation. However, the much anticipated resumption of global demand can be expected to exert upward pressure on prices worldwide going forward.
To mitigate the impact of inflation on profitability, it is crucial that business managers:
Keep overheads low through implementing cost/loss reduction strategies;
Build cash reserves to buffer short-term price increases;
Carefully watch their margins and worry about growing profits, not sales;
Avoid long-term contracts that have narrow margins with large customers;
Begin to make several small price increases instead of large ones all at once;
Eliminate or pay down any variable interest loan as these payments would most likely increase with inflation.
Even when the economy seems hopeless, there are many things businesses can do to combat the effects of inflation. Knowing how to predict economic changes is a very important financial tool. As such, local businesses must make use of investment tools and business strategies to combat the impact of inflation if they are to remain competitive and ensure sustainability.PF