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“Wage increases higher than inflation - who is paying the price? They go ahead and increase their prices, safe in the knowledge that all their competitors are doing the same and that their customers are, in any event, too locked-in to go elsewhere.”

Budget - Who Pays the Price?

Wage increases higher than inflation – who is paying the price?

During 2010 South Africa enjoyed some of its lowest inflation rates in years. Inflation stayed within the Reserve Bank's 3-6% target band throughout the year, hitting a five-year low of 3.2% in September. For December 2010, inflation was just 3.5%.

And yet at the same time, the average wage settlement in the first nine months of last year was 8.3%. The year before it was even higher, at 9.3%. The settlements received by parastatal and public sector workers set the tone for everyone else.

This means labour costs are increasing by around double the rate of inflation – and for most businesses, labour is the most significant input cost; the wage bill dwarfs all others.

Many other input costs are going up much faster than the official rate of consumer inflation as well. Eskom is the biggest culprit here, with electricity costs set to increase by a whopping 25%-odd for each of the next three years. This alone would put a sizable dent in the profit margins of many businesses; add in increased wage costs and the outlook is bleak indeed.

The very largest companies – the banks, financial services companies, telecommunications providers and others who account for another large chunk of business expenses – are of course too big to feel much of this pain. They go ahead and increase their prices, safe in the knowledge that all their competitors are doing the same and that their customers are, in any event, too locked-in to go elsewhere.

Small and medium-sized businesses, however, don't have the same freedom to increase their prices to compensate. Most small to medium-sized business owners we speak to confirm that they are under strong pressure from customers to contain price increases to something close to the official inflation rate.

So it's these businesses that are feeling the biggest pain – and paying the highest price – for the apparent mis-alignment between the official inflation rate and the actual costs of running their businesses.

And yet this is the segment of the economy to which all the lip service is paid. Here is where you find the farmers, the entrepreneurs, the innovators, the makers, the manufacturers and the creators of new jobs.

The mis-alignment between the official inflation rate and the perceived rate is creating significant pressure on the ongoing sustainability of these businesses. So what happens when the sustainability of these businesses is compromised? Some will go under, others will stay afloat by cutting their costs – particularly their labour costs. So either way, we can expect a new wave of retrenchments.

We may not see the headline numbers that the major industry players lay off when they retrench, but rather a groundswell of many smaller-volume retrenchments across many smaller businesses. This quickly adds up to many, many jobs.

Certainly, these businesses won't be taking on many new workers. High costs combined with our restrictive labour laws will make sure of that – and many among the current crop of matriculants can expect to join the ranks of the long-term unemployed.

There's potential for a nasty vicious cycle to set in here if businesses try to cut costs in yet another way – by delaying investment in new productive capacity (which may include training as well as new machinery or software). These businesses may survive, but they won't grow – or at least not as fast as they might otherwise.

So, while our low official inflation rate looks good on paper, the reality most businesses are facing is very different: Rapidly increasing costs that are not matched by the ability to raise prices to compensate. This is not a recipe for sustained growth in the small to mid market sector of our economy, it is in fact a recipe under which the very sustainability of these businesses is threatened. asa

Kevin Phillips CA(SA) is the Managing Director of idu Software.

You can earn verifiable CPD points from this article – visit the Click2start Website to get your free verifiable points and click here for the manual on how to answer Accountancy SA CPD questions.