Understanding inflation and its effects on consumer behavior

Inflation is running at almost 9% in Europe and shows no signs of slowing down. Driven by the conflict in Ukraine and increasing competition for natural resources, inflation can significantly impact our disposable incomes and influence our purchasing behavior.

Businesses worldwide are worried about the impact of inflation on their bottom line, but what’s the reality?

First, let’s look at what inflation is, why it matters, and its impact on consumer behavior.

What is inflation, and why does it matter?

As you’ll know, if you’ve bought gas or shopped for groceries, prices are rising for almost everything.

Inflation is a collective measurement of price increases over a set period. In Europe, inflation in Europe is running at 8.9% at the moment, compared to 2.5% in 2021. That means that during the past year, prices for goods have risen an average of 8.9% across Europe. Some inflation is OK (in fact it’s desirable), but too much inflation can damage an economy very quickly.

Some countries have seen higher levels of price rises than others. You’ll also notice that some items have increased in price much more than others. That’s because inflation is an average that reflects the increase in costs of a specific set of goods that reflect national spending habits.

Inflation is measured according to the Consumer Price Index, which reflects the housing costs of the average person.

It’s important to understand that inflation will affect us all differently. Some people, particularly those on lower incomes, will be affected more than those with larger incomes, for example. Those who drive will be hit harder than those who cycle.

On the surface, higher levels of inflation should translate into lower sales across the board. But that’s not the case. Here are three things every business and brand needs to know about the impact of inflation on our spending habits.

Consumers don't stop spending immediately

Inflation may see our spending power reduced, but people that doesn’t mean we stop spending.

Instead, we’re more discerning about where we spend our money and on what. The lesson? During levels of high inflation, there are winners and losers.

One example is sales of groceries that actually increase during periods of high inflation.

Why is this the case? George Rogers Clark, Professor of Management and Marketing at Yale explains this phenomenon with a simple example:

"When people start eating out less at restaurants, they spend more on food products they’ll consume at home. Since I’m not spending $20 on fish at a restaurant this week, I can go to the store and buy not the cheapest fish, but one of the better fish.”

This anecdote is supported by PWC, who found that 75% of respondents expect to maintain or even increase current levels of spending across most categories in the next six months. While prices will rise, the willingness to pay them remains the same. Economists call this "inelasticity", which means price changes don't affect consumer purchasing behavior.

The important takeaway here is that inflation provides opportunities for some eCommerce players and threats to others. It depends on what you’re selling and who you are selling to.

If consumers change their shopping habits, they do so usually in five ways:

If consumers change their spending habits during economic downturns, they usually engage in what economists call "trading down" behavior. It means finding a cheaper and (subjectively) lower-valued alternative to a product they have previously purchased.

A simple example is swapping your regular Starbucks coffee for a homebrew. The coffee beans and milk you buy at the grocery store, are substitutes for the more expensive Starbucks coffee. As a result, you’ve traded your coffee consumption down.

During inflation, trade downs operate in five ways:

1. Choosing lower prices or lower quantities

McKinsey estimates that the most respondents (60%) who said they will "trade down" are doing so by reducing their quantities or pack sizes. The lesson is, they won’t stop spending on a product or category, but will spend less.

Retailers have quickly jumped on this trend. They’re using a selling method some call "increasing the whole of the donut". Essentially, you’re charging the same price for a smaller product. Imagine your favorite potato chips. The pack price is the same, but instead of getting 150g, you get 130g.

Have you ever picked up a chocolate bar and remembered it being bigger? It’s probably because it was bigger years ago. Same price, smaller product. Slimming down portion sizes may seem underhand, but for Cadbury’s at least, it hasn’t affected sales.

2. Switch to private labels and lower priced brands

A more extreme form of "trading down" involves substituting brands for lower-tier products. This particularly affects the luxury and premium goods industry, but also the entertainment and fashion sectors.

An Ipsos survey found that 35% and 33% respectively will buy cheaper brands, private labels or in-house brands from larger retailers. The cited McKinsey survey found that "only" 26% of respondents will change to cheaper priced brands or private labels.

Procter and Gamble and Unilever, which offer generally premium brands have recognized this trend and responded by introducing cheaper, lower-tier products across many categories.

In a recent Reuters article, Proctor and Gamble executives said that “for now consumers were switching to better-value premium products such as single-dose detergents or higher-priced diapers, adding they would focus marketing efforts on such offerings.”

3. Customers go after promotions and discounts

Customers are more willing to spend on goods with discounts and promotions during inflation.

Professor Georg Rogers explains:

"One very clever thing Costco does is to offer a few cents discount on gas. People hate to pay for gas, so when gas prices go up a lot, they go to Costco more and end up buying a lot of other stuff."

4. Shoppers will be more selective and research more

FullStory, the digital experience intelligence company, and Ipsos have found that customers are researching products in more detail than ever before purchasing. Over half (51%) say they’re getting into the details for every purchase, to ensure they’re getting the best deal.

Most of the research consumers do is aimed at cutting costs. 42% search online for coupons or discount codes. 33% are researching lower-priced alternatives, including discount brands.

Consumers also spent time checking out different retailers and stores to find the lowest prices. But is it a strategy that will work? 74% of 18-24 year-olds believe some retailers are doing a better job in managing increasing prices than others.

5. Delay purchases or buy in bulk

A significant portion of consumers are delaying purchases, says Morning Consult. Where they may have made impulse purchases in the past, they’re waiting – even if their incomes haven’t immediately been hit. The most affected sectors are, understandably, luxury/premium goods, dining out, entertainment, and fashion, says PWC.

Almost two-thirds of US consumers (64%) are very concerned about their spending, and it’s influencing our consumer decisions. We’re less likely to load the credit card with debt, instead making considered purchases and searching for the best value.

Customers are seeking strong value signals from brands they chose, which means online retailers must adopt new pricing strategies, says McKinsey. Instead of losing customers altogether, brands must build new relationships, addressing pain points while preserving customer value.

High-income millennials are top spenders during inflation

Ipsos, PWC, McKinsey, EY all agree that during times of high inflation consumers will increase their spending on necessities, such as groceries, and decrease spending on discretionary goods, such as electronics and fashion.

Inflation will have a differing impact, depending on the age and income levels of customers. Millennials, who earn more than $100000 per year are willing to increase spending across all categories and are optimistic, says McKinsey.

However, Millennials, Gen X, and Boomers with an income below $5,000 are most likely to cut back spending to the bare essentials.

What can businesses do?

It’s critical that businesses understand that inflation will have an impact on demand, but that demand will still be there. During times of high inflation, brands must react and refocus their offer to customers.

Strategies could include cutting prices, promoting lower-cost options or increasing information so customers can compare alternatives. It’s also important to reflect changes in products in your advertising strategies and creatives.

The key for every business is to find a strategy that continues to deliver customers. We can’t predict the future with any certainty, but those businesses who can ride out the tough times are best placed to embrace the benefits when inflation recedes and the recovery kicks in.

Channable provides digital retailers with the tools to rapidly create, roll out and manage product feeds across thousands of channels. Learn more about the potential of Channable to inflation-proof your digital marketing strategy.