Inflation, Recession And Stagflation: A Conversation With Dr. Ram Charan

Dr. Ram Charan is an invaluable resource for CFOs who are dealing with inflation for the first time in their careers (which, let’s face it, is most of them). I recently caught up with Ram to get his views on how CFOs can deal with inflation and a likely economic slowdown in 2023.

Ram is a noted CEO advisor and expert on business strategy, execution, building a high-performance organization, 21^st century leadership, corporate boards, and succession. He has worked with leaders of some of the world's most successful companies, including GE, Bank of America, Verizon, Coca-Cola, 3M, Merck, Aditya Birla Group, and Tata Group.

Ram is the author or coauthor of more than thirty books that have sold over four million copies, including Execution, which spent 150 weeks on the New York Times bestseller list. His most recent book, Leading Through Inflation and Recession and Stagflation, offers very pragmatic advice for executives looking to grow their companies in an economic slowdown. Below are the highlights of my conversation with Ram.

Jack McCullough: Ram, we have not had significant inflation for 40 years. What caused it to emerge recently? And, can it be tamed through policy changes?

Ram Charan: I lived through the inflation of the 1980s, where interest rates were as high as 21%. No one who has no memory of this time knows how vicious or insidious it can be to the public, because inflation eats into the psychology of people, and it chews a lot of cash for the same amount of business. The only remedy is to precipitate recession. We have no choice. It must be tamed. We must be firm. We must be determined. And yes, it will be tamed, no matter what it takes—policy, action by the Federal Reserve, and influencing the psychology that price rises will not take place.

McCullough: The title of your most recent books is Leading Through Inflation and Recession and Stagflation. For our readers who were not around in the 1970s and early 1980s, what is stagflation?

Charan: Stagflation is even more insidious than inflation. It is happening in the United Kingdom and throughout Europe. It can happen in the US, but I hope not. Stagflation is a condition where the prices are rising, and demand is declining. Taming that is even more difficult, but necessary.

McCullough: When I talk to CFOs, the biggest challenge they face is recruiting and

retaining talent. A company cannot grow without talent, but the cost of attracting high-performance employees seems to be spiraling out of control. How can companies find talent and deal with increasing costs at the same time?

Charan: The fact is the talent is here. High performance employees will go where the company will meet their aspirations of job content, respect, career opportunities, and less bureaucracy. The fact is costs are going up. There are industries where the cost of this talent will go up more than 30% over a three-year period. You should preserve your talent, pay the market price, recruit talent and pay the market price, but also provide the opportunity they deserve for promotion, better job content, and improved work conditions.

Now how do you pay for this increased cost? Here you separate those leaders who have good business acumen from those who do not. A leader with good business acumen will say this is the reality, we can offset some of it through productivity gains and improved organization structure, but not all of it. So, you then investigate a new way to develop a business model. In inflation, generating cash is a must, margin must be maintained. And so, one area of the business model is preemptive pricing. Forecast cost increases ahead of time, look at 3 years cumulative, and see what price increases you must have. Figure out how to pay your sales force, how to re-open contracts you have made, and how to manage discounts. Many companies have had to do that already.

McCullough: Many companies are raising their own prices to deal with inflation, an obvious tactic. What else are you seeing companies do that is not-so-obvious?

Charan: Other than price, what is not obvious is to never let the value of your brand go down. If you increase the price, which I suspect you have had to do, you must create value to the customer. Think of a new version of your product, your package, your value. That increased value at a higher price might mean better service, or more ease of use, but be explicit about that value.

McCullough: Working capital management is critical now, more so than a few years ago. How do CFOs better manage working capital?

Charan: A few years ago, our cost of borrowing was really close to zero. We had plenty of money available. This all has changed. Some banks were charging prime at 7% and being selective on awarding credit. So first look at your accounts receivable. Follow rigorously those customers who falling behind on paying and understand why. Do not hammer your customers, work with them, show on a value chain basis what they need to do for themselves, because inflation is adversely affecting every link of the value chain.

McCullough: Many companies were not prepared for supply chain disruptions over the last couple of years. With cash flow being critical, they do not want to tie it up in inventory, but of course they cannot risk not being able to fulfill orders in a timely manner. How should finance chiefs be thinking about this?

Charan: The question here is continuity of the business, or just keeping the cash at hand. They must fulfill the orders. Maybe they shrink the business, cut out marginal products, marginal plants, marginal SKUs and customers and therefore reduce the need for cash. But if inventory is not available, the business will stop, which you cannot afford. Find the right balance.

McCullough: I know you have identified a new set of priorities for CFOs. What are some key areas finance chiefs should be focused on to combat inflation?

Charan: They must shift their focus from percentage growth to managing cash almost on a daily basis and help business leaders see the difference. They should also reevaluate incentive pay to be sure it is aligned with cash. Every capital investment should be evaluated or reevaluated under new assumptions about inflation and recession. Some projects may have to be cut. They should also increase the frequency of communication with investors. Help them see what the company is doing to deal with inflation, recession, or stagflation and explain that any hits to revenues or profit margin in percentage terms will sustain and strengthen the business.

McCullough: I know you do not have a crystal ball, but your track record is better than that of anyone I know. What do you see in 2023 and beyond?

Charan: Nobody has a crystal ball, but we do know some drivers of what will come. We should all focus on those early warning signals. We know an increase in the funds rate already at 4.5% is working through the economy, and core inflation is still around six percent, excluding food and energy. That means that inflation is not in any way being controlled. A small decline is good for cocktail party conversation but is misleading. Learn how prices are increasing or not. The worst part is services, which is 80% of the US economy. So, while changes are good, we will see one or two small % increases next year. One does not have to be a precise forecaster. When it comes to a cash crunch, forward-looking leaders plan for the worst, because the adverse effects of lack of liquidity are fatal. Missing on the upside is ok, but it is not ok to miss on the downside. Plan for the worst-case scenario, stay with it, do not be lulled by your growth. Redo your numbers on an inflation-adjusted basis. Strong-willed leaders know how to lead in a crisis, and they take their people with them.