As companies face much higher inflation, they should consider price cross-subsidization

Companies should assess purchasing power conditions and how much discretionary spending budgets are going to get squeezed, as consumers must cover for higher prices of food, energy, and transportation, in order to inform their pricing strategy in each country. In some markets, consumers will be willing and able to stomach price increases to maintain access to certain products and services, while in others, consumers will be forced to trade down if prices increase beyond a certain threshold. Multinationals might want to consider “cross-subsidizing” prices across countries depending on their price sensitivity.

Overview

Russia’s invasion of Ukraine will further exacerbate lingering supply chain issues provoked by the COVID-19 pandemic, leading to significantly higher energy and food prices. Higher costs along the supply chain—which in LATAM translated into producer price inflation of more than 20% already last year in countries such as Brazil, Chile, and Colombia—will be inevitably passed on to final prices as companies try to protect their margins. For Latin America this will mean much higher-than-expected inflation in 2022. Looking at the region’s top-6 markets, we are now expecting Brazil’s inflation to average 10.2% up from 7.1%, Mexico’s 6.7% up from 4.7%, Colombia’s 6.8% up from 4.9%, Chile’s 8.2% up from 6.0%, Peru’s 7.2% up from 4.6%, and Argentina’s 74% up from 51%.

Our View

The extent to which higher inflation will lead to demand destruction for discretionary goods in each country will depend on two main factors. The first factor is the percentage of household budgets that is normally allocated to food, energy, and transportation during a normal year—the three categories where we expect price increases to concentrate. The second factor is the ability of consumers to increase their overall budgets by tapping into extra income, credit, savings, or government transfers, which will depend on how quickly jobs have recovered from COVID-19; whether consumers have extra capacity to take on more credit or to continue to tap into savings after two years of doing that during the pandemic; and the current fiscal capacity of governments to extend additional cash transfers, tax breaks, or price subsidies. The more consumers need to compromise their budgets to cover for food, energy, and transportation, and the more cash-strapped they are as prices rise, the bigger the hit to discretionary spending, and vice versa. Following this logic, Peru is the most vulnerable country to discretionary demand destruction, and Colombia and Ecuador are the least. All other countries will face medium risk of demand destruction, either because consumer spending conditions are fragile at the current moment, or because consumers spend a disproportionate amount of their budgets on food, energy, or transportation.

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