How to Operate in a Deflationary Future: It is widely believed that the massive deficits being run by the United States government will result in inflation. Inflation that would cause tax revenues to increase and allow national debt to be paid off with inflated dollars is something that politicians dream of at night. If one studies the economic history of Japan over the last few decades, you will see that a significant issue for many businesses in the United States is deflation. The risk of deflation is almost greater over the next few years and could cause even more failures for the unprepared.

“The World Is Flat: A Brief History of the Twenty-First Century” became an international bestseller when it was published in 2005. The book discusses the factors which increased global competition and how to remain competitive in the global marketplace. Many businesses service customers in a narrow geography and mistakenly believe that they are not impacted by what goes on half way around the world. If a business or its customers are affected by inflation, energy prices or interest costs, the globally economy is having a larger impact than might be obvious.

Looking at some key drivers of inflation may be instructive and while you are reading this, think of how much inflationary pressure the fact will exert or not exert over the next few years:

Employment: It’s not likely labor rates in the US will be increasing anytime soon with the current and projected level of unemployment. Government workers have been laid off in half the states. Twenty-two states have instituted unpaid furloughs. It appears that consumer demand even from public sector employees may be soft. How often do you hear about unemployed workers being hired at lower wages than they previously enjoyed? The celebration of getting a new job is likely to be muted.

Oil: We’ve seen some softening of oil prices in the late spring driven by the weakening of the Euro. Europeans are already paying over $7 per gallon and if the Euro weakens further it is likely to reduce demand in Europe which will have a beneficial impact on US imports. We could see political risks and holiday gouging but the outlook for the next few years is likely to be deflationary for energy costs.

Social Security COLA: For the first time, Social Security benefits did not increase due to COLA (Cost of Living Adjustments) leaving that population with no additional income to stimulate the economy.

Interest Rates: With the Euro down about 12% compared to a year ago, the US Treasury will benefit from a continued flight to safety and capital preservation. My adjustable mortgage has been less than 3% for the last year and a half and it is not unusual to see mortgages advertised in the 3-4% range. Businesses will benefit from improved margins as a result of lower interest costs.

Taxes: Likely to take a bigger bite out of the consumers’ wallet. The public sector is between a rock and a hard spot - the more governments take out of the economy in the form of taxes, the less money there is to spend on goods and services in the private sector. Without stimulus spending (which has largely be funded by borrowing) the economy will likely lose some of the feeble momentum it already has. Between December 2007 and April of this year, disposable personal income would have been DOWN just over $900 billion without the stimulus money. Increased property taxes, income taxes, sales taxes and gas taxes will only further reduce the amount of spendable income available to buy products that companies need to hire employees to make. Will government spending in the 2nd half of 2010 and next year rival the levels of the 2009 stimulus? Probably not.

Real Estate: Anyone think that home values are going to be the piggy bank they were a few years ago? How about the commercial real estate market? With the amount of for lease signs, landlords aren’t likely to have pricing pressure anytime soon.

Factory Utilization: You don’t hear a lot about companies raising prices because the demand outstrips their capacity to produce. With a lower Euro, it will become more difficult to compete with European made products.

Over my 25 years in the chain restaurant business with brands like Jack In The Box, Burger King, Arby's, Pizza Hut and others, it was almost standard to increase prices by 2-3% per year. That would offset increases in minimum wage, supply increases and other costs. Everyone would feel good about that even if transactions were flat or slightly down. It's not likely that many brands will have much pricing power in the immediate future so increase sales to existing and new customers will be of critical importance.

25 of 27 European countries are running deficits in excess of 3% of GDP. Ireland has a deficit of 14.3%. Portugal is at almost 10%. Greece is almost 14%. Greek debt for 5-year bonds is now 15%. There is no way for them to grow their way out of the problem if interest rates are at 15%, up almost fourfold in less than a year. Rates are rising for other European peripheral countries as well. Europe is likely to buy fewer goods and services and will attempt to utilize a weaker Euro to export its way out of its problems. So what happens in Greece, really does affect businesses in the US.

With consumers saving more, limiting spending, deal seeking and trading down, many businesses are seeing reduced revenues even if customer counts are up. While some of your costs may be down, less volume may be spread over fixed costs making the need for growth imperative if not urgent. In an economy like this, businesses fail. The good news is that new competition may be less likely so there are opportunities to grow share in a declining market. With competition failing, the survivors can thrive by gaining share even in declining markets.

Despite, the preceding, I am highly optimistic about the future although operating in a deflationary environment is likely to be a much different paradigm. The challenge is to figure out not only how to survive but thrive. It’s survival of the fittest. How fit is your business?

Here are a couple of best practices to consider-

Costs: Keep a strong watch on your costs. Defer adding head count, invest in automation and productivity improving technology. Look at some cost categories that have gone down in recent years - VoIP, cell phone minutes, commercial real estate rent rollbacks and even wages at many companies. You need to reduce costs if you want to maintain margin in the face of pressure for price cuts or discounts.

Technology: Invest in technology and automation to minimize competitive disadvantage from lower wage rates around the world - labor is only one component of costs and if you can engineer it out of your product and processes, you improve the competitiveness of your business.

Customers: Do you have a customer base in which no single client accounts for more than 10 percent of total sales? If you find the majority of your customer base comprising of only one or two good customers, it is important to consider reinvesting your profits into additional capacity and/or marketing to acquire a broader customer base.

Growth: You need to have a realistic growth strategy. You can’t save yourself to prosperity and it is likely that you’ve already cut costs where you could over the past few years. It makes sense to have a written plan describing future growth and how that growth will be achieved based on industry dynamics, increased demand for the company’s products, new product lines, market plans, growth through acquisition, and expansion through augmenting territory, product lines, manufacturing capacity, etc.