Sep 17, 2023
by Humera

The unanticipated rise of inflation has resulted in price increases across the board, making it more expensive to conduct business and to simply exist. The rising cost of energy is a significant issue for businesses today, along with wages, materials, and services. This blog covers the impact of inflation on the overall price of goods and services. As a consequence of rising consumer prices and the ensuing wage inflation, competition for talent is intensifying.

Inflation may cause a decline in the value of IT assets. When inflation is high, investors are sometimes unwilling to invest in new technological firms. Because of this, IT companies may have less capital to deploy, making expansion and innovation more difficult. Lastly, inflation can impair IT firms by diminishing their purchasing power. Consumer purchasing power declines as the cost of living rises due to inflation. This makes it more difficult for IT companies to maintain market competitiveness, as they must pay more for the same resources. Despite the fact that inflation has severe effects on the IT industry, businesses can still flourish with the proper preparation and investment.

The good news for companies concerned with maximizing output is that this change is prompting unprecedented investments in services and technologies that may mitigate the impact of inflation. As the cost of labor and capital continues to rise and infrastructure becomes a focus of the political climate, it is anticipated that corporate expenditures will transition toward productivity enhancement and technology that can reduce the cost of doing business. There will be an increase in demand for and competitive advantages for businesses that provide novel and cost-effective solutions to problems.

The MSCI World Index, which follows big and mid-cap firms across developed nations, was generally in line with valuations for these deflation facilitators before the epidemic. Through the end of 2021, the valuations of companies in this industry increased, but that trend reversed at the start of this year. Companies that are known to offer technology and services to reduce expenses and increase productivity have been trading at a discount to the market recently. Three important technologies that have a large impact on most industries and are at long-term inflection points that stand out as deflation enablers are artificial intelligence, renewable energy, mass energy storage, and mobility.

1. Artificial Intelligence

Due to cheaper and more powerful processing capabilities, artificial intelligence (AI) models are advancing at a rate that transcends the predictions of conventional models. For example, the pharmaceutical industry has employed AI and machine learning to expedite and reduce the cost of drug discovery. This trend may result in the development of scores of new medications, creating a $50 billion market over the next decade. Numerous companies are undervalued relative to the market as a whole, and this presents an opportunity for investors if AI has a similarly disruptive impact on other industries.

2. Renewable Energy

There will likely be inflationary price pressures as a result of the drawn-out and precarious transition away from fossil fuels, which will only become more challenging due to geopolitics, climate change, and a greater emphasis on energy security. Companies that have developed cutting-edge renewable energy technology and have few direct competitors may see their profit margins rise as a result of increasing investment, providing a higher return for their backers. As many clean tech equities have not yet factored in a robust growth outlook, analysts advise investors to consider companies that will benefit from the widening gap between rising utility bills and falling renewable energy costs.

3. Mass Energy Storage

The widespread availability of low-cost battery storage would be of tremendous benefit to numerous industries. The long-haul and heavy-duty trucking industries, for example, have been severely strained by rising labor and fuel costs and a scarcity of available drivers. However, making the transition to battery-powered trucks could help mitigate these issues. Improvements in large-scale energy storage are also anticipated to expedite the development of electric automobiles and, eventually, autonomous vehicles. Battery technology has a long way to go before it reaches its full potential, but as these technologies become more accessible and affordable, more and more end users will be able to take advantage of their products and services, creating a significantly larger total addressable market for companies in the industry.

Some forecasts from Canalys are as follows:

Cloud infrastructure development will ultimately slow down. In the past few years, cloud computing has outperformed all other technology categories, and hyperscalers have expanded swiftly to meet demand. Over the span of the next two years, AWS anticipates introducing new availability zones in over 30 cities across the globe. The associated expenses will continue to rise. Even though hyperscalers benefit from economies of scale when purchasing equipment, they are not immune to rising component costs. Increasing energy prices and interest rates (which will have an effect on the cost of leasing capital equipment) contribute to the rising cost of maintaining a global cloud infrastructure. In addition to hardware companies, Microsoft has announced price increases for Office 365, and Google Cloud has also announced price increases. Given their size and market dominance, Amazon and Microsoft will be better equipped than their competitors to overcome these obstacles. However, these competitors will struggle to invest at the same rate in infrastructure. If cloud service providers are forced to raise prices, customers will be compelled to reevaluate their reliance on the cloud and establish new priorities.

Over the past decade, revenue growth has taken precedence over profitability in the technology industry. These businesses, which had expansionist shareholders backing them, used generous stock options to compete for the best talent in the sector. As a consequence of the stock market's recent decline (exacerbated by the conflict in Ukraine and anticipated increases in interest rates), many employees' equity options will be rendered worthless. In a highly competitive job market, compensation will be critical for attracting and retaining top employees. Amazon has also made significant changes to its pay policy by increasing the cash portion of its employees' salaries. As stock prices decline, investors' attitudes will also change. Profitable businesses have a greater chance of winning the battle for talent and attracting investment capital.

Nevertheless, there are political and economic headwinds (war, taxation, and the regulatory environment) in addition to increasing expenses and inflation. Initial public offerings (IPOs) by digital ventures and venture-backed companies may be less appealing if the stock market is volatile. Large suppliers with ample cash reserves will attempt to reinvest this cash in productive assets. Manufacturers will increasingly utilize third-party resellers and support organizations. The retention of outstanding employees has become a top priority for technology companies. In contrast, vendors will increasingly rely on the partner ecosystem to strengthen their services and support capabilities, as well as their sales reach. Recently, it was rumored that Google Cloud's support personnel would be reduced. While it may appear that only a small number of employees will be affected, it was emphasized that some of these duties will be outsourced. Even in traditionally direct sales channels, such as the cloud, partners will assume a greater role in the future. So far, inflation has been beneficial for partners, as price increases have contributed to the partner ecosystem's top-line revenue. As a consequence, partners may anticipate greater opportunities in their service and support businesses and the ability to charge higher prices. Services and support are traditionally people-driven industries; consequently, partners will experience the same problem as vendors: price increases. Those who are able to automate the delivery of their services will prevail.

Soon, there will be an explosion of innovative equipment. Tariffs, raw material shortages, production delays, and logistical delays are at the core of growing technology prices. When pressures eased, the sector had an opportunity to catch up, but then a war broke out in Ukraine. Over the past five years, it has become increasingly apparent that global supply chain disruptions are not only possible but also highly probable. In the future, R&D divisions of hardware manufacturers will have to prioritize supply chain risk mitigation and product durability. The primary outcomes will be the creation of hardware-independent software, the adoption of modular form factors, and the use of fewer, more accessible components. The good news is that many of these tenets also align with the increasingly essential sustainability goals of businesses. All hardware manufacturers will work to develop environmentally friendly products that can withstand disruptions in the global supply chain.

Over time, automation will eliminate a large number of positions. While automation will assist, it is unlikely to be sufficient to stop the overall decline. Numerous occupations and responsibilities are amenable to progressive automation; the majority of these occupations are specialized. Upstart, a US-based online lender, asserts that 60% of its loans are autonomously underwritten with AI and other forms of automation. This is not the first time that a technology company has disrupted an established industry. Traditional technology industry vendors and partners will use automation to increase profits. Software providers will significantly rely on APIs in order to integrate with various markets. Managed service providers will use automation to track and resolve IT issues. Over-automation, however, may diminish human interaction. In 2019, automation has risen from being the least-complained-about issue in 2018 to being among the top five. Companies will need to strike a balance in their interactions with both partners and consumers.

As technological progress flourishes, the rate of inflation falls

The previous year was tumultuous for a large number of software companies that attracted investors' attention because of low interest rates. Interest rates and expanding enterprises inevitably have mutual costs and benefits. Reduced interest rates result in lower bond yields, producing a less favorable environment for bond investing. As investors seek to maximize their profits, technology stocks, which are frequently valued more on the basis of their potential for rapid development than on their profitability, become more attractive. Some private equity strategies benefit from the historically low interest rates and reduced costs associated with raising capital through debt issuance. However, due to expensive debt, private equity buyouts and other related transactions become more expensive, which may diminish the market's desire to acquire and invest in technology companies using debt.

Adapting to the Situation

True, artificial intelligence (AI), pure energy (renewables), and massive energy storage (MES) are examples of technologies working to combat inflation, but they are hardly the only ones. There are additional technologies that serve specific industries. To withstand the current inflationary climate, investors may wish to investigate a wide range of service providers that employ automation technology. These technologies range from manufacturing robotics to software that optimizes corporate operations to self-checkout systems' IT hardware.

Conclusion

IT product and service costs, as well as IT capital expenditures, are all directly affected by inflation. The price of hardware, software, and labor all goes up when inflation rises. As a result, it becomes challenging for an IT firm to keep costs down without compromising the quality of their services or products. As a result, increased inflation can boost demand for high-tech services and products even as it dampens expenditure by the general populace. This development significantly complicates the already difficult task of remaining competitive for information technology companies.