Inflation is putting the squeeze on Minnesota's small businesses

Shawn Nelson has worked in the home building and renovation industry for more than 25 years.

In those years, he has never seen his business affected so severely by inflation.

The cost of lumber, windows, cabinets and other materials this year increased by as much as 15%, he said, dipping into company profits.

In the last eight months, a $15 box of potatoes for Anchor Fish & Chips rose to $60, said owner Kathryn Hayes. What was a $49 box of beef tallow, an animal fat oftentimes used as cooking oil, now costs $110 per box. For fish, the price per pound has risen $2 in that time span, Hayes added.

The Minneapolis restaurant has raised prices twice this year.

"It's something we never had to do," she said.

Nelson too has passed some costs onto customers.

But the profit margin also took a bite. The reality is that larger competitors can afford to temporarily lower profit margins either because they have larger credit lines or can take a lower profit margin.

And for many small businesses, the profit margin was already razor thin.

"They don't have the liquid assets and resources that large corporations have to weather negative affects like inflation, or weather disasters such as flooding," said Geri Aglipay, the Great Lakes Regional Administrator for the U.S. Small Business Association.

At best, most small-business owners have enough money saved to keep them afloat for at least one month if profit margins are poor, Aglipay said. Inflation has been particularly troublesome for minority-owned small businesses, she added.

Larger companies also tend to have buying leverage with suppliers that small businesses do not. Large companies can buy goods and services they need at negotiated prices, assuming the more they buy, the better the price will be.

This is particularly challenging when there is a shortage in goods — hence inflation and supply-chain disruptions — leaving smaller companies in a take-it-or-leave-it situation, or with nothing at all if suppliers are unwilling to fulfill small orders that won't boost their profits, said Ron Wirtz, regional outreach director at the Federal Reserve of Minneapolis.

A recent Federal Reserve Bank of Minneapolis report shows businesses across the region, mainly those in the Twin Cities and Greater Minnesota, are seeing declining profit margins due to inflation and higher labor wages. More than a third of business owners reported they saw a decline in revenue of 5% or more in the past three months compared to the same period last year, and nearly half said profits are lower when comparing the same three-month period in 2021.

Among the top challenges facing operations are price increases for equipment and materials and higher interest rates on loans and financing costs.

Nelson, a board member and former president of Housing First, an advocacy organization for the state's home construction industry, has heard from members how inflation continues to affect home building and remodeling. New construction at the lower price point has been hit the hardest, with builders having to spend more on materials while trying to keep home prices moderately low.

While lumber prices have lessened some, even to pre-pandemic levels, what hasn't come down are the prices of manufactured goods, which remain significantly high, Nelson said.

Some of those costs have been passed onto customers, said Nelson, who owns two businesses in the home remodeling sector, New Spaces and Blue Sky Skylights, both based in Burnsville.

"This is the most inflation that we've seen," he said. "The other issue we've faced that is getting a little better is the supply chain, which I think is driving some of the inflation, just the scarcity of things."

The unpredictability of prices has hindered Nelson's ability to anticipate the cost of projects. Due to delays in supply chain, by the time his company cleared permitting and the preconstruction process, prices for materials went, he said.

"That hit our profits," Nelson said.

Fortunately, for now, demand remains high despite higher prices, and his companies have grown significantly.

In the state's hospitality sector, profit margins are especially tight, said Ben Wogsland, executive vice president of Hospitality Minnesota, an association and advocacy group. Citing a recent Hospitality Minnesota report, Wogsland said 77% of the state's hotel, food service, restaurant and resort operators say prices have jumped between 5% and 10% this year.

Less than half are passing rates onto customers.

For Hayes and Anchor Fish, the basic staples of the restaurant's menu account for 90% of sales. For her, buying cheaper food isn't the answer, so for now the price increases have helped.

"We're not making any of those changes because it would jeopardize the quality of our food," she said.

Either is Tammy Wong, owner and chef of Rainbow Chinese Restaurant and Bar on "Eat Street," otherwise known as Nicollet Avenue. But she also has not passed on the increased costs to customers.

A neighborhood staple for 35 years, Wong wants prices to reflect what loyal customers expect to pay.

"We have to make it affordable for everyone," she said.

Yet it makes running a business complicated, she admits, when the price increases are the highest she has seen in her nearly four decades in the restaurant business.

To keep within her budget, Wong has eliminated some of the more unpopular items from the menu. In the meantime, she's hoping customer traffic increases.

"We don't have the [sales] volume," she said. "We want to make it profitable, but it's not right now."

Lisa Smith, chief executive of Twin Cities consulting company Smith Co., indirectly sees the results of inflation. The less money her clients make, the less they spend on her services.

"What I'm able to provide to them affects them, and what affects them affects me," Smith said. "Everything is interrelated. Inflation has been huge, particularly because some of my early clients were in software-as-a-service, or information technology, architecture and engineering, and their industries are hurt by supply chain, by the cost of materials going up, labor going up and by gas going up."

According to Hospitality Minnesota's report, 57% of restaurant owners and 59% of hotel operators in the state say they do not anticipate revenue returning to prepandemic levels until 2023 or later.

"Given the razor-thin margins many hospitality businesses operate on, absorbing such additional costs without offset is not sustainable and furthers the economic squeeze many are facing," the report reads.

That's in addition to businesses navigating a change in consumer spending habits, as people continue to cut back on dining out or traveling amid budget cuts of their own.

Hayes has witnessed this too often at her restaurant in recent months, where sales numbers are falling below prepandemic numbers. She attributes this to more people eating at home.

To abstain from cutting salaries to make up for lost revenue, Hayes is contemplating having customers absorb the 3% credit card fee. It would make a difference, albeit a small one, she said.

Meanwhile, Hayes is trying to adjust to services for composting and recycling climbing $150 per month. She's beginning to suspect some companies are taking advantage of small businesses who depend on their products and services.

"I think some people are 'chancers,'" she said. "It makes me sad, because I don't want to put our prices up anymore. I don't like doing that."