How Can Japan Overcome Deflation?

Introduction 

Japan’s deflation problem that has persisted for more than two decades has adversely affected the country’s economy. For years Japan was a model economy, and every other country aspired to mirror the country’s economic strategies. However, the admiration came to a stop with the asset battle that led to declining product prices beginning the long-term deflationary period (Fleckenstein, Longstaff, & Lustig, 2017). Domestic companies responded to the economic changes by either lowering prices or maintaining the stable prices in the hope of reducing their losses by merely breaking even or experiencing a minimal decline in revenue. On the other hand, consumers began hoarding money waiting for further price declines before making their purchases. BOJ’s numerous efforts to overcome the country’s deflation problem have been unsuccessful, and the companies are staring at a bleak future. The survival of these entities is dependent on the adoption of effective strategies that will help them to stay afloat. For the Chairman of Ina Food Industry, the formulation of an effective marketing strategy for the company is vital to ensure it remains profitable, and the decision will be influenced by the understanding of different constructs related to deflation. 

Common Deflationary Forces in the Global Economies 

Global economies face common deflationary forces. Foremost is the occurrence of systematic risk in a country’s financial sector. Systematic risks occur when unprecedented events affect all the financial institutions negatively (Fleckenstein, Longstaff, & Lustig, 2017). Usually, systematic risks begin with one bank and quickly spread to other entities like in the 2008/2009 financial crisis that began with the failure of the Lehman Brothers Bank. Systematic risk results to the financial failure of banks disrupting money supply and causes other negative externalities. For example, the loss of the public’s confidence in the system leading to hoarding of money, collapse of other economic sectors like construction, and uncertainty about the economic health of a nation. 

Moreover, systematic risks lead to the credit crunch as the banks are unable to fulfill their intermediation function; thus business investments decline. Over time, systematic risk leads to falling economic activity unless the government responds using appropriate monetary policies. For example, systematic failure preceded the Great Depression that affected the USA in the 1930s, where repeated bank failures led to massive bank withdrawals as the consumers sought to protect themselves from the uncertainty of losing the money. The world once again would have found itself facing a similar scenario in 2008/2009 had the Central banks not responded to the problem by saving most of the banks from collapse. 

The sovereignty risk of a country is another deflationary force. Sovereignty occurs when a nation becomes over-indebted and is unable to payback its debts on time (Fleckenstein, Longstaff, & Lustig, 2017). Globalization has led to the interconnectedness of economic and financial markets, and countries often borrow money from other nations or international bodies. High sovereign risks are associated with high-interest rates, and the burden of making the payments slows economic growth. Indebted countries have high-cost pf capital, and this reduces the cost of bonds and other debts instruments; thus people prefer to hold money waiting until they get more lucrative investment options. At times, the sovereignty risk escalates to very high levels causing deflation. 

Business cycle risk is another contributing factor to deflation. The business cycle comprises of four critical stages including expansion, contraction, depression, and recession; and a country’s economic performance under each stage differs (Fleckenstein, Longstaff, & Lustig, 2017). For example, during expansion, there is GDP growth while recession leads to declining economic growth. The cycle is affected by different factors like technological innovation, political instability, variation in consumer needs, financial market collapse, interest rates, unemployment, and changes in investment trends. Economic performance is lowest during recessionary periods that are characterized by changes in aggregate demand and supply. Due to the low unemployment rates during a recession, consumers’ spending power declines, and people are more wary of spending money because of the uncertainty over the economy’s performance. Consequently, deflation can arise many times during the crisis depending on the length of the period. 

The last factor is the collateral risk; another force that drives deflation in the global markets. Collateral revaluation refers to the process of estimating the value of an asset based on the current market value (Fleckenstein, Longstaff, & Lustig, 2017). Usually, collateral revaluation leads to deflation when many consumers have different types of debts. For example, deflation often leads to underwater mortgages as the borrowers are unable to refinance their loans resulting to loan defaults — for example, the crash of the USA housing market that led to the recent financial crisis. The forces driving deflation in countries differ depending on the unique conditions of the economy, but the negative impact is the same. The biggest priority for Japan is to find a quick solution to its deflation problem. 

How Can Japan Overcome Deflation 

Overcoming Japan’s deflation problem will require a combination of monetary policy strategies from the BoJ and companies operating in the country. Since the deflation has lasted for many years, the public especially the old are hoarding significants amount of money in their homes and not in the banks (Watanabe, & Watanabe, 2018). Moreover, many businesses have become savers instead of spending; thus the amount of money circulating in the economy is low. Therefore, all the strategies adopted to fight the deflation should strive to increase the amount of consumption in the country. 

The BoJ should be on the first line towards solving the deflation challenge through the adoption of accommodative monetary policy. The purpose of the accommodative policy is to raise the amount of money circulating the country by lowering the number of lending interest rates to make loans more affordable to businesses (Bernanke, 2018). By using the accommodative policy, Japan will move from its current liquidity trap, and the additional funds will be used to increase market investment and create new employment opportunities. Moreover, organizations will have adequate funds to improve the employees’ salaries, and the money will reenter the economy through the purchase of household goods. Undoubtedly, the BoJ will need to wait for some time before the results of the accommodative monetary policy can be noted because prices will increase at a slow rate. For that reason, the BoJ should continuously monitor the changes in the inflation rate to determine whether the monetary strategies are effective or there is a need to introduce more aggressive tactics. 

Additionally, Japanese companies should focus on the production of products that meet consumers’ needs and drive demand through the innovation of new products and the adoption of differentiation strategies. Japan is one of the most technologically developed countries in the world, and companies have adopted a standardized method of mass production of quality goods. However, the demands of the traditional wealthy and middle-income consumers have significantly changed over the years, and there is a high demand for expensive and innovative products. Note that some consumers prefer to purchase some of the domestically available products in other countries in spite of the low costs of the goods in the market. Companies need to produce innovative goods and services that will attract the consumers prompting them to use their savings to buy the goods, and this will, in turn, inject more money into the economy (Kurihara, 2018). Besides, companies should also increase the production of luxury goods because of their inelastic demand. As a result, producers of luxury goods will have the capacity to increase product pricing without fearing a retaliatory decline in quantity demanded. 

Furthermore, the Japanese government should combine monetary policy with fiscal policy to achieve the desired objective. Despite the government’s efforts to introduce different types of monetary policies over the years, its efforts have been hugely unsuccessful because the attempts have been isolated (Kurihara, 2018). The government will achieve better results by proceeding with the planned tax increment to force companies to raise product prices in the shortest time possible. Currently, plans are underway to introduce a 10% sales tax throughout the nation, but the plan faces opposition from business owners that feel the move will scare the public, but this will not be the case. Implementing the policy will improve the consumers’ confidence in the governments’ commitment to overcome inflation and its ability to pay loans on time. 

Mathematical Calculation for Changing Price Margins 

Gross margin= (Revenue –Cost of Goods Sold)/ Revenue 

Current gross margin= 30% 

Expected gross margin after 5% price increase= 30%*(1+17%) 

=35.1% 

New Revenue= Old revenue + 5% increase 

=1.05 old revenue 

Cost of goods sold will remain unchanged 

The above changes can be summarized using the following mathematical equation: 

35.1% Gross Margin= (1.05 Old Revenue –Cost of Goods Sold)/ 1.05 Old Revenue 

The Viability of General Business Idea 

Tsukakoshi’s beliefs that the company can easily raise the prices level to increase profits during deflation as long as competitiveness is maintained are not viable. One of the key characteristics of deflation is the reduction in prices giving the consumers more power over the actions of a company (Sado et al., 2018). Price wars accompany deflation as companies tend to lower prices to attract more customers and maintain their loyalty. However, other companies opt for the latter that is to increase the prices during deflation. 

There is no denying that the adoption of a competitive strategy helps companies to avoid the price cuts; instead, the entities can result in price increases. The technique is suitable for organizations that have differentiated their products like Ina Foods since the purchases are driven by the high quality of products and not the prices. Consequently, the consumers may fail to notice the adverse changes to the prices and maintain the same product demand in the short-run. However, the changes become more noticeable in the long run and consumers may reconsider buying the goods because of the prices especially if they feel that the amount is too high for their constrained budget (Kurihara, 2018). Therefore, it is not easy and smooth for companies to raise expenses easily during deflation, they are limited by the consumer's attitudes and perceptions about the price variations. 

Besides, consumers often decide to delay their spending waiting for the prices to decline during deflation. Arguably, consumers are the happiest stakeholders in the economy when deflation sets in because they enjoy relatively low prices and continue to wait for these costs to dip further. Often the customers decide to wait until their expectations are met, thus the companies that decide to raise prices may record declining revenue within the first few days of implementation (Sado et al., 2017). Such performance discourages the organizations from raising prices as they prefer to lower their costs by going the alternative route. This argument goes to prove that the process of executing pricing changes is not smooth. 

Also, it is difficult to execute price increment without considering other aspects of the supply chain. For example, Ina Food gets its raw materials from other factories and incurs additional cost transporting the goods to the desired locations. The price rise should be enough to cover all the needs within the chain to be effective. Consequently, companies generate adequate funds to meet the operational costs incurred during the period. 

Besides, it is difficult for companies to maintain their competitiveness over business rivals for long periods. The success of a business organization attracts the attention of other people and the establishment of other entities providing the same services. There is a high probability that smaller organizations copy the observed competitive advantage to increase their revenue. Consequently, companies have to invest significant sums of money for research and development that allows the discovery of new processes, ideas, or products to maintain their advantage (Mitchell, 2017). For example, Tsukakoshi’s determines that the company will need to focus on research and development, and the task requires numerous staff members and investments that may be too costly for the company. As a result, organizations face increasingly challenging time making prices increase decisions without the knowing whether there is enough capacity to sustain the development. 

Contrarian Strategy 

A contrarian strategy refers to a common technique that is often used by companies to respond to adverse market changes in the environment. A contrarian is a person whose actions are opposite of what others are doing, for example, investing in a stock when other people with access to the same information are liquidating the stocks. The contrarian strategy is founded on the belief that people tend to overreact on different events that affect their operations, thus act irrational (Aked, Mazzoleni, & Shakernia, 2017). For example, stockbrokers underprice stocks upon the receipt of negative information about a company. A contrarian perceives this weakness and manipulates the situation by exhibiting a different reaction to the same event. Companies adopting the contrarian strategy assume a high risk for their actions or generate a high rate of return depending on the outcome. 

Ina Food’s decision to increase the prices during the deflation is a contrarian strategy. While Tsukakoshi decided to raise the price of all the products, other companies are expected to react differently by cutting the prices to encourage consumers to purchase the merchandise. Ina Food’s decision to follow the contrarian strategy is based on three primary reasons. One, consumers purchase goods that fulfill their needs and wants without paying attention to the price changes. Two, a company’s pricing decision affects the consumers’ decision-making process; high prices communicate that a product has hedonic value. As a result, more people purchase the good an develop more loyalty to the entity. Three, the company’s products are price inelastic; thus the demand remains relatively the same even if the price value is altered upwards or downwards. Based on these arguments, Tsukakoshi is confident that the company can increase the prices without worrying about the potential impact of the decision on the sales value. 

Alternative Strategy: Lowering the Prices 

If Tsukakoshi had chosen to lower prices like the other firms, the situation would have been different. The rationale for reducing the price levels is to help the company to minimize the potential negative impact of lower aggregate demand of products in the country. While the reduction in prices would help Ina Foods to attain price competitiveness, the decision would have far significant adverse impacts on the firm. 

The first negative effect would be the profitability squeeze in the company. Despite price reductions, consumers will be wary of spending their money in purchasing necessities and other commodities. Therefore, the company will not record as many sales as expected, and to make matters worse, the organizations cannot pass on the high prices incurred in the production process to the final consumers. The higher costs reduce the gross profit margin and profitability amounts, and the extent of the problem will be shown within the company’s financial statement. 

Second impact will be the destruction of the Ina Food’s brand value. According to Tsukakoshi description, Ina Food produces differentiated products and part of the appeal is the use of the premium pricing strategy. However, lowering the prices will lead to the loss of consumers’ confidence in the quality of the product and brand loyalty. As a result, the customers will look for other retailers selling products with hedonic value, and the company will have no option but to serve the low-income customers that are attracted to the products. Usually, brand destruction lasts for long periods; thus it will be difficult for Ina foods to recover its lost glory after the end of the deflationary spiral. 

Also, Ina Foods will be forced to undertake massive employee cuts in pursuit of short-term profitability. Salaries and wages are one of the biggest costs incurred by many companies today. According to the case, Tsukakoshi believes that the employees are critical resources and the company should strive to meet their everyday needs. For example, Tsukakoshi decided to reduce the production rate because it was affecting the employees negatively. Initiating employee layoffs will significantly affect the motivation of the remaining workforce due to their uncertainty about the security of their jobs. Subsequently, the employees’ motivation, commitment, and productivity will reduce, thus limiting the company’s ability to reduce the existing level of product demand. Following this discussion, it is evident that price decrease would not be the appropriate answer to Ina Food’s challenging business environment. 

Price Elasticity of Demand (PED) 

PED= Percentage change in quantity demanded/ Percentage in Pruce 

Old demand=200 

New demand=150 

Percentage change in demand= (150-200)/150 =-0.3333 

Old price=10 

New price=12 

Percentage change in prices=(12-10)/10 =0.2 

PED=-0.3333/0.2 

=-1.6665 

The PED is greater than 1; therefore the quantity of products demanded is dependent on the pricing strategy. The relationship is negative meaning that demand falls with the price increase and vice versa for the case of Ina Foods. 

Companies rely on the PED to select between different marketing and pricing strategies in the market. The PED is used in the deflationary period to test consumers’ response to proposed price changes in different sectors of the economy through the use of historical data. The information that should be used in calculating the PED should be obtained from the period when the entities were relatively stable as the changes in prices are not affected by sporadic events. Also, the past information should be used as the basis of estimating the future quantity and price demands. Of course, these values would also be affected by other elements like expected economic and political changes in the country. When the PED is greater than 1, the advice is that the companies should not attempt to change the prices upwards because that would lead to lower demand. 

On the other hand, decreasing the prices would attract more customers that feel attracted to buy goods at cheap prices. All in all, when the PED is elastic, the price changes should not be carried out, but the strategies are effective when the PED is inelastic. Therefore, the correct interpretation of the PED will influence the decisions made in the economy during a deflation. Moreover, the PED can be used to assess the chance that an economy will recover from a deflationary spiral as it shows whether people will agree to spend their money or not. 

Conclusion 

Deflation is significant economic challenge affecting global economies. Japan has a chronic depression challenge characterized by growth stagnation, negative inflation, and low wage rates among another myriad of problems. Due to the deflation issue, many companies like Ina Foods are contemplating changing their market prices to increase their survival rates in the market. Notable is that the deflationary forces that led Japan to its current states are also felt in other countries. They include collateral risk, systematic risk, business cycle risks, and sovereignty risk; these forces have been recorded in other countries at different time periods in history. However, countries have easily overcome deflation unlike Japan’s case, and the recommendations for solving Japan’s problem are the adoption of an intersectoral approach to the issue. This will be characterized by the participation of all stakeholders in rebuilding the country. For example, the BoJ will implement the monetary policies, firms will raise the wages, and the public spend more on the market. As a result, companies like INA Food’s will operate in a better environment and will not need to result to pricing strategies to stay afloat. 

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