All of us – as family members, business owners, employees and employers, and buyers and sellers – know what has taken place over the last 18 months. COVID is nowhere near done with us – actually, there is no credible consensus when it will end. Thus, rather than focusing on what was or what was lost, the “smart money” is focusing on “What’s Next.”
Just as a virus mutates and adapts to its ever-changing environment to survive, so does our economy. Some of the evolutions we’re seeing today were in progress before COVID (like the transition to e-commerce), while others were gaining traction before the pandemic accelerated the progress (like the widespread adoption of remote work). Many people may have even reassessed aspects of their lives (work, retirement, leisure) directly due to the “COVID effect.” So what does the future hold?
To look ahead, let’s first understand where we are today.
Assessing Businesses Post-Pandemic
While we expect employment to continue to recover, supply chain shocks to even out and certain macro-measured indicators to return to pre-pandemic levels, the economy will never fully return to the state it was in on December 31, 2019 (How many people expect to go to their city office 5 days a week again?). Oversimplifying for the sake of discussion, businesses that were operating in 2015 to 2019 can be placed – basically – into three categories in 2021:
1. Businesses that have failed.
This first category is straight forward – or is it? Did the business fail only to be reopened in a new incarnation? Is the demand for the service still there (now and tomorrow) and did the business fail due to the lockdown itself?
2. Businesses that have had banner years.
As for businesses that had banner years – can the business and/or industry sustain their recent trend? Are the 2020/2021 levels of revenue, profit and backlog realistically expected to continue? In 2020, when vacation travel was severely limited, people spent significant amounts of money on their homes. At some point, this will slow down or end as competition for a family’s cash flow will increase with the reopening of travel and leisure venues.
3. Businesses that have muddled through.
Here is the trickiest to assess. What defines recovery? Different businesses may identify recovery differently. For example, is a recovery of revenue a recovery if the product is a commodity (retail gasoline is a prime example), recovery of profit (by percentage of revenue or a hard dollar amount; e.g., if you made $10 on revenue of $100, have you recovered if you now make $10 on $200 of revenue?), or is some other metric more appropriate (Revenue per Full Time Equivalent (FTE) employee, or profit per FTE for example)?
Future in Focus
As we look forward we can identify a few issues to discuss:
- Managing through mandated openings and closings
- Managing through the politics of the pandemic itself
- Managing through capacity constraints (government and economic)
- Identifying capacity constraints – is it the item itself or the delivery of the item?
- Defining capacity. For example, has a restaurant ever really run at 100% capacity? How can we define 100%? Does that mean a line for tables every night, or seven of ten tables being occupied for dinner?
- Coping with widespread staffing issues across industries – from amusement parks to coffee bars. Perhaps staffing shortfalls are posing capacity restrictions of their own.
From the valuation and income perspective, how should you handle these issues when they affect your client? Is this a temporary issue, a permanent issue or do we treat it as a hybrid? Since COVID is not finished with us, we should be careful in making permanent decisions prematurely.
The Cost of a Second Earner
Families appear to be re-evaluating the contributions of second earners. After considering all of the costs of that second job (automobile, child care, lunches, time, clothing, stress, etc.), is the additional income actually a benefit? In economics, it’s not what you make, it’s what you keep. If the returns of the second earner job are less than they were perceived (quantitatively and qualitatively) pre-pandemic, significant changes to your staffing, retention and long-term financial planning are probably coming.
Furthermore, what difference could this make on your profitability? Will pre-COVID metrics and norms still apply? Many in the business valuation industry have asked if pre-2017 Tax Act multiples are still relevant after those business income tax changes were made (and will continue to be made). The corporate rates were in effect since at least 1986. Will historic metrics (pre-2019) still be a valid comparison?
Summary and Recommendations
On the capacity question: Pre-pandemic, we might assume that the business was running at its effective capacity if its operations were consistent prior to the measurement date. Will rolling lockdowns become more common – similar to rolling blackouts in electricity generation? We need to be prepared to manage through that.
On fluctuations in demand: Don’t let the pandemic create an excuse to lower expectations and perhaps settle for or expect less. Similarly, don’t let the rush of activity flowing from pent-up demand lead you to believe that the current trends are sustainable.
The Great Depression and World War II affected our grandparents’ lives more than anything else. Many argue that the economic and human suffering cannot be appreciated by most of today’s generation. But the GI Bill, the creation of the middle class, the Interstate Highway system and the expansion of college opportunity all came as a result in the following years. These were not foreseen either.
On updating core principles: The long-term ramifications of adjustments made over the last 18 or so months are yet to be known. Create flexibility wherever possible so you’re best able to roll with the punches, or explore new opportunities.
Above all, “Don’t Stop Thinking about Tomorrow.”
If you have any questions concerning your business’ adaptation to a post-COVID market, contact a Friedman professional today.