After the economic collapse, the focus has now shifted to the nascent recovery. Governments worldwide have lifted or partially lifted strict lockdown measures. Several vaccine candidates are in advanced stages of clinical testing and the early data are looking positive. This has led to a general sense of optimism particularly related to the economy – “a rising tide lifts all boats”. However, questions remain about exactly how robust and widespread the recovery will be. In this article, we are going to focus on understanding some of the unique pitfalls the recovery phase might entail, and how these could turn into huge opportunities for savvy businesses.
One way to understand these pitfalls is to do a thought experiment together: Let us pretend we own a small restaurant. We closed the business during the lockdown, as we had limited takeaway business. Our variable costs like food & some labor costs stopped or reduced with the business closure, but we still had to pay our fixed costs (largely rent and some salary costs). With zero revenue and still some costs ticking away, we were operating at a loss for this period. Let us assume that we covered these losses through our personal savings. Thankfully, there is light at the end of the tunnel as the restaurant dining ban has ended. While we are excited for the recovery, there are still some thorny challenges we need to navigate as we reopen.
The first challenge we face is demand visibility. Are our customers ready to come back? The end of the ban allows them to do so, but do they feel safe enough to return? Are they going to cut back on eating out to cover their own loss of income? These are vital questions. If we miscalculate and open too early, we will be incurring additional costs for too little revenue and only increase our losses.
The second challenge we face is re-opening costs. Our restaurant was lying idle for five months and needs maintenance (e.g., pest control, cleaning, minor renovation). We also have re-stocking costs, rehiring costs as some of our staff have left the city and training costs for new staff. Thus, we not only need to make sure we have enough demand to cover our usual costs, but also to cover our additional re-opening costs!
There is a third challenge: working capital financing. We have depleted our savings, yet we need capital to fund the re-opening costs described above. We need to find a bank that will loan us this capital. This borrowing will come with further costs in the form of an EMI we will have to pay.
The fourth challenge we face is operational volatility. Even once we start, there is uncertainty around the health environment and our customers’ confidence. What if our area sees a sharp outbreak of cases? There may also be onerous regulations designed to prevent further outbreaks that may reduce profitability.
What does this thought experiment teach us? Businesses will face an extraordinary amount of uncertainty even during the recovery phase of the crisis. Importantly, while we took the example of a small restaurant, these challenges apply to varying degrees to all businesses. Even online businesses are still going to face uncertainty and challenges in managing their cost structure. As a result, as investors, it is imperative that we do not lose our critical eye and just assume that our businesses will automatically recover with the economy. With so much uncertainty, it is almost certain that plenty of businesses will make mistakes, and with increasing costs, the consequences of these mistakes will be greater. But like with any time of great change, this background provides a huge opportunity for savvy businesses to turn these challenges into opportunities.
Businesses that make, on average, better decisions than their competitors are, are well-positioned to gain market share and emerge from the crisis stronger than before. As an example, let us consider our restaurant. On-demand visibility, we could survey some of our old customers to get a better sense of if they were ready to eat out again. We could look to build our delivery business. We could negotiate with our landlord to help cover some of the re-opening costs. We could build flexibility into the costs of the business by cutting unnecessary costs. By implementing these creative steps, our restaurant may fare a lot better than most, and capture a greater share of customers as a result. In short, there are lots of creative steps businesses can take. The quality of these steps and the decisions made will determine whether a business can transform a crisis into an opportunity to gain market share at the expense of competitors. As we look towards the recovery in our portfolio, we are similarly asking which companies appear to be in the process of doing the very same.
Here are some steps that all investors can implement to stay on top of their businesses:
- To what extent are your investee companies impacted by the four challenges discussed above?
- What is management saying about how the pandemic has affected their business?
- What is management saying about their go-forward strategy?
- How does this compare to competitors?
- Do you agree with the approach? Do you think it will be one of the winners?