Approximately one year ago we at Ephor predicted that any economic recovery, especially in the SME (small to medium size business enterprises) sector of the economy, in 2010 would be slow, gradual, and characterized by “jobless” recovery attributes.
We suggested the barriers to a more robust economic recovery would be a result of:
- Chronic unemployment due to the absence of SME “stimulus programs”;
- Changing spending habits as a result of the aging baby boomers reacting to the massive amount of wealth lost in the equity markets; and
- Changed costs and economic pressures.
Our 2010 outlook was unfortunately accurate, and only further exacerbated by the economic policies of the current administra
tion.
At Ephor we feel 2011 will be a year of gradual and improving economics for the US economy as a whole. However, the SME sector will experience significant barriers to recovery and further erosion caused by the following small business economic drivers in 2011:
- Commercial Real Estate: Members of Federal Reserve Board and the U.S. Senate Finance Committee for Small Businesses have cited the commercial real estate sector as being a critical barrier to near-term economic growth. It is clear that weaknesses in the sector will be a significant drag on the economy, especially in early to mid 2011, as construction activities will continue to be suppressed and lenders are forced to digest the reduction in values of 2009 and 2010.
In that commercial real estate loans are typically held by small regional banks, the good news is this sector does not pose the same systemic threat which the residential real estate sector posed to the entire economy in 2008. However commercial real estate is almost always a lagging indicator of economic growth; therefore the continued weakness in this sector will be a prolonged inhibitor of recovery. With the construction sector being a large employer of low to middle level skilled workers, especially by skill trade contractors which are generally SME’s, its effect will be a continued reduction in hiring.
- Small Business Spending: Historically SME’s have been responsible for nearly 60% of the GDP and nearly 65% of all jobs. In addition, it is fundamental to SME sector growth that small businesses generally do business with other small businesses. Therefore as small businesses become less of a factor in the economy, growth will be further impeded. The economic trauma of the past three years has affected the SME sector more so than any of the other Post War cycles, and likewise we anticipate that this will continue well beyond 2011.
In addition to the SME sector having limited access to credit, the lack of available equity capital has obstructed companies’ ability to make the required capital investments which would enable them to grow and hire. It is clear this limitation to needed capital will continue in the near-term. With government borrowing huge amounts of money to finance bailouts and economic stimulus packages, there is simply less capital available for the SME sector. This will be especially prevalent for “asset-light” services companies that are dependent upon cash flow lending for growth capital.
- Regarding the Small Business Administration: “For S.B.A. loans, there are a number of lenders based out of a small community bank doing S.B.A. loans on a national footprint… if they’ve done two S.B.A. loans that year, you’re marching up the wrong street.”
- Capitol Hill has made no secret of their desire to cut deeply and broadly including “programs within the S.B.A. that could be eliminated or substantially reduced.”
This will result in companies in the SME sector remaining cautious and unlikely to add jobs, as illustrated in the temporary worker segment of the economy, where hiring has lagged significantly behind previous recovery cycles. Nothing is changing small businesses reluctance to hire workers: there are currently five unemployed workers for every job opening according to US Dept. of Labor February report. Until it becomes advantageous to firms to hire new workers (from a cost perspective), we will continue to see a struggling job market outside of public and government hiring and spending.
Additionally, inflation is and will continue to drive costs increases. Core inflation per the chart is trending down (partly due to reduced labor costs through productivity increases and partly because consumers are spending on core basics); of note is that asset inflation is occurring. The interest rates are low because government is trying to give more incentives for people to borrow and invest as usual. The problem is that with so much liquidity in the system, and growing, once velocity kicks in, which it will when confidence returns, the economic landscape will be noticeably different as big corporations and big government will be a much larger percentage the new normal economy.
These forces clearly are within the realm of having “double-dip recession” attributes characterize the SME sector in 2011.
- Demographic Changes to the Population: It’s official: as of Jan.1, the oldest of America’s baby boom generation started turning 65 at a rate of 10,000 a day — a trend that will last for the next two decades. As the workforce is aging, this results in a workforce that will grow more slowly than previous post war periods. Additionally history has proven to us that younger workforces are less productive than older workforces.
It needs to be also noted that the number of people in their peak spending years (around 50 years old) will start to decline at an accelerating rate as the baby boomers age. Therefore this recession is likely to incent the baby boomers to postpone retirement out of necessity, or promote the inclination to “preserve what they have”, therefore resulting in more work time and less time for consumer spending activities.
Longer term, we at Ephor are concerned that we will have a society where the elderly absorb huge amounts of public funds at the expense of the education system which will be needed to augment the skills of the younger workforce. Therefore over the next decade we will have “skill demand versus skill supply imbalance”, especially in the SME sector, therefore creating a significant barrier to economic growth in that sector. The coming wave will mean big business for many industries. Many of us who offer financial services linked to retirement have been anticipating the day when the largest wealth transfer in our nation’s history officially begins.
- Small Business Sector Capacity: Bankruptcy Rates Increase: The number of SME’s that have failed in the past 3 years is staggering and the number continues to increase. In 2007, we had approximately 500,000 bankruptcies reported in the SME sector; however in 2010, when the final tally is in, there will be nearly 2,200,000 failures to date in our sector. This is a four-fold increase in a three year period.
This reduction of capacity and capability will only further reduce the size of the SME sector of the economy, therefore putting another cap on productivity. It is well known that leading mid-market companies are more productive than their large company counterparts and government agencies; therefore economic recovery can only be reduced when compared to other post recessionary periods.
Small Business Priorities for 2011
It is clear that all of the aforementioned presents a compelling case that we are indeed in a vastly different environment for the SME sector.
Having interviewed more than 400 executives as part of our ongoing research; the majority of executives say their companies have "Misalignment of Strategy, People, and Operations to Demand.” They struggle with setting a clear and differentiating strategy, ensuring that day-to-day people performance (i.e. execution) is aligned with their strategy and allocating resources in a way that supports the strategy.
Our research also highlights that “best-in-class” performers achieve “constituency alignment” and outperform the market when thier companies strategy, capabilities and portfolio solution offerings are in sync.
Other key market research findings include:
- A majority of executives (68 percent) say that their biggest frustration factor is "revenue challenges coupled by labor productivity.”
- In addition, nearly half of the executives (41 percent) do not think they have the necessary people or capabilities to be able to effectively execute their strategies.
As leaders and executives in our sector we must come to the realization that we as a community must change and adapt to this new environment or those failure rates mentioned above will continue to increase. Another year of this level of bankruptcies will only further suppress the entrepreneurial spirit and desire that has made our economy the world’s largest and the leader among developed nations.
The changes required must include a complete examination of our “legacy thinking” and “legacy management processes.” The SME “bailout” will be a function of us, as a community, having the courage, skill and commitment to embrace the changes required, and to seek out the skill assistance needed to garner a competent command of the issues and challenges presented.
We will be required to alter our strategies and the construct of our business models to reflect this altered reality, and to make the necessary commitment to our employees to provide the skills necessary for them to be more productive and successful. Finally, we will need to alter our application of technology and embrace management science to ensure we are more productive and economically efficient.
At Ephor we believe that the most effective, efficient and unique business models in the “New Economy” will be those that will create wealth and reinvigorate the entrepreneurial spirit of our country.
Good Luck in 2011: We appreciate the opportunity to be of service to you! Have a prosperous 2011!