How COVID-19 has amplified profits, skewed capital, brought forward horizons and changed consumer habits.
Faraday & Company establish and chair professional advisory boards across most industries, providing us with a unique insight into the COVID-19 impact on companies and their response.
This latest Level 3 lock-down whilst Auckland based, has affected all of New Zealand and could not have come at a worse time. Many companies who took aggressive corrective actions during Level 4 were relying on a period of execution to rebuild supply chains, scale up operations, engage customers and reduce the need for further borrowing. A rule of thumb we follow with clients is nothing meaningful gets done in less than a quarter. For most the 89 days between the end of Level 4 and return to Level 3 simply wasn’t enough time to implement meaningful corrective change.
This pandemic has accelerated trends that were already confronting industries and traditional business models. Companies who were future-ready and had access to high levels of problem solving capability from their executive and advisors have reaped the benefits of the COVID-19 accelerant. Some of the businesses we work with have seen more than a 100% increase in sales since COVID-19 emerged. Most show no signs of slowing down.
On the flip-side, companies caught milking returns from their traditional business models, in transition to new business models, or lead by less capable management teams have been victims of the speed of change. They have been “caught in irons” headed into the winds, stalled and unable to manoeuvre.
Many are hoping these head winds will change pushing them onto a tack that will get them through under their own momentum or are looking for new capital. The reality is there will continue to be COVID-19 shocks that strengthen their competition and most new capital flows to top performers. The outlook for these companies is bleak.
After surveying our advisory board chairs in Australia and New Zealand, four common themes we are seeing are:
COVID-19 has made the good companies great, bad companies worse and November will be a watershed month for the mass of companies in the middle
We see evidence in our client portfolio that the divide in profits between top performing companies and the rest of the pack has been greatly amplified by COVID-19. This is an ominous sign for the mass in the middle now fighting for market share or looking for new capital to bridge their way to recovery
The acceleration of trends has seen the third horizon (FY25) growth scenarios suddenly become real second horizon (FY22) opportunities for businesses with plans designed to improve competitive market position
The rule of thumb on changing consumer habits is showing signs of holding true and is accelerating in this environment
Research shows on average it takes 66 days for consumer habits to change. The first lock down was 51 days, arguably not long enough to materially change how consumers behave if you consider lockdown as the key driver of behavioural change. However, if COVID-19 is the primary driver of behavioural change, consumers have now been living with the effects of the pandemic in New Zealand for over 150 days. They have changed how they work, live and play. They have changed how they buy and consume. More good news for companies seeing growth, more cause for concern for those businesses who have lost market share since March 2020.
The cost to win back consumers who have adopted new habits is going to be high and made more difficult by the skew in profits and new capital. Companies who do not understand the new marketing and sales dynamics and how consumers behave in this new environment will find it difficult to compete.
Historically more than 50% of new capital flows to top performing companies in each market. Money follows returns. With the profit gap widening in favour of top performers, its logical to assume new capital will skew further towards these same companies, taking oxygen away from average and underperforming companies. We are already seeing this manifest in our client base with very favourable multiples being offered by investors for high quality assets, and little or no interest in assets outside that group. Again this is bad news for the mass in the middle who will need access to new capital in the last quarter of 2020.
Looking across our client base, there are three key observations:
The top performing companies are spending time reviewing opportunities for expansion on their own terms. They are generally not looking go acquire distressed competitors, but are rather buoyed by their own performance through COVID-19. We are seeing them either achieve or exceed their monthly and quarterly targets which continues to reinforce our view that these owners and management teams understand the situation well and can anticipate the results of their actions with a high degree of confidence despite market uncertainty. They are methodically working through problems as the arise.
The bottom performers are “thrashing” at the whim of the market. For some their inevitable fate has been brought forward by 2-3 years by the COVID-19 accelerant. For others owner fatigue is setting in and the reality of an uphill battle to break even against the long head winds and economic uncertainty make trading beyond this calendar year highly unlikely. Its not true to say all these businesses were broken before COVID-19, but it is fair to say many had not made enough headway in the last three years to give them a chance of survival.
The most divided group is the mass of companies in the middle that were marginally profitable before COVID-19. Some of these companies worked relentlessly through Level 4 to address productivity issues, reallocate capital from underperforming lines of business, develop plans to reposition their business for higher margins and made brave decisions on their strategy going forward. Those who executed aggressively before the return to Level 3 may have done enough to give their investors and bankers confidence in their plan to continue trading into 2021. However, some simply didn’t make sufficient progress before the latest lock down to demonstrate a track record on delivery and will need to make some difficult solvency and going concern decisions in November 2020.
As Auckland prepares for a return to Level 2, it’s become clear the lion share of profits are going to be more concentrated in a few companies. New capital is going to be difficult to access for most companies, planning horizons have been brought forward by 2 to 3 years and consumer habits have changed forever.
Directors, business owners and managing directors are facing problems outside their day-to-day areas of expertise at a time where big moves will be necessary to survive the COVID-19 economy, and the ability of leadership teams to solve higher level problems will determine the immediate future of many of New Zealand’s businesses.
It’s not all doom and gloom for companies who act as soon as possible, who are willing to test their long-held beliefs and business assumptions against the new world order. This is the time to make big moves. Hope is not a strategy.
About Faraday & Company
Faraday & Company specialise in establishing and managing professional advisory boards small and mid-market companies in Australia and New Zealand. Visit www.faraday.company