When will SMEs recover from COVID-19?
Part 1
All across the globe, small to medium-sized enterprises (SMEs) are fighting for their financial lives as the pandemic lingers, causing tragedy on a scale never previously recorded in modern history. Health professionals concede that there is little clarity on when the current crisis will end, with many providing conflicting definitions of the word “end.” Confidence in world leaders to craft a solution to turn the tide against the virus seem to be waning as the death count rises (albeit at a marginally lower pace).
It’s not surprising that SMEs, and its stakeholders are growing concerned about their ability to survive when the crisis traverses into 2021 and perhaps beyond. Credible surveys in both the United States and the EU confirm that for the first time since the outset of the crisis, more SMEs are facing the possibility that their business will fail. With consumer demand in the EU and the United States still at a fraction of pre-COVID-19 levels, SMEs have not seen the anticipated increase in revenues needed to break even, let alone operate profitability.
In this two part series, we will look at the impact the pandemic has on the economies of the EU and the United States. In the second article, we will look at current research to see when an economic rebound might occur for SMEs in the EU and the United States.
SMEs and the factoring industry are symbiotic and the dark trends witnessed by SMEs globally could have a negative impact on our industry. Simply stated, when SMEs are thriving, the global factoring industry becomes the largest single source of working capital utilized by SMEs. When SMEs are failing, the need to utilize our working capital evaporates. As new AR volumes to be factored decreases, the domino effect in our space is instantaneous. Lower industry revenues coupled with significantly higher risks result in lower profitability in the industry
On a simultaneous basis, the ability to find new clients to offset eroding volume becomes impossible to accomplish. Young SMEs come to a halt, and a shift in business deaths and births causes contraction in the number of SMEs. SMEs (for obvious reasons) halt expansion, which further reduces the need for working capital from the proceeds of factored AR and other financing sources.
This dire forecast will hopefully not turn out as bad as outlined, but the fate of SMEs is driven by how quickly a small business recovery occurs. This leads us to try to project when a recovery is likely and how SMEs can adapt to operate its businesses in the new normal. Its ability to attract working capital as fuel will be the most challenging job to master when the economic recovery appears. This is also where our industry (who has had an unwavering role of serving SMEs) can nurture them in their greatest time of need. We need to be ready to do so with personnel and capital ready to deploy.
Even the perceptive entrepreneur who has successfully lead their SME through prior economic downturns will be challenged like never before as we enter the final quarter of 2020. An unbiased look at our economies [in the EU and United States] reveals that our last precarious economic condition was the Great Depression 90 years ago. After a record number of jobs evaporated, unemployment levels remain elevated at 15% in the US and there appears to be little economic news on the horizon that could cause an increase in employment. The US Federal deficit has ballooned to $26 trillion and there is no worry about the implications of this irresponsibility by economic and political leaders. In many ways, we are kicking the can down the road and this is not a smart way to manage anything, let alone the country with the largest GDP on the planet.
To add to the economic misery, the nature of the pandemic brings challenges for SMEs in both the EU and the United States. Many SMEs have to contend with a dramatic shift in consumer behavior caused by the crisis. In addition, a large percentage of SMEs are facing a trifecta of bad events – these include tepid consumer demand, operational and digital challenges, and customer expectations that seem impossible to profitably provide [free shipping, delivery, etc.]. Due to continued health and safety regulations, consumers have altered consumption/shopping patterns towards digital channels.
Even SMEs who planned ahead and anticipated this shift from physical brick and mortar activity to digital platforms are still finding it difficult to meet new expectations. Brick and mortar stores and commercial enterprises run by SMEs that remained open during the crisis now find that they must offer curbside pickup, expand free delivery services, contactless payment options, and physical barriers. Taking this into account, it is no understatement that SMEs have their hands full, let alone planning for what might happen in the future. This environment of turmoil makes developing new strategies a difficult task.
In an increasingly polarized world, there is one thing we can agree on, this is that the economic recovery from the pandemic will take time. The next question is “what will recovery look like?”
The answer to this question is difficult to conceptualize. In the past, economists, business leaders, and policy makers would look at historical data that documented how long a recession occurred and the length of time required for an economy get back to full steam. Given the unprecedented nature of our current economic downturn (in the EU and US), I am not sure that prior analysis will provide guidance as we try to determine when economies will recover.
According to data by the Bureau of Economic Analysis and the United State Department of Commerce, there have been nearly 50 recessions in the United States beginning in 1776. There is disagreement over whether some of the economic downturns in the 1980s in the United States qualified as a recession. The widely utilized definition defines a recession as a “contraction in economic growth lasting two quarters or more as measured by the gross domestic product (GDP)”
Since 1945, there have been 13 “correct” recessions in the United States. These 12 prior recessions, on average, have lasted less than a year. The current pandemic caused the longest period of economic expansion on record in the United States to come to a screeching halt in March of this year. If you look at the data impartially, our previous recessions seemed as if to occur as a natural (and painful) part of the business cycle.
As for the EU, the history of recessions that have occurred post-World War 2 correlates to when a downturn occurs elsewhere in the world. A dated, but interesting research White Paper published by the ECB in their monthly bulletin reviews the correlation between economic expansion and recessions in the EU and United States over a 40 year period (between 1970 and 2010). As can be seen below, the recessions in the EU and United States were synchronized. In fact, in this period, the EU recorded about twice as many recessions, when compared to the United States.
ECB’s research concluded that “patterns of euro area and US macroeconomic cycles have been relatively close to historical experiences. For the most part, historical regularities appear to have held during this cycle, in that:
(i) the euro area has lagged the United States (at least in the downturn);
(ii) the downturn in the United States was deeper than that in the euro area (at least relative to average growth);
(iii) the US downturn was matched, with a small lag, by widespread downturns across advanced countries; and
(iv) the recession was particularly deep, as it coincided with a financial crisis and associated balance sheet deleveraging.”
But from all indications and research I have done on the impact of the current pandemic in the EU and United States, the current economic downturn in the EU has the potential to be one of the worst in recent memory. Projections for the EU predict its’ worst contraction ever in history could occur in 2020. Due in large measure to the strict quarantine measures imposed earlier in the year, economic activity in the EU was brought to a halt. According to published Eurostat data, the EU’s statistics agency, gross domestic product dropped by 11.9% in the second quarter for the 27 member countries of the EU and by 12.1% in the 19 countries that use the euro as currency. The actual drops exceeded what EU experts anticipated with the EU economy.
Even more stunning is the fact that when compared year-over-year (YOY) to 2019, the EU GDP fell 14.4% and a record 15% by the countries that use the Euro as their currency. These are the steepest drops ever since the EU began keeping statistics in 1995. The financial pain of the pandemic was worse in several of the largest economies in the EU – including Italy, Spain and France, whose economies shrunk by 17.3%, 22.1%, and 19% respectively compared to one year prior.
While the EU has had its’ fair share of economic duress over the past 25 years, the current expected drop is almost two times worse than what was recorded in the worst year of the recent financial crisis. At the height of the financial crisis in the EU, a 4.5% reduction in the total GDP of the EU occurred. The current 8% decline must also be viewed relative to what EU policy makers were predicting would occur in GDP pre-COVID-19. Only 6 months ago, the EU Commission expected GDP to inch up by 1.2% in 2020, and similar increases were forecast for the year 2021.
Instead, the pandemic has every EU member of state heading full steam into a record-breaking recessionary period. Official statements from Brussels of a 7.75% decline in EU GDP are based on the best-case scenario where the EU’s economy gradually reduces confinement measures and the COVID-19 pandemic does not return.
In fact, the Commission also released models that were much less optimistic than the one summarized above. One such scenario concluded that GDP could fall almost 15% in 2020 if lockdowns were extended and could fall another 10% decrease in GDP if a second wave of coronavirus happened in the coming months. All of these forecasts confirm that there will be wide differences in the economic impact of the pandemic in different parts of the EU.
Their forecasts conclude that some countries, including Germany and Poland are likely to recover all losses by the end of 2021, but other countries including Italy, Spain, Greece and the Netherland will not recover to pre-COVID-19 levels of output until 2022 at the earliest. The Commission has made it clear that the widening chasm between the weak and strong member countries could be a serious problem. It wrote that “entrenched economic, financial and social divergences between euro area Member States could ultimately threaten the stability of the Economic and Monetary Union.”
Finally, as if on que for this first part of my two-part article, troubling news was announced recently (September 30, 2020) on the overall performance of the United States economy. It was reported today by the Department of Commerce that the U.S. economy plunged at an unprecedented rate this spring and even if a record rebound were to occur in the 3rd quarter of 2020, the overall United States economy would still shrink for the year 2020. If this does happen, this would be the first time since the Great Depression that the total GDP of the United States declined YOY.
Data reported by the United States Department of Commerce reveals the true magnitude of the financial impact the pandemic in the US. The GDP fell at a rate of 31.4% in the April-June quarter, only slightly changed from the 31.7% drop estimated one month ago. The decline that was more than three times larger than the previous record-holder, a fall of 10% in the first quarter of 1958.
Perhaps the only bright spot in this round of economic news is that there is a growing consensus that the United States economy could rebound in Q3 of 2o2o at an annualized rate as high as 30%. If this actually were to occur, it would eclipse the one quarter record for growth in GDP that was previously recorded in Q1 1950 of about 17%.
Overall for the year 2020, the economy fell at a 5% rate in Q1, and was followed by a Q2 decline of 31.4%. Consumer spending, which accounts for 70% of the total GDP of the United States, has fallen over 30% year to date. If consumer spending rebounds, I wonder if the United States economy will recover to pre-COVID-19 levels. SMEs, as you have read, have borne the brunt of the drop in consumer spending, and many of their financial futures are determined by what will occur with consumer spending into 2021.
---
Part 2
In the first part of this series, we reviewed data on the financial impact that the pandemic had on small to medium-sized enterprises (SMEs) in the EU and United States. The damage inflicted by the virus on SMEs is brutal. It is then hardly surprising that SMEs and its impacted parties are growing concerned about its ability to survive if the crisis continues into 2021.
Whether or not an SME can survive this crisis is determined by variables including how financially prepared it was for the downturn, its overall financial health, and its ability to adapt overnight to a digital marketplace. In most respects, SMEs have direct control over each of these metrics listed above and many, if not all, have taken steps to adapt.
These changes have a negative impact on the health of SMEs. Most are working harder to keep pace and negative mental health effects due to the pandemic have been reported across a variety of platforms. As an aside, recent research reports that the average working individual saw their personal screen time increase from an average 11 hours/day to 14 hours/day. No wonder our levels of stress were negatively impacted over the last eight months.
However, one wild card that SMEs have no control over is the length of time it will take for economies to recover from the pandemic - and this may determine if the business enterprise sinks or swims. As noted in part 1 of this series, the ability to predict the recovery from this pandemic using data is unlikely and (at best) flawed given the nature of this crisis. Nevertheless, data from prior recessions do provide some insight into what might happen as economies emerge from the scourge. That being said, the lack of Federal policies (at least in the United States) that address unemployment and the sinking economy add a new set of worries and it’s pushing companies to eliminate jobs and the downturn to take a turn for the worse.
After the last U.S. recession in 2008, larger corporate enterprises needed four years to see its revenues return to pre-recessionary levels. On average, SMEs in the United States did not see a rebound in revenue until 6 years after the downturn. Therefore, recovery time will be driven by overall economic levels of vulnerability present pre-COVID-19 and the industry outlook on macro level.
While the pandemic spared no industry financial pain, certain industries such as the travel, transportation, tourism and hospitality industries have borne the lions’ share of the financial impact. Even the most prepared SMEs who relied on these industries for revenue suffered severely.
A recent McKinsey & Co. and Oxford Economics article entitled “US small-business recovery after the COVID-19 crisis” provides data on what U.S.-based SMEs can expect in terms of the time it could take to recover from the pandemic on an industry-by-industry basis. As can be seen below, the research concludes that it could take more than five years for the most affected sectors to get back to pre-COVID-19 levels of revenue in a muted recovery.
When reviewing the 18 key industries analyzed in the McKinsey/Oxford research, those that are projected to take the longest are also the ones that generate the largest percentage of revenue for SMEs. If these sectors follow a protracted script path, this will be dire news for SMEs globally. The two worst sectors in terms of economic rebound are the arts/entertainment/recreation and accommodation/food services; the share of SME revenue in these sectors are 68% and 53% respectively.
This is bad news for SMEs and factoring firms that operate in those industries. Other industries such as transportation and manufacturing also have lengthy recovery scenarios, factors with concentrated transportation portfolios may simultaneously experience reduced flow of new accounts receivables (AR) and heightened debtor risk. These are challenging times.
A final thought on their modeling - the industries anticipating faster recovery (compared to those above) including real estate/rental/leasing, professional/scientific/technical services, information services, and healthcare do not traditionally use factoring. As a result, the ability for the factoring industry to rebound may take longer than hoped.
So the above modeling leads to the final area of analysis in this article: when do we estimates the coronavirus will be contained? And will this come soon enough to save SMEs globally?
As you know, there are more than 1,000,000 deaths worldwide from COVID-19. We seek a return to some semblance of normalcy. So what will an end look like? There is an array of how the word “end” is employed in these discussions and a McKinsey Public Health White Paper [When will the COVID-19 pandemic end?, September 2020] reveals the timing of an “end” to the current pandemic.
The article, a collaborative effort by Sarun Charumilind, Matt Craven, Jessica Lamb, Adam Sabow, and Matt Wilson, concludes that the likely scenario is that an end will not occur until the late summer or early fall of 2021. Of course, this is subject to change as the research uses current information. Public health professionals and highly respected firms like McKinsey do not have the ability to use historical events to help predict what is going to happen with the current pandemic. While there are vague similarities to prior health pandemics, this current crisis is unlike anything we have mired in modern history.
The research referenced above presents a thorough discussion on what must happen before we see an end to the pandemic. I am not going to delve into the science portion of the research, but I will summarize key conclusions drawn from current data.
The most important part of the research is two definitions of “end” and each has a distinct timeline. The initial definition revolves around the concept of herd immunity. One “end” will occur when herd immunity is achieved on an epidemiological basis. What does that involve? When the proportion of society immune to COVID-19 is “sufficient to prevent widespread, ongoing transmission.”
This requires that a vaccine is administered and effective. When this occurs, the maze of health emergency actions would not need to be enforced. They also suggest that this “end” might require regular revaccinations [like an annual flu shot] over time, but in any case, the threat of another widespread outbreak would be gone.
The second “end” is when almost all aspects of social and economic life resume without the fear of ongoing mortality. They believe this is likely to happen before achieving herd immunity. Ongoing mortality is when the current mortality rate is no longer higher than the historic average.
In order to have this “end” occur, many variables need to fall in place including tools such as vaccines, testing, improved therapeutics, and continued strengthening of public health responses, but they caution that the new normal is not going to be like the “old.” When these variables are accomplished, activities we took for granted in the “old” days (like traveling on airplanes, going out to eat without a mask, and sporting events) will once again become everyday occurrences. I can’t wait!
All of this research about the epidemiological side of the pandemic leads to the conclusion that the United States and the EU are most likely to reach COVID-19 herd immunity by Q4 of 2021. Herd immunity may come sooner if vaccines are highly effective, or if significant cross-immunity is discovered in a population. However, data also states that if the early group of vaccine candidates have efficacy issues, the pandemic could extend to 2022 or later. A diagram from the research does an excellent job of looking at each of these three different scenarios.
If these timelines are accurate, the implications for the global economy are concerning. Even the most optimistic timeline does not anticipate an end until nine months from now.
This conclusion leads me to ask a series of questions. Will SMEs have the financial stamina to ride out this period of economic chaos and subpar levels of revenue? Will the factoring firms that serve them be able to find unfamiliar industries to plug the whole of lost AR volume that these SMEs used to provide them? Will the debtor strength of SMEs AR deteriorate to a point that the risk/return equation to the factor no longer makes sense? Will global credit insurers continue to withdraw or significantly reduce available coverage that factors used to rely on as a risk mitigation tool? And if they continue to do so, will coverage be widely available at a cost a factor can even afford?
So many questions, and yet so few answers. The only answer I can draw is that the factoring industry will be tested like never before over the coming years. The factoring firms that survive will be the ones that can adjust to change, can be agile (technically and strategically), and have a stomach to serve SMEs with equitably priced and structured working capital. Buckle your seat belt tight; it’s going to be quite a ride.
One final thought, I never like to end an article on a down note. Optimism will also be one of the cornerstone traits needed in the factoring industry and in the SMEs we serve to navigate in the post COVID-19 world.
I have faith in the power of the human spirit to overcome adversity and prevail. History is flooded with scenarios that often appear impossible to correct, but time and time again, horrific events like this tragic pandemic accelerate our efforts to find a solution that powers us to overcome.
When a vaccination is found [and it will be], it could provide the catalyst for a once in a lifetime economic lift to the global economy. Could this come as early as in 2021? Why not? Finding an effective vaccine is now a globally focused effort by companies and researchers that may become household names. In all of the reading I do, there is an increasingly positive tone emanating from public health officials around the world that an effective vaccine will be available in the near future.
A recently published article in the Wall Street Journal [October 5, 2020] stated that the World Health Organization had documented 170 vaccine candidates currently in development and 26 of these are being tested on humans. They also stated that eight of these are close to completing the final phase of testing, which means some could be available in 2021.
A Deutsche Bank research report notes that the current AstraZeneca/Oxford University collaboration appears to be the front leader in the race to find a vaccine. There are other firms also mentioned including Moderna, Pfizer and others. Someone will perfect a vaccine and when effective, firms prepared to meet never-before-seen demand for goods and services in the global economy are going to accrue windfall success like rarely ever seen before.
We should be mindful and take the advice that was written more than a century ago by the brilliant scientist Louis Pasteur about what success is and how we can achieve it in our factoring businesses. He astutely notes "Chance favors only the prepared mind." By this he meant that success is rarely an overnight event that happens as a result of a sudden flash of insight or brilliance, i.e. an “Eureka” moment. Rather it is the result of being prepared to take advantage of a situation or opportunity due to planning, hard work and focus on never cutting a corner just to get across the finish line first.
Pasteur should serve as our role model as we combat the virus. Think about all that he accomplished in a single lifetime, and many of his successes occurred when he was ready and prepared to take on an “impossible” task. His ground-breaking work in fermentation and crystallization caused industries to change almost overnight. His research with germs and microorganisms opened up new fields of science and health advances, but these chance events happened only because his mind was prepared to observe, act and respond to the challenge he faced.
This leads me to a final thought about how we can also emulate Pasteur and others who literally changed the history of the world forever. In my years of serving SMEs, I have often wondered why some companies [and individuals] are successful, and why others never utilize their potential to the fullest degree. I have come to the conclusion that, regardless of the industry, economic conditions or business environment, the one common denominator in all successful SMEs is that they are led by men and women who are prepared mentally, financially and strategically to lead their employees, partners and themselves. In the vast majority of cases, this "prepared mind" is an ordinary individual who performs in a remarkable way. How? By utilizing their God-given talent to the fullest to anticipate events in the future, assess what needs to be done, make a decision, and act with drive, even when they only have incomplete information or facts.
For them, good fortune is not a matter of chance; it only occurs through intentional preparation by building upon core principles of honesty, integrity and service, making sure their business is committed to using these as the basis for the value they deliver to their clients, partners and employees. These “North Star” principles are exactly what we need as individual factoring firms and as an industry as a whole to guide us out of the current economic downturn and successfully emerge in the new “normal.”
---
Mark Mandula is National Sales Manager of Florida-based alternative finance firm United Capital Funding. The firm provides commercial finance opportunities to small businesses with B2B and B2G relationships by funding accounts receivables. Learn more at ucfunding.com.