Although we have seen our fair share of casualties during recent crises, many are actually recording record results. Cost-of-living crisis? Technical recession? Slow growth? Not for everyone. With some businesses seeing record profits despite downturns and recessions, there are clearly winners and losers. But why? What makes some businesses thrive while some nosedive? Why are some enriching shareholders and owners but others have been rescued and stripped? There is a surfeit of reasons behind some of the record results. So, let’s look at some reasons behind stratospheric surpluses and how others missed out.
Downturns and recessions are times to raise prices
It may sound counterintuitive that increasing prices in a trough or a crisis makes you more money. After all, the theory is that people and businesses have less cash to splash. This is over-simplistic. There are five major reasons why prices may rise despite a downturn or economic recession:
- Demand
- Supply
- Money supply
- Geopolitics
- Profit margin
Now, let’s look at each of these reasons in turn to understand how these affect prices.
1. Demand
Inevitably, if we keep on buying things, even after price rises, it gives businesses the confidence to continue increasing prices. Similarly, if demand is shown as inelastic, despite alternatives and price changes, prices will rise. Although many now believe that businesses serve a range of stakeholders, including meeting ESG and social value goals, they primarily exist to maximise profit. After all, why be in business or invest in businesses if you don’t make a return? The pandemic also provided a fantastic insight into collective psychology, particularly for food and PPE. People and businesses bought too much – stockpiling supplies and paying higher prices. Fear has perhaps led to supermarkets changing ownership, such as Asda and Morrisons, due to the higher returns on offer since 2019. It has also led to higher stock levels in some industries.
2. Supply
Supply constraints inevitably result in price increases, particularly when there are few or no alternatives. This is partly to maximise profits but also to avoid running out until new stock arrives. Sadly, various crises and wars since 2000 has seen shortages of everything from toilet paper to natural gas and wheat to semiconductors. The result? Surprise, surprise. Huge increases in prices and, in some cases, attempts to ration supply. The forces of supply and demand tend to go hand in hand, with surges in demand (if unforeseen) straining supply chains. When production lines shut down during the pandemic, it took a while to start up again, which is why semiconductor prices remained high. Similarly, when Europe could no longer rely on gas from the East, it paid more on the open markets until new supplies were available. Many countries have since signed off or built LNG (liquid natural gas) terminals to supply Europe.
3. Money supply
Ultimately, more money available drives demand. We understand this. However, when Governments splurged during the pandemic and, to some extent, during the cost-of-living crisis, it put more cash in pockets and coffers. In many cases, this cash provided a lifeline for struggling households and organisations. In some cases, it simply gave more money to people who could afford price rises anyway. The result was increased consumption with the ‘artificial’ stimulation from additional funds. Yes, households splashed out on new electronics, exercise bikes and toys. Businesses splashed out on additional stock, invested in new equipment (including to benefit from the Chancellor’s accelerated depreciation) or bought other businesses. Much of these excess funds have now dispersed and the UK faces Government debt of around 98% of GDP (which is dropping as it gets inflated away).
4. Geopolitics
The sorry state of global politics is undoubtedly having huge effects on pricing. Gas prices rocketed after the invasion of Ukraine. Oil prices have risen due to conflict and OPEC reductions in output. Both may have risen because of the insatiable demand from fast-growing China and India. Furthermore, nervousness over the potential invasion of Taiwan has caused Western Governments to build semiconductor factories closer to home. It goes without saying that a semiconductor ‘wafer’ costs a lot more to produce in Arizona, Kumamoto or Dresden than it does in Hsinchu. These increased production costs will find their way into consumer and business pricing, which is the cost of securing supply. Similarly, though we all would like to see less reliance on fossil fuels, not all countries can produce the vital battery elements lithium and cobalt. South American lithium production is largely from Chile, in a continent that is experiencing great instability. Similarly, African cobalt production is from the Democratic Republic of Congo, which is considered poor on worker human rights and safety.
5. Profit margin
Never look a gift horse in the mouth. At times of uncertainty, it presents an opportunity to mislead customers about the need for price rises. Furthermore, nobody knows for certain when any cost pressures have eased, enabling you to preserve higher prices for longer. If you can get away with it, why would you not make more profit? The rub comes when this involves collusion, price-fixing or other market manipulations. Where an industry operates under regulatory oversight, you also open the door to investigation and punishment. However, in many industries, prices rose because they could and the general mood music made it more acceptable. However, before anyone gets too angry at the situation, it is worth reminding ourselves of wage inflation. It is not so long ago that both private and public sector organisations were handing out double-digit raises. Prices had to rise to maintain profit margins as a result, just as they do to rising energy, raw material and supply constraints. This money is then used to reward investors, invest in the business and (hopefully) to pay taxes that fund public services.
What about the losers in a downturn or recession?
Some business hit the wall rather than report record results. Yes, brands from Ted Baker to The Body Shop have gone into administration. Voluntary liquidations are at record highs, largely due to a dearth of customers. Businesses with high fixed overheads, those that failed to digitise during and after the pandemic and those who only just survived COVID-19 fell soon after. According to some recent research, the compound annual growth rate of those who prepared and invested ahead of time was around 4x those that did not. Yes, they grew about 16% since 2004 compared to just 4%.
For those who ‘got lucky’, such as those involved in home improvement, either DIY or DIFM, there is now a slowdown. The macroeconomic environment forced people into homes and to stare at work that long needed doing. Similarly, certain technology and software businesses rocketed ahead with WFH and demand for technology for work and entertainment. These businesses are also now seeing weak demand and bulging inventories, causing stocks to plummet. There is a lot to say for preparing for a downturn but also for preparing for a soft landing beyond the downturn.
Don’t panic about the recent recession
We currently define a recession as two consecutive quarters of negative GDP. Most experts predicted only a shallow recession in the UK. Why? Because, there were none of the structural or external shocks seen in the last two downturns. Sure enough, we come out of recession with 0.6% growth for January-March. Despite interest rates at relatively high levels and inflation still above 2%, this is good news. For highly leveraged businesses, there is a problem due to the cost of rolling over debts. Failure to boost demand or to successfully get price rises to stick means declining margins or losses. However, there is some potential good news touted for the next rate review in the summer.
Unusually, private equity houses are supposedly sitting on record amounts of ‘dry powder’, waiting for their next investment opportunity or takeover targets. The trouble is that the opportunities are far from clear cut in the current environment. Some say that software is the main focus area as PE houses look to higher returns in the future. Given the huge rise in tech stocks linked with AI, such as Nvidia, Intel and Google, there are clear benefits of getting AI right. So, unless you are in software and seeking investment or burdened by crushing rents or debts, don’t panic.
Think Beyond is a partner for the good times and bad
We are a management consultancy that helps you to achieve your targets in the right way. We support you with growth strategies and plans as well as streamlining and transformation for a leaner business. Whether you need long-term plans, insights to find growth or a turnaround plan, we are there for senior leaders. We also provide insights into your market, customers and competitors to recommend competitive strategies. So, if you need a steer, need a hand, need to find an advance or need to cut, we are ready to jump in.
To prepare for the future downturns and recessions, why not drop us a line with your request.
Alternatively, why not read about decision-making with a broad view or how to deal with complex business issues.
Finally, you can access other advisory articles to help you decide.