When You Don’t Have the Answers, Ask the Right Questions
We are halfway through 2021, a good time for business owners to pause, assess where things stand, and identify challenges to be faced in the second half of the year.
One year ago, we wrote an article titled, “It’s Going to Be a Longer Haul”, in which we counseled business owners to plan for a COVID-19 economy that was not likely to revert to 2019-like conditions any time soon.
We started off by saying, “It’s the start of the second half of 2020, pandemic-induced shutdowns are lasting longer than most businesses initially thought they would, and the rate of infection in the U.S. is getting worse, not better. Although the world will get back to ‘normal’ at some point, it’s going to be a while.”
In hindsight, that statement was largely correct, but we did not predict the astonishingly fast recovery seen in many parts of the economy. A year ago, the word “unprecedented” was overused, but there really was no other way to describe the Now, we have to use it again – this has been an unprecedented recovery.
The high-level themes are familiar territory by now – some sectors (entertainment, hospitality, and restaurants) suffered badly during the pandemic, but many others actually thrived. Consumers used stimulus checks to buy a lot of stuff, boosting profits for some companies beyond anyone’s expectations.
Most of us learned to work from home much more effectively than we thought we could (and learned the phrase “Zoom fatigue”), ordering new computers and other home office gadgets, tablets for our children to attend school remotely, as well as groceries and other items, to the benefit of those who supply those goods.
Uncertainty – the Word of the Day
But we are not back to where we were in the “before times” and no one knows how long current patterns will last. The Federal Reserve expects the high inflation seen in the past month or two to be transitory, as it appears to be largely driven by temporary supply shocks (including semiconductor chip shortages, hoarding of industrial metals in China, shipping container issues, etc.). Indeed, record-high lumber prices – that have contributed to high building costs in a white-hot housing market that no one would have predicted a year ago – have come down in recent weeks. Nonetheless, the Fed admits there is uncertainty in its optimistic outlook.
What does this means for business owners who need to plan for the second half of the year? We have yet to find a crystal ball or tarot cards that can reliably tell us what will happen in the future, but in the face of uncertainty, the first step is usually to ask the right questions. We offer our take on important questions you should use to examine forecasting for your business for the second half of 2021.
To update financial forecasts for the rest of the year, we suggest starting at the top, with revenues. The questions to ask here involve both the level of demand and pricing –
- Will orders continue to follow the pattern seen over the past 12 months, revert back to 2019 patterns, or settle somewhere in between? If your business has seen a “COVID boost” in demand, it may be unreasonably optimistic to expect that trend to continue now that we are moving back to a new normal.
- Where is pricing going in your industry? If your costs have increased, whether raw materials, labor costs, or both, how much can you pass along to your customers? What are your competitors doing?
Collecting data on customer buying patterns to use in making forecasts is important, but for most businesses, comparing the past 12 months to 2019 will not be useful. As much as you can, talk to your customers and seek out industry insights about demand over the next six months.
Demand for some businesses, such as software companies that are not supply-chain dependent and are not tied to the mass shift to Working From Home, may be fairly predictable. For those whose revenues were positively impacted by the WFH phenomenon, carefully consider what your renewals will look like.
One of our client’s revenues increased 4X due to WFH; that growth trend is most likely not sustainable, and it may dramatically slow or even y turn negative if renewals disappoint.
The Financial Crisis vs. the End of WWII
When forecasting sales, note that the current environment is not at all like the economy we faced coming out of the global financial crisis of 2008. Today, many businesses are flush with cash, as are many consumers.
The closest parallel may be the end of World War II. There had been a huge disruption in the way society functioned —with so many men away at war, women had entered the workforce, and manufacturing businesses had shifted to support the war effort. Businesses and society, in general, had to readjust when the war ended. Faced with today’s readjustment process, here are some other points to consider in making your revenue forecast:
- Holiday spending, including travel, hotel stays, and gift buying, may be frenzied this year. That may benefit your business if you are ready for it, but pent-up demand may fade quickly.
- It may make sense to do two revenue forecasts: a “best estimate” as well as a worst-case forecast. Then, determine where you could reduce costs if you have to.
Cost Drivers – Inventory and People
While you would not want to miss out on a surge in customer demand through the rest of the year, that demand is high uncertainty.
Therefore, avoid increasing fixed costs (such as expanding manufacturing capacity) unless you have confidence that orders will stay strong, based on your particular customer base. Forecasts for the near term should reflect the fact that raw materials have increased dramatically.
However, as noted above, this may not last beyond the end of the year, so you do not want to overreact. With respect to inventory, do you need to build in more lead-time because of supply chain issues, shipping delays, and raw materials shortages? You do not want to under-react, but building up too much inventory is risky —after people spend what they want to spend this year, demand may be sated and you do not want to be stuck with a warehouse full of unsold goods.
In forecasting personnel costs, labor shortages have been widely publicized. Growing numbers of employees are quitting, confident that they can easily find another job, particularly for unskilled work. Will you need to increase pay to retain your workforce?
According to a recent article in the Wall Street Journal, employers should be prepared to lose 25% of their employees, as turnover has been higher than in a traditional “recession”, and the next 6-12 months will be anything but typical. That hit to productivity and increased hiring costs should factor into your forecast.
Attracting and retaining quality employees is critical, and while remote work has made it possible to cast a wide net when recruiting, there are difficulties with working remotely. Another WSJ article reported the highest turnover among employees who had never been in the office. Zoom and similar tools have been invaluable, but in terms of building work relationships, they fall short. By definition, online meetings are “by appointment only”; remote employees cannot walk by co-workers and say, “I have a question,” or “what do you think of this?” – spontaneous interactions are lost when WFH. Ask your team members how they are doing, and really listen to their answers.
Note that there is often a discrepancy between how productive a remote employee thinks he or she has been and how they are perceived. Consider being proactive with employees you really want to keep – tell them you value them and want them to stay. Bottom line: many KPIs that measure productivity point to the importance of in-person interactions.
Look at other elements of your cost structure, including office space and technology. How much space will you need going forward? Under a hybrid work model, you still need space but may need to reconfigure what you have – maybe more conference rooms for in-person meetings? The cost of technology upgrades made during the pandemic will not be ongoing, but you will have to maintain any new technologies that have become an integral part of how your company now works. If the pandemic accelerated the adoption of technology you would have eventually implemented anyway, congratulations – you are ahead of the curve. But, if new tools were only needed to get you through the pandemic, decide whether to maintain them. Separately, now that people are traveling again, look at your travel budget – it should probably be much bigger than in 2020, but not as big as in 2019.
Although all forecasts are inherently uncertain (unless your crystal ball works better than ours), making a forecast focuses attention on the drivers of business profitability. That, in turn, helps you to make informed decisions when responding to a changing situation. To update your company’s forecast for the year, start by asking about the issues we raised here. And, here’s to a healthy, productive, more in-person second half of 2021.