July 12, 2022 •First Franchise Capital
The state of the U.S. economy is at the top of most business owners’ minds. While opinions vary on the degree of severity, most economic pundits agree a period of recession or stagflation will occur in the near future. Stagflation occurs when inflation and unemployment increase, but economic growth slows. World Bank President David Malpass believes the Russian-Ukrainian war will likely lead to a period of stagflation not seen since the 1970s.
Factors leading to stagflation
One of the main factors that could lead to stagflation is the historically high inflation the U.S. is experiencing. Bruce Hostetler, Director of Underwriting, explains the root of the current inflation levels, “In response to the Covid pandemic, the U.S. government borrowed or printed about $5 trillion and sent stimulus checks to businesses and people. This stimulus, and the Federal Reserves’ loose monetary policy, is the root of our current inflation. Ongoing supply chain issues, labor issues, and a war in Eastern Europe are deepening the pain.”
In response to the high inflation, the Fed is using its monetary policy tools in an attempt to cure inflation; and doing so in a way we haven’t experienced since the 1980’s. Federal Reserve Board Chairman Jerome Powell will attempt a soft landing, i.e. a tightening of the monetary policy without causing a significant recession. However, predictions of slowed growth are already making headlines. The Conference Board predicts a U.S. Real GDP Growth rate of less than 1% in 2023. Inflation can be blunted quickly, and without a hard landing, if government officials bring deep fiscal and economic reforms. Monetary tightening in addition to tax, spending, and regulatory reforms will help ward off sustained inflation and stagflation.
Another element of stagflation, increasing unemployment, is becoming more and more a reality as supply chain issues and rising energy costs force companies to consider employee layoffs and company shutdowns. While the labor market is still tight, there are signs that the market is weakening. In a recent report, the number of planned layoffs reached 32,517 in June, the highest since February 2021. Additionally, the number of people working part-time due to economic reasons increased this year as well.
What does this mean for the QSR industry? It may mean more families will have less disposable income to spend on fast food, but there may also be more people looking for work in the QSR industry to make ends meet.
How to prepare for stagflation
With these threats of stagflation, how can franchisees prepare? Bruce recommends franchisees begin to plan for a downturn sooner rather than later with the objective of survival. Most operators have already implemented menu price increases; however, commodity prices and labor have risen even higher leading to a compression of margins. Franchisees can raise prices further but should be aware that raising menu prices could negatively impact traffic counts. Furthermore, the higher inflation will reduce discretionary spending as families’ budgets are pinched further leading to even lower traffic counts. Through June 12, 2022, the industry has experienced 14 consecutive weeks of year-over-year negative traffic growth.
What to do? First, keep an eye on your cash. If your growth plans include an acquisition you may want to reconsider your approach and ensure you have available capital in reserve. When considering an acquisition, don’t overpay for 2021 operating results as they may not be sustainable in the coming year. With the rising costs of fuel, acquiring units near your existing network may make the most sense. Stay cautious of expanding too rapidly or too far geographically to avoid overextending your resources. The ongoing labor challenges make a strong acquisition integration all the more important to ensure staffing levels remain or are able to be achieved under your ownership.
Instead of acquiring another unit, remodeling an existing unit may be a safer investment. Real estate and construction costs remain elevated, but a revamped location may be the key to maintaining traffic counts during stagflation. Review your development plans carefully as you may not survive many missed swings. If you are unsure about an opportunity, seek advice from other franchisees in your network who have experienced previous economic downturns.
For those with liquidity and patience, there will be opportunities to grow where others miscalculated. Financially strong operators will continue to find lending sources, but communication with your lender is vital. Resist the impulse to delay bad news; it doesn’t age well. Update your budgets and share them with your lender.
If you are considering a growth opportunity and are looking for capital, contact First Franchise Capital. Our expert lenders are well acquainted with the challenges and opportunities of the QSR industry.
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