The words of Charles Darwin feel ever-more poignant as we move into this uncertain time: “It is not the strongest of the species that survive, nor the most intelligent, but the one most responsive to change.”
Whilst all signals point to a very difficult time for business and consumption in general, unfortunately the accelerated corporate Darwinism that we have been predicting is both needed and coming.
The huge fiscal stimulus unleashed in response to COVID (and more generally since the Global Financial Crisis over a decade ago) dramatically lowered the cost of capital, flooding business models that didn’t deserve funding with not only more than they needed but at valuations that were, at times, eye-watering. The upshot of excess stimulus is the incredible levels of inflation every business is now faced with. The challenge is that inflation is embedded throughout every single cost code from freight and haulage to the costs of digital marketing caused by greed from monopolistic technology 2.0 platforms, and the battle for talent. Coupled with this sky high and multi-decade record inflation, we have the uncertainties of war, a record low in consumer confidence and the fact the transitory nature of COVID-derived supply and demand imbalances aren’t yet behind us.
The housing sector demonstrates how extreme the situation is and how the markets are reacting. In the last six months, due to the changing cost of money, a new US mortgage is 67% more expensive for the same house. This is the largest percentage shock in 50 years and putting housing affordability back to levels last seen at the peak of the housing boom. For this reason, public markets are already anticipating a severe slowdown in housing activity with US homebuilders down by approximately 30% from their peaks.
Therefore, alongside input cost inflation business is faced with a dampened and rapidly falling level of overall consumer demand. In short, it’s a perfect storm and a storm that is just beginning given we are at the start of the interest rate cycle upswing.
In the short term at True, we are concentrating on preserving cash, preserving talent and preserving the brand equity in our businesses. We won’t allow short term seismic challenges to destroy, (in some cases), decades of hard work in creating a powerful consumer value proposition. Recruiting and retaining talent is perhaps the biggest challenge – not only is it the biggest cost, it’s also the biggest reason inflation will not be transitory in the near term. Witness the anticipated rail strikes where unions are demanding double digit wage increases. Witness the price of an e-commerce director which has broadly doubled in 24 months despite the skills on offer remaining the same. All of these aspects have been caused by the monetary stimulus present over the last decade with the Fed’s balance sheet increasing from less than $1 trillion in 2007 to more than $9 trillion today, an incredible flood that will take a long time to unwind. In short when capital is free people delight in giving it away whether that is to consumers, Google, Meta or company employees. Unfortunately, there is only one inevitable result - inflation. Faced with shareholder demands for dividends and an eventual return on their investment, management will need to cut costs to survive. These cuts will be hard, deep and broad-based. Those with business models that lacked sustainable economics will fail and the unemployment rate is set to move higher, a consequence of every reset during the Global Financial Crisis.
Whilst painful however, this shock is needed. Only with economically unsustainable competition being removed can the economy reset allowing business models that are sustainable to thrive again. It will take the heat out of freight costs so that $20,000 for a 40ft container transporting goods from Asia to Europe can return to its historic $2-3,000 level. It will allow the algorithms that drive Google and Meta’s platforms to reset to allow brands to actually make a profit from advertising with them (just as good for Google and Meta medium-term as for the brands themselves). It will allow the demand for talent to reset in most categories and it will allow the overall customer demand to be spread to those that are sustainable. Whilst none of us want the pain of failure, it is what makes capitalist economies work in the long term. It will allow new companies and new iterations of existing companies to be created and prosper, and ultimately it will lead to broader progress in the world even if it doesn’t feel like it in the coming months. Buckle up as the storm is here, it is nearly time to act whilst others are fearful because accelerated corporate Darwinism is on its way.