zombie economy

Starting a business in the Zombie Economy

It’s risky times and this makes starting a new business a lot more precarious than it already is. This Zombie Economy feels half alive but also half dead. It is possible, but you can’t use old boom time playbooks to start a business in times like this. You need to understand the new landscape. Knowing about blind spots reduces your risk of failure.

Let me preface this article by saying that starting a business in tough times is something I have been an advocate for in the past but this time one needs to be far more skeptical about the decision. Test your theories heavily.

I so believe this that I actually started a new business in November 2019 which I began to close in late January 2020 with the view that it wouldn’t work in a pandemic.

Now you may be wondering why I would write a post that may talk people out of starting a business? I like people more than I like money. I don’t want anyone failing at my expense. I also want a bunch of customers on our online accounting software and apps that are successful. That’s satisfying.

I actually started Saasu back in June 2000. Just 2 months after the Dotcom crash. Developers were going to be available and cheaper relative to heady boom days. It was a strategic move. Competitors would be going broke or in damage control and I needed at least 2 years to get to market with something hard to build (this has the benefit of attracting less competitors). A recession or slowdown provides that time. We were inventing online accounting so it was going to take time.

This is very hard though. You need to have a personality type that can mentally accept playing the long game. Most people prefer instant gratification and need to be constantly rewarded or entertained with what they are doing. Long games are a grind, take endurance, capital and might not be glamorous. It was a huge investment in time and dollars in hindsight and I made lots of expensive mistakes. Few are willing to go there but that’s exactly why it can pay off.

Your ability to delay gratification is one of the most important ingredients for success in life.

Disclaimer: Please work out your own investment view and position with your financial advisors. This is not financial advice. It is just my personal view. It is just one possible outcome in a risky world. My context and investment approach is not like yours. You should seek specific advice for your circumstances.

What might you need to be aware off

Difficulty in raising capital

As I write, it’s still possible to raise money. We may be in a suckers rally where much of the investor population feels we are going through a convenient V-shaped recovery and all will be fine when the economy opens back up. There are those buying the dip, feeling optimistic and opportunistic. In some ways feeling like the end is in sight. We need to remind ourselves that investors are lending and buying from others who are borrowing to delay their demise or just selling, getting out before it gets worse.

I think if you prudently presume we are in a Zombie Economy, you are less likely to get caught out when you don’t see the best case scenario of a V-shaped recovery out of a recession.

We could be at the first phase of a typical recession cycle. The bargain hunting phase. Where people play catch up football. Hoping to relive the boom of times past that they missed.

I personally think the next phase will be the reality check, a reckoning, a call to account. As you see household names like Golds Gym, Laura Ashley and Virgin Australia are collapsing it starts to wake people up.

Assets will need to be sold. As an ex-investment banker I know the books at Australian trading banks would be littered with problems not easily solved. Giving grace on paying helps them delay facing the reality of unemployment and its impact on loan books. Negative equity situations need to be rectified in time. Capital might be locked up and thus dry up for new businesses starting out.

It is the part of the cycle that can cause a credit squeeze, deflation followed by inflation and movements in interest rates away from the levels governments attempt to set. The interest rate that you and the government get to borrow money at now might not be where you get to borrow at during the more mature stages of a recession or depression.

Here’s a simplified example of economic cycles from a markets perspective. I’ve marked out the stages against the 1927 crash that triggered the Great Depression. Note that history does not imply the future so don’t take this to mean that this will happen this time. It will most likely be different but there is some familiarity in previous collapses if you choose to go and look for yourself. You can argue its Zombie Economy phase was from 1930 right through to 1935. Five long years.

Market Psychology overplayed on the Great Depression

Bank lending is now more difficult

Banks are rethinking how they lend in light of what I’m calling the SLAP they just got. Sectors, Legals, Apathy and Proximity. These are all problems not catered for in lending models. They are systemic long term changes to the game. So what are these?

Sectors and industries will be vulnerable to a long term sustained reduction in addressable market size. Many participants in that sector will fold or already have. Tourism and entertainment are two examples. Obviously air travel will diminish in market size for years to come. Commercial office space will see less demand also.

Legal contract strength and reliability is under serious threat from governments. Your presumption that you have a lease and it will be paid under law is no longer valid. Your presumption that as a lender you can enforce your borrowers to make payments is no longer valid. The presumption that as a business you can choose to pay a dividend is gone. Jacinta Arden in New Zealand just did the unthinkable by denying banks the right to pay dividends. These socialist concepts in capitalist systems are real change for business owners to bear in mind. You can no-longer rely on contract law. Just look at New York. They have a bill in progress forcing landlords to forgive rent completely after pressure from the #RentStrike 2020 movement. This is a cancellation, not a delay in payment. Look at Australia forcing businesses to shutdown in entirety without any democratic process or compensation.

Apathy becomes apparent in crisis. Lenders are realising how large the population of grasshoppers in the economy is versus the ants. Very successful industries are riddled with people almost broke because saving for a rainy day was not a lesson they got from their “Rich Dad”. Debt was presumed to never be a problem. Revenue, and the boom, was assumed to go on forever. Understandably, it did seem to go for decades.

Proximity just became a new variable. Does your business have proximity risk. Cafes, cinemas, sports stadiums etc. Does your workplace building pack 200 staff onto one level of a high-rise in the CBD with shared air supply? These are all now lending risks not just business risks.

Fear pervades and infects in the Zombie Economy

People underestimate the effect of fear and confidence in persisting a Zombie economy more than any other variable. Consumer sentiment is an excellent lead indicator. Another I refer to is the what you might call an economic doomsday indicator. If you look at the value of a basket of Food and Essential goods stock prices (e.g. Coles, Woollies etc.) and compare them to Luxury goods and services then the difference (the spread) is a good gauge of how much fear pervades an economy. This is more technical but even anecdotally it’s interesting to watch the behaviour of these against each other as a rough guide of fear levels.

Liquidity and the velocity of money

Nothing is more ignored and more misunderstood than the effects of liquidity and velocity of money in economic circles. I recall a conversation with a trading mentor I had when I was first learning to trade that liquidity flows trump economics in setting prices in markets. With three decades of experience later, I agree. The velocity and availability of liquidity can’t be underestimated in its impact. As I write, governments in a zombie economy hold market power. They print money like zombies. It’s called quantitive easing. They do this until they can no-longer afford to print money at the risk of creating inflation and other related issues.

Our financial system is based on leverage and debt. To deleverage is painful and can be catastrophic. Liquidity is needed to hold up a system so leveraged.

Future taxation

The long term cost to the short term benefit underwriting of wages by the government is a heavy forward tax burden on businesses. High levels of business tax already exist in Australia. Can we really increase GST and not see some economic repercussions of that? The biggest disincentive for me in starting a business (other than the red tape) is Australia’s high levels of tax.

Zombie Economies take years to get over

The Zombie Economy staggers, falls, and then it gets up. It then falls again, maybe loses a limb but pushes on. It takes its time. Do we really think this will be over in just 6-9 months since the start? I’ve never seen an economy do a V shaped recovery like that after a recession or a depression. I think a gross miscalculation on the net disruption cost to so many industries is what governments and economists are underestimating in predicting early recoveries. Disruption, change and transformation is just that. It kerbs growth during its effect. Decay and even extinction of some market segments has to play out. Just look at how software ate the world in the last decade. So many products became extinct due to the phone in your pocket. MYOB was close to death (saved by Bain Capital) due to Saasu amongst other online accounting software companies.

Unit cost of labour

Australia’s unit cost of labour versus global levels is our biggest success and our worst nightmare. It’s great that lots of people are wealthy in Australia but it is a curse if we need to try and reduce our dependency on Chinese imports. Versus global peers Australia’s labour costs are very high. That’s mostly the government fault, people can still earn good money but at lower labour costs to companies. The way that happens is by reducing all the rules, costs and involvement by government. Look at what makes up a persons pay. It’s a marginal tax rate of 32.5% on an average Australian Salary. The cost of carrying an employee on balance sheet is estimated to be another 30-40%. So you can see that versus countries where these two variables are half that we cannot compete. Our unit labour cost problem is mostly about the size of our government. It’s too large and it sucks tax from the economy to pay for its bloatedness. It has wrecked industry after industry over the last few decades.

Flawed industrial relations system

It’s terrible if you are a casual in these times (no job certainty) and it’s terrible if you are an employer (penalty rates make it expensive to stay open on weekends and public holidays). These are just two of the many clear examples. It doesn’t work for either side, that’s obvious. The consensus amongst my friends (who own businesses) is that it is an utter mess of complexity. It was designed by bureaucrats to support employees but actually works against them in so many ways. This is quite simply because you remove the economic incentive from the business owner then how can they hire employees. Just ask Holden and Ford about that. It’s criminal what both parties in government have allowed to happen to Australian manufacturing. It’s hyper-complex and inflexible. It disincentivizes hiring locally versus offshoring or automating. It has killed off entire industries in Australia and it persists.

Large amounts of red tape

They claim red tape is low, even global data says Australia is low red tape but what isn’t made clear is the non-federal government red tape businesses are dealing with. Blockers exist at industry level, state government, local council and technology levels. What? Technology? Yes technology is red tape if it consumes your time away from selling or building products and providing services. Legal and Tax complexity in HR, contracts law, corporate law is extreme.

Digital red tape is the new red tape. Governments absolutely kid themselves that they have made it all easier for us. Have they really sat down and linked all the departments to their myGov account for themselves and enjoyed that experience? Have they sat through the trauma of setting up super stream, STP, and other only filing requirements. Yes we do that at Saasu but I’m not going to pretend it is easy at any software provider. There is only so much private enterprises can do to simplify a system to fit into government designed complexity. Have they dealt with state payroll tax? Of course they haven’t. They aren’t “users”, they are the “programs” as we learned in Tron. There lies the crux of this problem.

We have certainly felt the weight of this over the last year. While governments attempt to digitise they invariably do that badly and systems seem to be more complex than their manual predecessors. Just look at how terrible the old AUSkey train wreck was. Look at how painful the new MyGovID is. It’s all terrible user experience caused by complexity.

Infrastructure not supporting business

Australia has some of the most expensive energy in the world. This is despite us having access to resources, vast oceans and cheap rural land. We even invented solar and we struggle to pull a dollar out of it (except TindoSolar in SA – support an Aussie Solar manufacturer!). So who’s at fault? The lack of long term vision in politicians who simply design policy for the next election. We have huge amounts of water that just head off into our oceans but we don’t have the long vision to do the infrastructure needed to utilise water in a sustainable way for people and the environment. Technology can solve these problems but they take decades and we don’t have the political will for it.

High proprietor and director risk

It’s too easy to make mistakes unintentionally or suffer the repercussions of a problem that was a blindspot rather than incompetence or negligence. What happens in a high complexity and risk environment is that the payoff for taking risk flips such that risk is much greater than reward. The new emerging post Covid19 economy is now riddled with these situations and that has two key impacts. Higher prices and less choice. These are some key ingredients of inflation and higher interest rates. New small business owners will reset their reward expectations for the risks they take.

There is promise in the Zombie Economy

There are two promising scenarios at present. New micro or small businesses where the risk and investment is very clear – low headcount and red tape complexity. Blindspots must be at a minimum – niche or focused. Funded from cash (possibly retrenchment money) and where the need for debt or capital raising is low.

Alternatively you must be very big but simplistic in your approach to a market. I say simple because complexity is the new riskiness. When the game is changing rapidly around you things that were safe quickly become problems. Scale allows businesses to cover many costs and risks mentioned above at reasonable levels per unit of product or service.

Regardless of the business model or size you need to be careful you haven’t engaged segments or markets now at risk in the long term. Ones undergoing long term transformation, forcibly. Businesses that trade in needs versus ones based on wants are a simple example of this at present.

Businesses that aren’t sexy but have products that are sort after even in tough times are currently flourishing.

Good luck with your business and email me at ceo@saasu.com if you decide to use Saasu Online Accounting for your new business and I will get my accounts team to add some credit to your subscription.

Story photo by Daniel Jensen