I spent the last couple of days at a mastermind meeting with one of my business mentors, Greg Crabtree. Greg and team bring together a group of business owners twice a year to look at the performance of their companies and learn about trends Greg is seeing.
The theme this time was the impact of inflation and particularly wage inflation. Greg’s company does outsourced CFO type services for companies of all sizes, in all sectors, and across the country. He has about as good a read on the real time status of small businesses as anyone in the country.
One of Greg’s points is that the Federal Reserve and other policymakers have about zero real time information. They only hear about small business performance when quarterly taxes are filed. Sure there are surveys but taxes are a much better indicator. His feeling is that the Fed and others extrapolate economic performance from public companies and misunderstand the economy as a result.
I’ve been urging Greg to create his own economic indicator. He tracks data about 100 of his clients’ financial performance that is updated each month. He’s been doing that for several years and can now show trends over time. I think he should publish it and call it the Crabtree Indicator. CNBC would go wild.
As part of the meeting we got a good read from the Crabtree Indicator. What it showed was a rapid increase in revenue starting almost immediately after the initial Covid downturn and accelerating into 2021 and 2022. Along with that he shows that employee wages initially trailed but then began accelerating faster than revenue growth. By the end of 2022, wage growth slightly exceeded revenue growth. As a result we’ve seen a flat profit line since the pandemic.
As Greg is fond of saying: revenue is vanity, profit is sanity, and cash is king. If you don’t believe that, try paying employees with revenue rather than cash. You get arrested.
I was also talking with a friend and fellow Crabtree client today who does a lot of private investing about exactly this. We see huge revenue increases from 2019 to 2022 in companies for sale or seeking investment but EBITDA isn’t catching up. A lot of suspect EBITDA adjustments are trying to do that work.
Greg is also fond of saying that his grandkids and everyone else isn’t having enough kids. If people don’t have enough kids then not enough people grow up to become employees. What we have is a structural labor supply issue. That means higher inflation for longer.
If the trends in the Crabtree Indicator continue, we’ll see profits starting to fall. That’s good for workers but unsustainable for business. What we are seeing is plenty of vanity and a lack of sanity1. In Greg’s view, making money from 2010 to 2022 was easy. From 2023 on, it’s going to get a lot harder. “It’s going to be a fistfight,” we’re his exact words.
While the Fed will keep rates high to suppress demand and therefore wages, it doesn’t seem like it’ll work long term. We are in for a period of high wage growth which will keep inflation going. The hope is the current clamp down will keep inflation from hitting the 8-9% levels we saw last year. Maybe we can settle into a long term 3-5% steadier trend.
My take away is that every business owner needs to quickly get used to the new normal. Employees will continue to be hard to find. They will want to get paid more and work less and as Greg says, “That’s a math problem.”
The winners in this environment will work hard on creating a culture that retains employees but they will also look to offshore labor to Latin America, the Philippines, etc. and adopt automation tools like AI. I also think they will get serious about measuring and enhancing labor efficiency and productivity. There are several ways I’ve been thinking about doing that which I will explore in a future post.
Now go get yourselves a new pair of boxing gloves you’re going to need them.
Cash still seems pretty good. Pandemic programs like PPP helped with that but Greg and team also beat on their clients about maintaining high levels of cash so that might not be indicative of all businesses.
A Lack of Sanity
Thanks, Steven. Much appreciated. Now if you can get my wife to think what I’m talking about is interesting, I’d be getting somewhere.
Excellent Alan. Will be sharing this widely.