Recent analysis from the Royal Bank of Canada (“RBC”) indicates the Canadian economy shrank by 10% annualized in the first quarter of this year due to COVID-19. With a significant increase of Canada’s unemployment rate to 7.8% in March – double the largest one month increase on record – the unemployment rate is expected to climb to 20% as more Canadians continue to report job loss due to COVID-19. RBC expects that the current shutdown and social distancing policies will remain in place for at least another two months and will only gradually be scaled back potentially in June and/or July. In both Canada and the US, RBC expects the GDP to decline in the second quarter by over 30% on an annualized basis.
Companies and businesses in industries such as manufacturing, distribution and retail, in the last several months have initiated wind down procedures to comply with government announcements responding to the COVID-19 pandemic. This has resulted in the reduction of various stages of labour, product supply and ancillary services. Some companies have been able to perform these procedures on a graduated basis while others have had a sudden halt with little prior planning.
In many ways, larger organizations have caused significant pressure on their supply base who were geared up for pre-planned product fabrication and shipment, whether they were through manufacturing or import methods. Suppliers in manufacturing whose production included lean manufacturing, have found the disruption has caused the eroding of supplier cooperation and raw material sourcing. In addition, with the layoff or termination of employees, skilled labour supply either went elsewhere or became reluctant to return to work without further extensive safety precaution measures.
Government programs as well as lender cooperation have assisted in softening the blow during shutdown and provided some relief with respect to liquidity and cashflow – temporary measures designed to keep businesses above water in the short-term. However, this will all come to an end in the not so distant future, and we can anticipate a slow and graduated return to normal over a much longer time frame than what was initially anticipated. This will be due to the additional safeguards put in place to protect employees, limitations on production, as well as a reduced number of people allowed at consumer gatherings, until a vaccine can be produced and distributed.
With the restart of our economy, there are several issues to consider for all types of businesses which include the following:
- Short-term liquidity
- Consumer buying patterns
- Manufacturer/supply base relationships
- Coordinating the restart and timing
- Planning for the economic recovery
- Labour workplace safety and costs
- Government program continuity
- Lender relationships
- Legal issues
The Wall Street Journal has reported that numerous manufacturers, companies in the entertainment industry, and various retail chains took action to bolster their cash positions as they have tried to survive the shutdown, as well as anticipate increased spending associated with a restart of business. While lenders cooperated by not enforcing covenant breaches – including reductions in margin security and operating losses – there should not be any expectation that they will necessarily agree to fund a restart.
Cash flow requirements can be minimized during a shutdown by cost cutting – including non-essential costs – and labour reductions. With a restart, there will be a need for suppliers to invest upfront in the cost of labour, the purchase of materials, and paying for logistics to bring inventory to their assembly lines or stores. It is anticipated that smaller suppliers will be hit the hardest, due to diminished liquidity as they rely mostly on accounts receivable for cash flow, which will be diminished due to the length of the shutdown. It will be difficult to collect from customers the remaining receivables, given the length of time since the provision of services, who will likely be in deeper financial distress.
Consumer buying patterns
With increasing unemployment and weakening consumer confidence, customers are expected to remain cautious regarding large purchases. A recent published survey indicated that 50% of all consumer spending is discretionary, and of that total, during the COVID-19 shutdown, there has been a 90% reduction of discretionary spending. How much of that spending reduction is permanent as a result of changing consumer habits during the shutdown, is an open question. With the staggered phase in reopening, it is unclear when consumers will feel comfortable making large purchases in this new normal environment.
A recent study by McKinsey & Company published by the Retail Council of Canada reported the following findings:
- Distance is back
- Resilience AND efficiency
- The rise of the contact-free economy
- More government intervention in the economy
- More scrutiny for business
- Changing industry structures, consumer behavior, market positions and sector attractiveness
- Finding the silver linings
In retail environments, we can anticipate that changing work rules will result in less customers in the store at any time. In addition, the changes in sales staff and customer interactions, work rules concerning product returns and interaction in change rooms, will make selling products in a brick and mortar setting more difficult. In particular, retail chains whose business plan is based on volume selling will be challenged and they will need to pivot to alternative strategies.
Manufacturers of consumer products such as automobiles, larger appliances and other more expensive durables will need to revise their marketing programs and develop alternative sales portals given the decreased importance on visual product interaction.
Manufacturer/supply base relationships
The supply base to large manufacturers will require some level of support to re-commence operations. Some manufacturers are in a better position to provide such support, as they provide upfront product payment and have access to a supply of raw materials. Other manufacturers have their own issues, such as not having access to source short-term working capital.
Unfortunately, given the need for working capital to rebuild, not all suppliers will survive. While companies may look upon a refilled order book as a good thing, in the current financial world, banks are not always willing to lend dollars to restart production when margin deficiency prevails.
Coordinating the restart and timing
A coordinated approach to a restart is the preferred path, however, any complications/inefficiencies may lie ahead in the execution. While numerous manufacturers have maintained contact with their global supply base during the shutdown, in many industries such as the automotive industry, there are hundreds of suppliers to a vehicle. Such coordination needs to be orchestrated simultaneously and have a staged production process plan in place. In addition, even local supply chains operate in multiple jurisdictions with different federal state/provincial and country wide guidelines that will have varying impacts on suppliers. Staggered or a multiply phased plan of re-openings, combined with the lack of visibility down the tiers will complicate a restart. A realistic start-up plan will be critical once employees are brought back and materials begin to be purchased, and further shutdowns become more costly. More recent analysis has discounted a “V” shaped recovery in favour of a gradual recovery with “normal”, not expected to be achieved before 2022 or not at all.
In the retail environment, product is usually sourced globally. The orchestration, while not linked, impacts product availability at the store level which may result in stores having limited product available for sale, and still having to pay for full labour support, commercial rent and utilities.
Planning for the economic recovery
Recent economic modelling provided by governmental sources has varied by state and province. While some jurisdictions have announced detailed plans and commenced the opening of services, others are vague, with limited information available. As a result, planning the recovery will be extremely complex, particularly for manufacturers. As referenced above, the unpredictability of consumer behavior and preference combined with government economic planning, production planning will have to consider multiple scenarios including; a fast recovery, continuing recession and a delayed and more limited progression. Likewise, distributors and retailers will need to determine different levels of product import and store openings.
Labour workplace safety and costs
Without question social distancing will become a fact of life for a far more-lengthy period of time than most businesses expect. Consideration will need to be given as to how laid off employees can be brought back given the heightened concerns about safety in the workplace, and the need for new safety supplies such as masks, plexiglass and disinfectants, which may not necessarily be available in adequate quantities.
In the manufacturing environment, social distancing policies will require a redesign of production lines and workstations, adding significant costs for product manufacturing. The Retail Council of Canada highlights the need to address and communicate with employees in an open and transparent manner. Expanding flexible work arrangements and other policies that allow people to work remotely and safely will become important in providing infection protection measures on site or when in direct contact with customers. A new store layout plan will include:
- Aisles/traffic control/spacing
- Sanitation stations/washrooms
- POS/counters/sitting areas
- Change rooms/elevators
- Product testing/sampling/displays
Government program continuity
Given the difficulty many companies will have in recommencing operations, the question that arises is the continuity and availability of government programs. At this time, it is too early to tell whether government support will be available during the restart. It goes without saying that an education program will need to be underway well before recommencement, with appropriate agencies to address the needs for additional support.
While lenders have expressed a desire to be supportive of all businesses in weathering the COVID-19 storm and in the restart process, they will need to remain aware of their own risks in this environment. Lenders will need to address how long they are willing to defer principal and interest payments and waive covenant defaults. To the extent that banks are willing to bolster business liquidity by allowing over advances and increasing eligible collateral, the question they will need to address is the source of repayment and the timeframes. As referenced previously, lenders will need to be prepared to advance additional funds to rebuild inventories and receivables.
Companies are expected to face a wide range of legal issues in coordinating and executing a restart. Many lawyers have recommended reviewing Force Majeure and material adverse change clauses as a result of COVID-19.
Many companies will face potential employee litigation risks associated with layoffs, terminations as well as employee infection and safety. In the retail industry, companies will be looking to restructure their leases given the anticipated reduction in sales volume and added selling costs. There will be no doubt that landlords will resist any changes to their current leases.
The startup of operations may be far more difficult than the shutdown. While the hope that COVID-19 as an existential threat may be removed in the next several years, it is unclear whether the recovery can be achieved in as a short period of time. The damage to economic systems may not be cured without a much more prolonged recovery.
What’s next for you and your business? Despite the existing state of uncertainty due to COVID-19, one thing is for sure: The Zeifmans team is here to help. We are ready to provide you with guidance, support and the resources you need in order to successfully pivot your current business strategies and effectively plan for the future. Contact one of our team members today to start the conversation.
 Survey: Canadian consumer sentiment during the coronavirus crisis: https://www.mckinsey.com/business-functions/marketing-and-sales/our-insights/survey-canadian-consumer-sentiment-during-the-coronavirus-crisis
 Reimagining stores for retail’s next normal: https://www.mckinsey.com/industries/retail/our-insights/reimagining-stores-for-retails-next-normal