The Market

last updated 14/05/2020

Economic outlook and the impact on franchising

last updated 14/05/2020

May 2020 - Westpac’s latest Quarterly Economic Overview suggests that Covid-19 will cast a shadow over the economy for years, but that recovery will be faster than after the GFC. What impact will this have on franchising?

The economy in six charts (from Westpac Economic Overview May 2020)

Covid-19 will cast a shadow over the economy for years after the virus has passed, says Westpac’s special edition Economic Overview published in May. ‘Consumers and businesses will go into their shells amid high unemployment, falling house prices, and damaged balance sheets. The farm sector will suffer an income hit due to a global recession. And the dearth of international tourists will be keenly felt. Scarring from the Covid-19 recession will permanently damage New Zealand’s long-run productivity, meaning GDP and wellbeing may never fully return to their pre-Covid-19 trends.’

Dominick Stephens, Westpac’s Chief Economist, comments that, ‘Disruptive events tend to accelerate trends that are already in place, and Covid-19 will be no exception. One example is that we have seen an obvious leap forward in the digitisation of the economy, and there will be no going back. That may be the last straw for some firms and a huge opportunity for others, but digitisation is a positive for the economy overall.’

And he continues, ‘Despite the gloom, it is worth pointing out that we are actually forecasting a more rapid economic recovery than after the GFC. For example, we anticipate four years of above-5% unemployment, whereas after the GFC there were eight.’

‘The magnitude of the coming recession warrants an unprecedented policy response. The Government is right to do all it can, but the consequence will be a debt to GDP ratio of 50%. That will leave future generations fewer options as they support the aging population. Meanwhile, the Reserve Bank will probably have to expand its quantitative easing programme and cut the OCR below zero for the first time in New Zealand’s history.’

Some specifics from the full Overview

As restrictions on economic activity continue to be relaxed over time, there will be a sharp lift in GDP as businesses reopen and catch-up activity occurs. Even so, a full recovery will take years. We expect annual GDP will drop 6.3% over 2020 and recover by only 4.7% in 2021. That said, we expect the economy will recover much faster than it did after the GFC, because the impediment to growth this time is temporary. This time we expect that the economy will recover to its pre-recession size after two years, whereas after the GFC it took three.

Weakness in our export sectors combined with the downturn in the domestic economy will leave businesses more focused on survival than expansion. We have already seen a number of business closures, and unfortunately there are likely to be more over the next few months. Among those businesses that do survive, many will have to borrow to get through. That means that once the recovery begins, they will be focused on balance sheet repair rather than expansion. Consistent with that, we’ve already seen many businesses scaling back plans for investment spending. In addition, there is likely to be further job shedding as the Government’s wage subsidy programme comes to an end. We expect the unemployment rate will rise to 9.5% in June – its highest level in 27 years.

Some people have lost their jobs, and others will become more financially cautious. We’re also likely to see wage growth fall from over 2% per annum in recent years to around 1% in 2021.Even people untouched by the labour market downturn will find that their balance sheets have been damaged. KiwiSaver balances have already fallen and, as discussed below, house prices are likely to fall. This will dent households’ wealth, requiring them to reduce consumption and save more in order to rebuild balance sheets

We expect house price growth will remain modest through 2021. However, that’s likely to give way to a period of rapid gains over 2022 and 2023. The Reserve Bank has reduced the OCR, removed its loan-to-value restrictions and mortgage lending, and delayed its requirement for banks to hold more capital. This will make mortgages more available and less costly over time. Once the virus disruption passes and confidence eventually returns, low interest rates will result in a very fertile environment for asset prices, including house prices. Even so, it will be around two years before house prices reclaim their recent highs.’

Impact on franchising

What will this mean for franchisors and franchisees? Franchise New Zealand editor Simon Lord comments.

The first thing to recognise is that the 37,000 franchised outlets around the country are not immune to the same problems that face all business during this time. They do have the usual franchise advantages of support, buying and negotiating power, but that won’t be enough to protect them all, especially in some sectors.

The extension to the Wage Subsidy Scheme announced in the Budget, along with other initiatives on business loans will certainly help save jobs, but the lack of action on introducing an Australian-style Code of Conduct governing landlord/tenant negotiations can only exacerbate financial problems for many. The wage subsidy will unfortunately not solve the problems for businesses that were already under pressure pre-Covid-19 and may indeed have the opposite effect, getting the owners of unviable businesses deeper in debt. Owners in a negative cash-flow position should therefore talk to their financial advisors before taking any additional lending or subsidies. Sadly, some franchisees (and many independents) will not have sufficient resources to survive and their businesses will tragically close or be resold. A hospitality business might recover 80 percent of its former sales levels relatively quickly, but the missing 20 percent can make all the difference.

Paradoxically, this means that there will be a number of viable franchised businesses which come on the market and represent good opportunities for those in a position to buy. With less debt, a new owner may well be in a position to benefit as markets grow again.

Another area of opportunity going ahead is the low-investment franchises, especially home-based and mobile services. It looks as if, in the short term, redundancies are going to be most common in the hospitality and tourism sectors. While many of these people (but not all - pilots?) may not have a lot of savings, these are people used to working long and sometimes unsocial hours. For them, ‘buying a job’ may be not just a necessity but a real opportunity. Franchisors will be looking for good workers as franchisees, and many will develop packages to make their opportunities more affordable for the right people.

As the Westpac report notes, homeowners will have seen their equity reduce and many investments have lost value, too, making borrowing to fund a business purchase potentially more difficult. Given that many franchises have solid business models and a proven business model, buyers may find funding easier to obtain when buying a franchise than an independent operation (or a new start-up). However, this will depend on the individual franchise and the sector in which it is operating.

Learning from history

Traditionally, the franchise sector performs well during recessions as people are moved out of declining industries and into growing ones. The period following the 2008 Global Financial Crisis was a strange exception to this, as unemployment did not increase as much as had been the case in previous recessions and finance was hard to come by. The next few years look more likely to follow the normal post-recession pattern with growth opportunities and more financial stimulus.

Choose well and those opportunities could start sooner than you think. We've already heard of one franchisee who has done so well in the last two weeks that they have paid off part of their business term loan early, while feedback from franchisors in less-impacted industries has been good and the rest are ready to go.

One final thought: each recession makes franchisors look anew at their business model to ensure it is robust enough to withstand the hard times as well as flourish in the good ones. Wise franchisors never forget the lessons learned, and pass these on to their franchisees. Wise franchisees take this advice.

If you are looking at buying a franchise in the current climate, then, it pays to look at how the franchise has survived this latest shock. One thing we would strongly recommend is finding out how the franchisor has supported franchisees during the Covid-19 restrictions (there are some case studies here), and talking to franchisees to find out how helpful they found that support. Above all, do take financial advice from a specialist before taking up any opportunity – franchised or not. Good advice will be invaluable in making the right decision.

Read the full Covid-19 special edition Economic Overview here.

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