A Sobering Reality Awaits Brick and Mortar

COVID-19 is an absolute disaster for just about everyone. There are ultimately three ways the virus ends and we go back to “normal”

1. A miracle cocktail of drugs staves off death. We don’t have a vaccine, we don’t have herd immunity, but we find that some type of treatment exists where, once contracted, the virus is no longer as dangerous. This could involve limiting death or hospitalizations.
2. A vaccine is developed and everyone is inoculated. Optimistically this will take 2-3 years, and that’s assuming no major hiccups to either production or testing. Remember, the first measles vaccine created a number of unfavorable side effects and was thusly pulled off the market, iterated upon, and fully released a whole decade later (by the way it takes 10 years for the average vaccine to get to market)
3. Herd immunity. Enough people need to catch the virus that everyday life is not impacted and we’re generally considered immune. Yes, the virus will mutate and hang around like influenza, but it would pretty much look like life as normal.

If you asked us, we’re betting on the third outcome to happen faster than the first two. That’s because hundreds of millions of people around the globe cannot afford to quarantine themselves until a vaccine is made available. Many of these people come from poorer nations, where they’ll be the last to receive any sort of treatment. In India alone there are an estimated 375 million people in the “informal” economy that can’t possibly adhere to quarantines; for these people the choice is risk the very, very small chance of dying from COVID-19 (which is looking to be in line with the fatality rates for the seasonal flu, which alters our social behavior none), or risk the 100% guarantee of starving to death next week.

Not every OECD nation is as rich as the United States either, so don’t be surprised if European neighbors start experiencing riots and social unrest over the deteriorating economic conditions created by the quarantines. This will effectively catalyze herd immunity as economies more fully open in demand to the unsustainable number of unemployed.

Brick and mortar, meanwhile, has to figure out how they survive. And don’t get us wrong, we think it will rebound when it’s all said and done. But it could be 2-4 years of real hardship.

Everyone is wondering how long this can go on, but we think there are really three major questions those in brick and mortar must be asking themselves.

How will my business perform if consumer spending is no greater than 50% of pre-COVID levels for several years?

The economy is going to be very sluggish, even when the markets reopen. Consumers are going to be nervous, and there will be a growing number of unemployed that suck the discretionary spend out of the market. We’re predicting 40M unemployed by June 1, but of course we want to be proven wrong. That would mean 25% of Americans are out of work, a number on par with that from the Great Depression.

The at-risk (old and sick) populations may continue to stay home if they can afford it. In the restaurant vertical those aged 50 and over represent 45% of all spend.

In China, table service restaurants are required to reposition their floor plans to space guests much further apart. This entails removing anywhere from half to 75% of the seating. That doesn’t include the capital expenditures necessary to keep customers feeling safe: temperature checks, gloves and masks, plastic barriers, and more. What SMBs can really afford to do this?

Many merchants have doubted their abilities to stay solvent through the crisis. The latest surveys show that 75% of SMB restaurants are likely dead, and we can imagine a base case where 50% of restaurants disappear. Grabbing from a quote in the WSJ, “You can’t do 40% of your previous revenue and survive, because your cost structure isn’t set up to support that,” said Ray Blanchette, chief executive of TGI Fridays, a chain with 840 restaurants. Which begs the question…

Do I reopen, or is it better to declare bankruptcy and wait it out?

There’s been little discussion about the legal unwinding that comes in reopening a business. Very few main street merchants have balance sheets, so when COVID hit they were drawing down capital or stiffing people that they otherwise should have paid. If a business decides to reopen, who gets paid first? Here’s a list of potential creditors:

• The merchant’s bank, who loaned them money to build their business
• The merchant’s suppliers, who extended credit and haven’t been paid
• The merchant’s landlord, who most likely never received their payments the past few months
• The merchant’s insurance company, who is looking for their lost premiums
• The merchant’s employees, who may be due back wages
• The federal government, who loaned money under the PPP program

This is not an exhaustive list, but you get the idea. Sorting this out will take attorneys and money the SMB doesn’t have. It might just be easier to declare bankruptcy and wipe the slate clean.

Will brick and mortar change permanently, and if so is my business even relevant anymore?

One must question whether the markets have been forever changed, and consumer behavior fundamentally altered. Will consumers increase their preference for ecommerce? The rise in grocery delivery has been staggering, with Instacart, a delivery provider, going on a hiring spree.

Will consumers continue their demand for off-premises dining? If it’s permanent, most restaurants are paying for a footprint they don’t need, and in a thin margin business this will prove unsustainable (hence the allure of the ghost kitchen).

Can brick and mortar merchants change their operations to meet these changing expectations? It will be very challenging.

Many merchants have large footprints for in-store customers. As these customers disappear the merchant is paying for space they don’t need. In the case of retail, there’s no sense in having inventory if you can drop ship the item direct to the consumer, so the physical retailer is adding additional costs with no real value. In the restaurant vertical, the merchant has space, systems, and people that are gratuitous for an off-premises business. Neither type of merchant can afford to spend money reconfiguring their stores either, so this benefits the existing ecommerce retailer and ghost kitchen operator, respectfully.

But even they’re not immune to shrinking consumer spend. Indian ordering platform Swiggy is letting go of its ghost kitchen staff in large numbers.

There’s a lot of uncertainty, but we need to be honest with the expected outcomes: for most of brick and mortar, there will be no V shaped recovery… just a few years of pain. But the human spirit will endure.