Taming the Inflation Tiger
Bording Ostergaard laughs in the face of adversity. Hah! Well, maybe he doesn’t laugh, but he’s not curled up in the fetal position on the floor of the Edmonton headquarters of Optrics Inc. either
by Shannon Sutherland
A near-fatal automobile accident, a catastrophic flood, the sudden death of a 43-year-old business partner – these were tragedies, to be sure. But he mourned them, managed them and moved on.
What might just do him in, however, is the damnable Alberta Advantage. His smile is definitely slipping despite the fact that he is in a province where the economy is the envy of the nation. The Conference Board of Canada predicts Calgary’s gross domestic product (GDP) will grow by 4.2% in 2007, while Edmonton’s economy expands by 3.7%.
Ostergaard should be gleefully wallpapering the coffee room with copies of his balance sheets. After all, his clients include Microsoft, Bell, NASA and PepsiCo, and between 2001 and 2006 his profits increased by 1,550%. The engineering firm’s 2006 revenues hit almost $4.4 million, and clients are banging at the door. The bottom line, however – that picture isn’t quite as pretty. “We’re expecting to see growth of about 8% this year,” says Ostergaard. “But revenues are flat. The dollar is killing us, costs are creeping up and profit margins are being squeezed.
“I’m sitting here looking at an empty desk right now and it has been empty for about 14 months,” he continues in a telephone interview. “The Alberta Advantage has become the Alberta disadvantage. Everyone wants the petro-dollar paycheques. I’m giving raises to try and keep ahead of the fact that employees are dealing with rising energy and housing costs, but recruiting is impossible. So what do I do? Panic? Cry myself to sleep?” He laughs. “Well, I’m not quite at that point yet, but I can’t do anything about my profit margins, so we reduce costs where we can, and we have been talking to American clients and advising them of the challenges that we’re facing.” He says Americans tend to be “rather inward looking,” so most of them really have no idea what’s happening up here. They are learning though. And Ostergaard is educating them. The value of the American and Canadian dollars are a definite problem for Optrics, and the rate of inflation in Alberta is most certainly compounding it.
The consensus across Canada is that Alberta has contributed disproportionately to inflation in this country. In June 2007, Alberta contributed 0.6 percentage points – or 27% of the total increase in prices – while Alberta’s share of the national consumer basket is just over 11%, says a recent study by TD Financial Group. It found that Alberta has consistently contributed more to core inflation in Canada than British Columbia and Quebec combined, and without Alberta, the core inflation rate in Canada would have fallen to 1.7%, which is well below the 2% target set by the Bank of Canada. Calgary’s inflation, which is already Canada’s highest, grew from an average of 4.6% in 2006 to more than 5.6% by June 2007. In March, it was a staggering 6.5%.
The cost escalation is affecting all businesses, but small businesses are the most vulnerable to the inflationary tiger’s claws. “The ability of the business to pass on higher costs to the customer has everything to do with succeeding in Alberta these days,” says Adam Legge, director of research and business information for Calgary Economic Development. “For some, the economic conditions in Alberta have created a perfect storm of sorts. In manufacturing, for instance, higher labour costs, a higher Canadian dollar, higher real estate costs and energy costs and competitive pressure to keep making things more cheaply make the situation an almost impossible one.”
For small businesses the situation is creating a cash-flow crisis. If customers don’t cut cheques quickly enough, paying suppliers, paying rent and even keeping the lights on becomes a struggle. Costs are increasing faster than business owners can price themselves back into a profitable position, never mind trying to stay competitive. Cutting costs is not just a long-term survival strategy; it often involves finding ways to free up cash sometime between now and right now.
Yet despite these grim facts, Alberta and B.C. continue to boast the most bullish small business owners in the country, according to the Canadian Federation of Independent Business’s (CFIB) business barometer. That could be because despite rising costs, there is still much money to made by Alberta-based businesses — particularly for those that can minimize the impact of inflation on operating costs. So how can you do that? Read on.
Waging War
Labour is one obvious area where the cost of doing business is going up fast. Average weekly earnings rose just under 5% across Alberta last year, according to Statistics Canada, and far more in occupations suffering an acute labour shortage. When asked how Alberta’s labour shortage has affected their firm, about two-thirds of Canadian Federation of Independent Business members said they are facing increased labour costs, according to a 2006 survey by the association, which represents small and medium-sized enterprises across the country. The survey also found that just over half of all small businesses are simply functioning with inadequate levels of staff or are ignoring new business opportunities because some employees can’t be had at any price.
“A lot of businesses are trying to come up with ways to improve recruitment and retention with short-term cost increases rather than long-term cost increases for things like wages,” says Danielle Smith, director of provincial affairs in Alberta for CFIB. “That’s why we’re seeing so many hiring and retention bonuses.” In 2000, U.S. Bureau of Labor Statistics did a study on the cost of hiring bonuses and found that they cost employers an average of seven cents US per hour according to the amount of hours employees ended up working. Since small businesses employ fewer people, hiring, retention and referral bonuses may be a great option for dealing with staff shortages now without building the increases into your cost structure for the future.
Cash remuneration does not tell the whole compensation story, though. It’s important to understand just how much an employee costs. For instance, if a business owner gives two weeks vacation, five holidays and five sick days, that is a total of 20 non-productive days that is paid by the employer. The work year is 260 days long, and that means that almost 8% of a business owner’s labour costs are being paid out for non-productive time. If one were to factor in the cost of other benefits, it’s easy to see how expensive employees are. The average “extra” cost of each employee can be up to 35% over an above wages or salary, although it is usually between 20% to 30%, according to the Alberta Women’s Enterprise Initiative. That means an employee earning $40,000 per year is actually costing the employer $54,000. If you want to keep a lid on labour costs, therefore, you should also consider ways to carry on business with fewer bodies.
Alnoor Kassam found BlackBerrys to be fruitful in improving productivity and reducing the amount of employee-hours needed to run his hotel. When Kassam took on the task of making 5 Calgary Downtown Suites profitable, he invested in the wireless
e-mail devices to help overcome staffing challenges and potential lapses in customer service associated with staffing shortages and quality.
“We trained all 120 employees to use a BlackBerry as an essential part of their job,” says Kassam, a former banker, serial entrepreneur and venture capitalist who has now set his sights on becoming mayor of Calgary. “Every housekeeper started using a BlackBerry to report maintenance requests. Paper use and errors resulting from hard-to-read writing were eliminated. The maintenance manager was able to reduce costs by prioritizing requests, developing a database of issues and improving operating systems. This resulted in reduced response times. The speed for resolving maintenance requests was reduced from two days to four hours.”
He says housekeepers also used the BlackBerry to update room status as soon as rooms were cleaned, and front desk staff could then assign rooms to guests earlier than before, which pleased guests and made it unneccessary for housekeeping staff to verbally report to a supervisor three times a day. “The BlackBerry system created huge efficiencies, lowered costs, reduced staff turnover and increased morale,” says Kassam. “BlackBerry use enabled our sales team to close sales 24/7. Sales resulting from overseas and East Coast e-mails could be closed in minutes, and sales people no longer felt bound to regular office hours or desktop computers.”
Another option for controlling your labour costs is outsourcing or even crowdsourcing, which involves outsourcing to a large, undefined group of people. Greg Balanko-Dickson, the man behind the Edmonton-based consultancy Remote Control CEO, says he himself uses crowdsourcing site CambrianHouse.com to leverage the expertise of others. For those who indulge in the more traditional form of outsourcing, payroll is often one of the first functions that is farmed out. An October 2006 ADP study found that those who do payroll in-house are spending about one-third more to do so than those who don’t. The study estimated that outsourcing payroll could save business owners about $939 each year on average.
Homing In
Sometimes, however, one must drop a few bucks – or possibly a few hundred thousand – to save a few. Kim Semeniuk knows how to keep his people happy: double their wages and buy them a house. “You have to take drastic measures to keep people,” says Semeniuk, operations manager of Calgary’s Impact Zone, which provides moving and delivery services.
Economists place the cost of housing squarely at the epicentre of this inflationary storm. The year-to-year rate of inflation for shelter grew at an average rate of almost 14% in the first half of the year in Alberta – compared to 1.2% in Ontario and 3.1% nationally. When the inflation in housing is excluded, the core measure of inflation in Alberta falls dramatically – closer to 2%. Semeniuk decided to confront the wage and price spiral at its source, the cost of housing.
“One gentleman I have working for me worked for three winters and he was good, but I’d lose him every spring when he’d go back to landscaping,” he explains. “Not only did he make more at that job, but they provided accommodations too. I couldn’t afford to keep losing him, so I increased wages and bought a [company] house. Another guy who used to work for me just came back and I had to give him more money, and now he’s staying at the house too.” Semeniuk was able to finance at least part of these increases by scaling back his business. Now he employs three, but at one time he employed 14. He was unhappy with the performance and ethics of his employees, so he fired all but one, and hiring that many people back on became impossible. “Obviously I’d like to grow my business, and the business is there, but I just can’t do it right now,” says Semeniuk. “And I know that.”
The moral of the story, though, is that accommodations can be used to attract and retain staff and reduce operating costs over time. Both Semeniuk and Ostergaard did it. If four employees can be provided with accommodations in a house, each employee could be saving more than $10,000 each year based on average rents in Calgary right now, and if average wages offered could then be reduced by even $5 per hour for each of those four employees, that would save more than $40,000 per year in wages. The bonus is, of course, that the business owner also owns the house and is building equity. It is also much easier to recruit from outside of the area where the business is located if you can provide accommodations.
Costs in Space
They might not be turning a profit, but they’re turning some heads with their take-the-bull-by-the-horns response to rampaging rental rates in the province. Three charities, NeighbourLink, Community Kitchen and Eye Way, joined forces to form Storehouse 39-3-10 to purchase 48,000 square feet of space in northeast Calgary. They said so long to their leaky, lacklustre digs that were costing them more all the time and bought their own property. Last spring they moved into 48,000 square feet of space in northeast Calgary, having purchased the property for $4.5 million in 2006. They invested $2.5 million in renovations, and now
Sara Barbosa, who works in donor relations and building management for the organization, says their equity has almost doubled.
There are five charities in the building with room for eight. They rent out to four tenants including commercial enterprises, but they will take back some of the space as the leases expire. Sharing volunteer co-ordinators, warehouse staff, bookkeeping staff and call centre staff is all a possibility. Many more groups and businesses are now co-locating to pool resources and share space-related expenses.
“Co-working is especially attractive for solo entrepreneurs,” says Balanko-Dickson of Remote Control CEO. “That doesn’t exactly sound new, but I’m talking about an open space where people can come and go at will – say 30 or 40 entrepreneurs. It’s a really great option for home-based entrepreneurs.” At The Network Hub in Vancouver, entrepreneurs can get shared office space for $350 a month or a private office for $650 with access to meeting rooms, a mail service and basic reception in a fully outfitted office in a heritage building downtown. That’s not a bad deal considering prime office space in downtown Calgary can go for about $40 per square foot. “When I talk to people about the cost of setting up an office, I tell them they’re looking at an absolute minimum of $18,000 per year or $1,500 per month, and then most of them gulp and say, ‘Gee, I don’t think I should do that,’” says Balanko-Dickson.
Securing affordable industrial space can be even trickier. “Dire,” says Iain Ferguson, a sales associate in industrial leasing at CB Richard Ellis Alberta Ltd. (CBRE). “That’s how I would characterize the situation for people looking for industrial space – especially if you’re looking for something that’s less than 10,000 square feet.” The total industrial inventory in Calgary is almost 107 million square feet of space, according to J.J. Barnicke Ltd. The vacancy rate is sitting at about 1%, and that is actually a generous estimate, says Ferguson. “There are several really large vacancies on the market that are skewing the numbers a little bit,” he says. “I’d say for spaces under 20,000 square feet, the vacancies are at zero.” In Edmonton, industrial vacancies hit a historic low of 3.5% in 2006.
Ferguson says that good tenants are still valued, though – maybe even more so in such a volatile market where people are having more and more trouble paying up, so long-term tenants don’t need to approach lease negotiations with too much trepidation. A reliable tenant is always preferable to a landlord than the prospect of turnover. Tenants need to recognize and leverage their own bargaining power.
Suppliers and Demands
Often a bigger expense than either labour or leases is the day-in, day-out drain of supplier accounts payable. Here, especially, there are no easy fixes, but rather cost control by a thousand cuts. Or clever ways to turn a straight cost into a revenue generator.
Kassam, for instance, found a way to negotiate a win-win scenario with his hotel’s telecommunications provider. “We found few hotel guests were using hotel phones because hotels were charging a dollar for calls within North America and even more to call internationally,” says Kassam. This represented lost revenue for the hotel in providing a value-added service as well as a lapse in customer service. “We decided to charge five cents per minute for North American calls and a few cents over our cost for calls overseas – eight cents a minute to London, England. We were able to negotiate a price reduction from four cents to 3.5 cents. We saw phone usage in the hotel jump from 2,500 minutes to 4,000 minutes a month. Sprint, our supplier, began treating us as a preferred customer because we were innovative and used a lot of minutes. Customers loved us. They not only returned to the hotel, they also told their business associates and friends.”
Sometimes even small-time buyers can negotiate bulk prices with suppliers if they show a consistent ability to buy product or services over time. It’s also often worthwhile to ask suppliers for a discount if the invoice is paid promptly or is paid by cheque rather than by credit. Revisiting terms of payment and offering even a 2% discount to customers who pay promptly can also improve cash flow. Balanko-Dickson says small business owners in a cash crunch – for example, who must pay suppliers within 30 days of delivery, but who allow customers 30 days to pay – are going to run into problems. It never hurts to ask suppliers for more time, and those who are not willing to talk may need to be replaced. He says it’s important to revisit these relationships regularly anyway, since a supplier that met a company’s needs two years ago might not best meet its needs today. Businesses grow and evolve, and if orders have grown significantly, but costs have not been revised, it might be time to shop around.
Another area worth watching is your inventory, which represents sunk operating costs. No business owner wants to run out of stock, but overstocking can run a business right into the ground, especially in an inflationary environment.
First, find out how well your inventory management compares with industry benchmarks. Most business owners can find out what the average inventory turnover rate is by calling their trade association. For a business owner to determine his or her inventory turnover rate, he can divide the cost of goods sold by the average value of inventory to get his average turnover rate. If a company started the year with $150,000 worth of inventory and ended with $200,000, then the average inventory would have been $175,000, and if the company sold $525,000 over the year, the average inventory turnover would have been three times a year. If the industry turnover for the same type of business is four times a year, the company could improve its inventory management by 25% simply by matching the average of its peers. That can give a business some extra cash to invest elsewhere as needed.
“This is the time when businesses need to know exactly where the money is going and where it is coming from,” says the CFIB’s Smith. “Small business owners recognize that no one is going to solve these problems for them. There’s no accounting department that’s going to be able to figure it all out and the pressure can be tremendous. But at the same time, the opportunities are enormous too.”
Life’s Tough. Pass it on
Ostergaard has learned that sometimes you’ve got to pass the buck to make a buck. “You hate to go hat in hand to people and say, ‘I need more money,’ but we do it because that’s what we have to do,” he says. Optrics’s American clients have been mostly sympathetic and have responded by offering marketing dollars and co-op dollars, but Ostergaard is also confident that he provides a service so valuable he will never price himself out of the market.
“I used to think it was a privilege to partner with these companies, and now I realize that we sell so many product lines that I can say, ‘Hey, if it’s not profitable to handle your product line, then I guess I just can’t do it,’” he says. “If we sell more of their product than anybody else on the planet, then it’s pretty hard to replace us. We have days when there are five or more companies asking us to help them get their product to market. We know how to get mousetraps under eyeballs, and people recognize that. So if you provide a service that is essential to your customers, I don’t think a slight increase is that big of a deal.”
Passing on increases to the customers is nothing knew. That’s why bread no longer costs 35 cents a loaf and a 1965 Mustang, $3,334. There’s more than one way to do that, however. Some businesses are breaking out charges for services such as delivery and are charging extra or are tacking on a fuel charge — after all, everyone understands all about the rising price of gas.
Boom times can be such hell. When opportunity knocks these days, it’s hard for business owners to know whether they should throw open the door and do a happy dance or cower in the corner as they calculate the cost of customer appreciation night and catalog shop for energy-efficient light bulbs. They need to have some sort of plan though, because the good times aren’t going anywhere just yet. “All I know is that it took me 10 years to get here and I’m not bailing out now,” Ostergaard asserts. “I’m not moving, and I’m keeping my team together. Sometimes dealing with these issues is distracting frustrating and absolutely overwhelming, but here I am. And here I will stay.”
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