12 Building in Public: Survival of the Fittest.
GM. Grab yourself a cup of coffee and settle in. This could be a long one, but I swear it’ll be worth it.
So, I think it’s fair to say the recession has arrived.
Quick question(s): Were the $2,000 stimulus cheques worth the 113% price increase in fuel? How about a 39% increase in air travel? Or a 16% increase in shelter (which is bullsh*t)? Not to mention the decline in wages by -3%? Was it also worth a global recession, food shortages (result of supply chain), and a likely housing crisis?
Maybe.
(lol, not)
Turns out giving away free money and printing trillions of dollars has consequences. Your mom was right, there’s no such thing as a free lunch.
And if anyone blames it on Putin (*cough* Biden). They are wrong.
But hey, here we are. And once again we’ve learned that government intervention within the free-market is bad.
One more thing before I end the rant. Socialists right now are screaming, “but the stimulus cheques helped lower-income families during the pandemic!!” True…
But you know who’s getting absolutely slaughtered by inflation now?
Yeah, those lower-income families. Imagine trying to put food on the table for a family of four on a household income of $60k/annually? You go to the grocery store, gas station, and get a carton of milk (up 15.9% year-over-year) and there goes half your pay-cheque! It’s gonzo!
I digress.
I’m still looking for glimmers of hope but all I'm finding are similarities between 2022 and 1929. Unfortunately this recession resemblances that era in an odd way. If you don’t know what happened then, I suggest you learn here.
As entrepreneurs, where do we go from here?
The beauty of entrepreneurship is the ability to dictate pricing, apply pressure, and remain Antifragile (a timely read for everyone). But many of us (myself included, obviously) have not witnessed an actual recession. Sure, we’ve had whipsaws in 2016, 2018 and COVID. And maybe you watched your parents dealing with the implications of the 2008 financial crisis. But this is different.
It’s different because inflation is running rampant with no signs of slowing. It’s different because people are more leveraged than ever. And it’s different because in an inflationary environment there are no winners.
If you don’t start your morning with a coffee and the financial times (jk i just read twitter) then maybe you’re not familiar with just how damaging the hidden tax of inflation really is.
Allow me to explain it to you like you’re 5 years-old.
“So, mommy and daddy give you $10 for a lemonade stand….” kidding. I’ll stop.
In all seriousness, you are likely grappling with inflation already. Or you will be soon after you spend over $1,000 on gas this month.
Bottom line: it will impact your cost of living, your portfolio (ouch), and most definitely your lifestyle.
Here is a mini lesson on the dangers of inflation for businesses and investors.
Let’s say you own a bakery. This bakery has $800k in expenses and does $1m in revenue, that’s $200k annual profits.
($1,000,000 - $800,000 = $200,000)
This is great! At the end of each year you get to pull-out $200k in profits. Your cash returns are your profits. Hell of a business.
So, if inflation is zero you will continually pull-out $200k in profits. Steady, reliable, and exactly how business is intended to work.
Sadly, inflation is already at 10%. BUT your bakery has *pricing power*, you’re the best in the biz. All this means is that your customers love your products so much that even if you raise your prices, they’ll pay more and stay loyal. So even though your cost of goods (dough, salaries, rents, etc) increased by 10%, you can pass this along to your pastry loving customers. No problem.
Here’s your new Profit & Loss: $1.1m in revenue ($1m x 1.1) minus $880k ($800k x 1.1) in expenses = $220k Profit. Woah, profit went up!!
Sounds good, right? Well it’s not. We're missing a crucial factor, and it’s Capital.
Your bakery needs new inventory and new fixed assets (ovens, mixers, etc.). In an inflationary environment the cost of your inventories and fixed assets are also rising, and these fixed assets need to be replaced more often than we think.
You need to keep pouring new capital into your bakery. And every dollar you put into the business is one dollar you can’t take back out (this is key).
Numbers → Let’s say you’ve invested $500k into said Bakery. That’s $0.50 of capital for every $1 of revenue. Pretty damn good! ($500k / $1m Revenue)
If inflation were zero, you're getting a 40% return this year on the capital you invested ($200k profit / $500k capital invested).
But when inflation has increased by 10%, your capital is 10% more expensive. Now your capital costs are $550k instead of $500k and as a result you can only pull out $170k instead of $220k ($220k profit - $50k Capital). Oh shit… here we go.
So, inflation is at 10% but the amount of cash profits you can take out has dropped by 15%. And it only gets worse.
That $170k is now worth less because our purchasing power has been eroded. It’s really $170k/1.1 = $154.5k. Ouch. In reality, the cash profits you’re taking out now have dropped by a whopping 23%, not the 10% of inflation.
Recap: Inflation at zero: $200k Profits. Inflation at 10%: $154.5k Profits.
Starting to get it?
Remember: this is assuming you have pricing power. The majority of companies DON’T have pricing power. This gets far worse if you can’t convince your customers to pay 10% more for your products. It’s survival of the fittest out there.
One of my favourite quotes from Warren Buffet is from this year’s Berkshire meeting: [paraphrased]
“The best hedge against inflation is being the best. The best doctor will still have patients. The mediocre will die.”
Simply put, in order to survive, you need to be the best. Same goes for employees. Head counts are already being slashed and we’re still early in the game.
You might be thinking, “okay, Matt, fun way to start my Wednesday. Wtf do I do?”
Well, two things. You want to find and develop companies that have these two characteristics (or at least one):
- Pricing power; and
- Capital lightness (think low fixed assets/capital expenditure).
Let’s flip this around for employees too. As an employee you want to:
- Be the best (pricing power)
- Have limited personal debt (capital lightness)
Hopefully you’re still with me.
So, what am I doing?
Personally, I’m focusing on increasing my income as much as humanly possible. People are scared right now, and it’s a good time to get aggressive. Focus on being the best and building.
I can’t control the market, nor can I control the government screwing everything up. I’m focussing on building two awesome businesses and trying to let the rest take care of itself.
Investing wise, I’ve been on the sidelines for the last few months. But now I’m gonna start *dollar cost averaging* (AKA I don’t care if my lemonade is $1.50 or $1.10, I’ll continue to buy it since I already bought it at $2.00). Can it go down another 20%? Hell yeah. But I’m not trying to time the bottom, so I’m okay with it.
I’m also focusing on new skills. This week I dove into video creation (i.e., Tiktok). Insanely challenging, but (short form) video continues to be the winner for marketing. Basically, I’m spending time building a skillset that will set-up me up for success when this shit passes.
Because this shit will pass.
TLDR;
- Increase income;
- Decrease expenses (live like I’m a student with debt hanging over me again);
- Build stuff;
- Gain skills;
- Have fun.
If you made it this far, thanks for reading. Hopefully I haven’t totally ruined your Wednesday and you have a bit more clarity on wtf is happening out there.
As for HeyCPA, we’re doin’ well! Continuing to build funnels and create content. Our traffic is increasing week over week, so all in all it’s good. We’ll get back on track next week, but I thought this was important to discuss inflation and its ramifications in this letter.
Cheers!