Dear Sakeliga Member,
When a business environment deteriorates, as in South Africa, it can be quite dispiriting. The budget speech of twee weeks ago was a case in point: it confirmed that national and local government, as well as state enterprises such as Eskom, are heading toward fiscal crisis.
The downside to dispiritment is that it doesn’t help you identify and create new opportunities, products and services. For that, you need pro-active engagement, deep thinking, conversations about future alternatives, and innovative strategies.
That’s why I asked Sakeliga’s analysis team to work with Russell Lamberti of ETM Macro Strategists on developing a post-budget risk containment and opportunity strategy. The question is: given the fiscal crisis building up at local level, national level and state enterprises such as Eskom, given BEE and other procurement barriers, what can businesses do to limit exposure to these risks? And what opportunities might arise in such an environment of state weakening?
Below, I share with you their discussion document. Please send us your comments. It is the kind of topic that will have to remain on the agenda.
Piet le Roux – CEO, Sakeliga
The budget and your business strategy
Russel Lamberti, Founder & Strategist: ETM Marco
With inputs from Gerhard van Onselen and Daniel du Plessis
In this piece, we want to outline what the budget and South Africa’s fiscal and economic climate means for business strategy. Although Mr. Mboweni’s recent budget effort was not quite a carbon copy of what’s gone before, his budget still lacked anything one could label as truly reformative.
What changed from previous budgets?
- Short answer: not much. Deficits remained very wide. Taxes kept rising, but actual collected revenues are falling. Large and volatile contingent liabilities (SOE debt, bailout risks, lawsuit liabilities) kept rising. The state payroll is set to remain huge at around 35% of the total budget. The state remains grotesquely bloated and runs like a charity machine.
- The government plans on running slightly larger deficits than forecast at last October’s mini-budget. The main reason is that it has decided to cover all of Eskom’s debt repayment costs, amounting to around R23 billion a year. This is, of course, an effective bailout for Eskom.
- There were some shake-ups to the energy sector. Eskom restructuring is being considered more seriously but promises to be a fraught, laborious, bureaucratic, and risky process at a time when Eskom’s infrastructure is creaking. The finance minister stated government’s openness to independent power producers and greater energy sector liberalisation, but the introduction of the carbon tax in June 2019 and subsidies to renewable energy producers remains a drag on energy sector liberalisation. The carbon credits market will now start taking off in South Africa under this regulatory and tax regime.
- SOE ownership: The finance minister is rather encouragingly trying to start a conversation on whether the state needs to own SOEs. Treasury is mulling partial privatisation (“equity partner”) of the transmission division of Eskom. But the finance minister faces stiff opposition within the ANC to relinquish control over these organs of patronage.
We think the most important takeaway from this budget was how fundamentally incapable the ANC is of real fiscal reform under its new leadership. Steady fiscal decay continues under president Ramaphosa.
In this way, it might be useful to think about South Africa as a country that, in economic terms, is in a state of de-development – that is, being a de-developing country that exhibits the opposite tendencies of a developing country. In a de-developing country, the middle-class shrinks, products and services become less abundant and competitive, and supply chains become thinner and less well developed and integrated. The quality of state services declines. Affording a good quality lifestyle becomes disproportionately expensive. The country’s poor become more radicalised and discontented. State corruption doesn’t lessen.
The budget reinforces our view that South Africa is fundamentally de-developing. De-development is a critical theme for your business. The four key pillars of South Africa’s de-development, as we see it, are a (1) broken ruling ideology, (2) a re-distributive “charity” and patronage economy propped up by a dwindling tax base, (3) rising crime rates, and (4) extremely high rates of skilled emigration.
Business strategy in a de-developing country
This is the unfortunate backdrop against which you are doing business. So, what does steady fiscal decay and economic de-development mean for business operators and business strategy? Below are some of our thoughts. We present the following with the intention of sparking a discussion among Sakeliga and its members. We want your input on how businesses can survive and thrive under the conditions of de-development and de-sophistication of the SA marketplace.
- Although an obvious strategy for quite some time, businesses should avoid doing business with the state. Corruption has permeated the state on many levels. The state is often implicated in vast networks of corruption and favour-seeking. It establishes patronage networks across many government departments and institutions, so you run the risk of being drawn into corrupt practices. The state has high and continually mounting BEE requirements. Acceding to BEE is a significant long-term risk to your business and your control over it, especially as BEE goalposts keep shifting. The state is a poor payer, which is a considerable cash flow risk. State contracts can be fickle, politicised and highly uncertain due to both corruption and a lack of finances. Many state projects are profoundly wasteful, meaning your business is contributing to wealth destruction and capital malinvestment. Government is bureaucratic and slow, and this risks infecting your business management and governance as you are forced to comply with government rules and regulations. If you do government work, you should expect 75% upfront payments (or higher) to secure cash flow and payment.
- Consider shunning BEE. South Africa is losing white and non-white skilled individuals to emigration. Skills are scarce and encumbering your business with rigid BEE and affirmative action burdens is going to be increasingly risky and costly. Instead, consider building a network of business suppliers, customers and consultants that also shun BEE or don’t need to be as compliant. One solution is to evaluate the offerings of international free-lance websites such as fiver.com or similar websites. Another option is selling directly to customers online using available e-commerce technology and efficient, niche delivery services or warehouse collections. BEE is an insidious policy to draw companies into a web of anti-market, bureaucratic obligations that they cannot extricate themselves from in the future. Bear in mind that ‘tooling’ your business to serve government requires upfront sunk costs, cost you could incur to serve other market ends. BEE diminishes business flexibility and creates unnatural ‘one big customer’ dependency. BEE deals are often also reliant on a rising stock market and growing economy to be successful. In a de-developing economy, BEE is an expensive and structural business liability. We also believe it is a fundamentally racial and unjust policy.
- For those that are already BEE compliant and locked into BEE-reliant contracts, consider processes and strategies to de-risk your business from BEE dependency. Perhaps seek paths to market that require lower BEE scores or selling directly to households or offshore-owned businesses, domestically, or export. Exploit niches or exclusive licences to become indispensable to buyers so that they will tolerate lower or no BEE points.
- We believe that in a de-developing economy within a high-tech world, retail can become bifurcated into basic, mass retail on one side and niche, high-tech retail on the other. If so, this means exposure to middle market store retail like that found in middle-class shopping malls is a risk. Store space could well diminish in favour of low stock/inventory, online, delivery-based retail. This favours online retail, slick and secure ordering and payment processes, and a slick, niche delivery network. Niche, flexible, rapid logistics operations should do well in this environment. Demand for large warehousing space may suffer as inventories decline.
- On the other side, simple, affordable products that can be sold in high volume will remain in demand as on the other end mass retail simplifies.
- In a de-developing country, operational risk keeps rising, meaning there is less forgiveness for low margin businesses. The only chance for low margin success is in very large mass retail. Outside of that, businesses need to seek product niches, protectable IP, low overhead, high margin lines of business. In de-development, unskilled labour remains cheap, but unfortunately, labour legislation is likely to become stricter, adding to the ‘cost’ of labour. We recommend reducing exposure to labour intensive lines of business as labour represents a volatile and inflexible overhead. The key in a de-developing economy outside of large-scale mass retail is to be able to make a good living on low volume.
- De-developing economies move more to the use of cash than toward the use of credit. We think cash-based businesses have an advantage. However, a large volume of physical cash on site is a crime risk. The use of safer EFT payments is already ubiquitous, but physical cash protection and management are another important strategic consideration.
- The characteristics mentioned above allow for greater resilience in the face of volatility and greater flexibility in the face of change, and a de-developing economy is far less stable and more prone to volatility and change. This volatility can present tremendous business opportunities for those flexible enough to take them. Business strategies may, therefore, need to become far more open to rapid shifts in preferred lines of business, switching product lines, and being structured to be able to pivot into new sectors, products or services quickly. Nimbleness is key.
- De-developing economies tend to suffer from rapid currency depreciation and greater currency volatility. This requires high margins as previously mentioned, but also smart treasury management and building export markets to earn foreign currency. One can manage currency risk by using currency hedging and options and futures structuring services. Export markets can be found through good online visibility or connecting with a network of import/export agents. Business surpluses could also be invested offshore to mitigate currency risks. The Sakeliga network should also extend overseas to make business connections to facilitate and find export markets.
- De-development means basic services and infrastructure decays. Business opportunities await in providing substitutes for these services. A broad array of services already benefit from state failure and can be exploited further, like private mediation and arbitration services, cryptocurrency services, private governance services (e.g. club setups with shared ‘public’ infrastructure), security and self-defence products and services, water, energy, refuse and waste services, and many more.
There are certainly many other implications that flow from economic de-development. We believe it is critical that South African businesses grasp the reality of what it means to operate in a de-developing country and adapt to this reality.
Please join our discussion on Facebook – we are looking forward to your input, suggestions and perspectives.