The past three years have tested the strength and resilience of America’s small businesses. While there are signs that economic conditions are improving — inflation has fallen faster than expected and the labor market continues to create jobs — small businesses are likely to feel the pressure of rising interest rates, the looming threat of recession and persistent labor shortages in 2023, according to Peter Boumgarden, professor of practice of the Koch family in the family business at the Olin School of Business at Washington University in St. Louis.
“Small businesses are a significant driver of the U.S. economy, accounting for two-thirds of net new jobs and nearly half of U.S. economic activity,” said Boumgarden, who is also director of the Koch Center for Family Business at the Olin School of Business.
“Understanding and addressing the challenges facing small businesses will be critical to promoting long-term economic recovery. This can be achieved with favorable political conditions, but also by giving these leaders and owners the framework to know how to approach this market agilely.”
Challenge no. 1: Growth of interest rates
In 2022, the Federal Reserve raised interest rates seven times to the highest level in 15 years in an aggressive attempt to tackle inflation. Additional interest rate increases are expected in 2023.
“Rising interest rates will be one of the biggest challenges for small businesses across all sectors as it will limit their access to capital, which has been relatively easy to come by in the past,” Boumgarden said.
With borrowing costs rising, Boumgarden said many small business owners will rethink plans to expand or take on large projects that would traditionally require an injection of a business loan. In some cases, these projects may be put on hold in 2023. Or they may seek other ways to finance the project, such as tapping into existing cash reserves.
“Many privately held companies must choose whether to prioritize growth, liquidity or control, and a change in access to capital could also change that decision point.”
Challenge no. 2: Economy
Some economic challenges – particularly inflation – will not be felt equally across all industries.
“If we go into recessionary winds, you should think about how sensitive your consumer is to those pressures and how that affects purchasing behavior,” Boumgarden said.
‘If we go into recessionary times, you should think about how sensitive your consumer is to these pressures and how that affects buying behaviour.’
Peter Baumgarden
The industries most affected by the recession, small or large, are real estate, construction, manufacturing, retail, leisure and hospitality, Boumgarden said.
“What makes these industries particularly vulnerable is that consumers are more sensitive to price changes. They have the choice to delay the purchase, downsize or find cheaper alternatives, all of which can cut into your top line,” he said.
Restaurant owners, for example, are already feeling the effects of rising food prices and rising wages, he said. With a relatively small profit window, many have no choice but to raise menu prices. But that means cost-conscious consumers will have to make choices like eating out less and choosing less expensive chain restaurants.
“If your customer is not willing to pay more, you have to eat the higher price of goods and thus live with lower margins. All of this implies the need for the business owner to play a game of chess as to how these subtle changes will affect the financial results of their business,” said Boumgarden.
Challenge no. 3: Work
“We’ve all heard people complain that ‘no one wants to work anymore,’ but the problem is actually much more complex,” Boumgarden said.
“Research at the Brookings Institution suggests that many systemic issues, including lower immigration, lack of child care, underinvestment and uneven investment in talent, discrimination and more, affect the workforce available to small businesses. While small businesses can do small things to solve these problems, policy innovation is also needed.”
Economists believe there is a 70% chance of a recession in 2023, according to a recent Bloomberg study. Ironically, this could prove beneficial for the low-wage employers most affected by the current labor shortage. Recessions push more people into the labor market and will cool rising wages.
The advantage of a small company
The coming year will undoubtedly be challenging; however, small businesses have some advantages over large corporations. If they play their cards right, Boumgarden said they could face less disruption in the coming year. For starters, small businesses have the advantage of being nimble — a skill many have honed during the pandemic.
“Because they’re not burdened with red tape, small businesses can often more easily experiment and pursue new opportunities,” Boumgarden said. “If I were a small business owner, I’d be wondering what kinds of little experiments I can run in the next six months to help me tackle the upcoming hurdles.”
“Compared to public corporations, smaller privately held companies also have the advantage of being able to give their business plans time to develop with a longer time horizon for execution. They don’t have investors breathing down their necks expecting immediate returns, so they could benefit from this patient capital. In times of economic crisis, this can be a great advantage.”
Small businesses also have another invaluable advantage over large corporations: public trust.
“Consumers are increasingly skeptical and critical of large companies, especially large technological ones. Small businesses, on the other hand, enjoy significantly higher levels of trust among consumers,” said Boumgarden.
“The opportunity for small businesses is to find ways to highlight and leverage that trust to differentiate them from larger competitors. Consider shopping at your local corner bookstore instead of ordering from Amazon. Amazon may offer two-day shipping, but local bookstores may offer personal touches like personal reviews and community meeting spaces. In addition, consumers like to know that they are supporting businesses that support their local community. The opportunity for these owners is to take advantage of the confidence in the business.”
Local communities can help
“Building regional support groups to share best practices is one way local governments and business communities can help small businesses thrive,” Boumgarden said.
“Research is also very clear about the value of educational interventions, so finding ways for universities to offer support to the educational needs of these companies to increase their ‘professionalism’ can really boost the economic growth of these companies and thus our regions,” he said.