Big Companies Are Still Raising Prices
It’s not about inflation. It’s not about wages. It’s about margins. Plus: the “water-bed effect.”
Good Morning!
Here are today’s highlights:
Can online jewelers offer a better experience than brick-and-mortar jewelers?
Even as downtowns struggle, gentrification can upend established businesses.
Is the ERTC a lifeline for struggling companies or a magnet for fraud?
The eternal question about franchising: A plum deal? Or a false promise?
THE 21 HATS PODCAST
Best Of: What It Takes to Build a Business: So, I decided to give the 21 Hats Podcast crew this past week off. Between the Memorial Day holiday and our first 21 Hats in-person event in Chicago—attended by five of the podcast regulars—it seemed the right thing to do. It also seemed like a great opportunity to reprise one of our favorite all-time episodes. We first published it in December of 2021, and it features highlights taken from the podcasts we’d published up until that point that cover many of the risks and rewards of business ownership, including what it’s like to sell your business, to fire an employee, to risk your own home in order to get financing, and even to deal with serious mental health issues. If you’re new to the podcast, I think you’ll find that these conversations bring real context to the journeys of the entrepreneurs you’ve been following here. But even if you’ve heard some of these discussions before, I think you’ll find them a refreshing reminder that choosing to build a business can be a noble mission, but it generally doesn’t come with an owner’s manual. We’re all figuring it out as we go.
You can subscribe to the 21 Hats Podcast wherever you get podcasts.
COMPETITION
OPINION: Here’s how the “water-bed effect” destroys local businesses: “Food Fresh is the only grocery store in a rural stretch of southeastern Georgia. It has many five-star Google reviews praising its freshly butchered meats, tomato bar, and friendly service. Yet it faces a threat to its survival that no amount of management skill can overcome. Big retailers like Walmart and Kroger ‘have a handle on suppliers that I can’t touch,’ said Food Fresh’s owner, Michael Gay. The chains wrest deep discounts from suppliers, making it impossible for the store to come close to matching the chains’ prices.”
“Like other independent grocers, Food Fresh buys through large national wholesalers that purchase goods by the truckload, achieving the same volume efficiencies the big chains do. What accounts for the difference in price is not efficiency but raw market power. Major grocery suppliers, including Kraft Heinz, General Mills, and Clorox, rely on Walmart for more than 20 percent of their sales.”
“So when Walmart demands special deals, suppliers can’t say no. And as suppliers cut special deals for Walmart and other large chains, they make up for the lost revenue by charging smaller retailers even more, something economists refer to as the water-bed effect.”
“This isn’t competition. It’s big retailers exploiting their financial control over suppliers to hobble smaller competitors. Our failure to put a stop to it has warped our entire food system. It has driven independent grocers out of business and created food deserts.”
“Losing small retailers also stifles innovation. New food companies rely on independent retailers to introduce products. But as this diversity of retailers gives way to a monocrop of big chains, start-ups have fewer avenues to success. This results in diminished selection for shoppers, who find store shelves stocked with only what the big food conglomerates choose to produce.” READ MORE
PRICING
The big corporations are still raising prices: “The bags of Doritos, cartons of Tropicana orange juice, and bottles of Gatorade drinks sold by PepsiCo are now substantially pricier. Customers have grumbled, but they have largely kept buying. Shareholders have cheered. PepsiCo declined to comment. PepsiCo is not alone in continuing to raise prices. Other companies that sell consumer goods have also done well. The average company in the S&P 500 stock index increased its net profit margin from the end of last year, according to FactSet, a data and research firm, countering the expectations of Wall Street analysts that profit margins would decline slightly. And while margins are below their peak in 2021, analysts are forecasting that they will keep expanding in the second half of the year.”
“McDonald’s reported that its sales increased by an average of 12.6 percent per store for the three months through March, compared with the same period last year. About 4.2 percent of that growth has come from increased traffic and 8.4 percent from higher menu prices.”
“Colgate-Palmolive, which in addition to commanding a roughly 40 percent share of the global toothpaste market, also sells kitchen soap and other goods, had a standout first quarter. Its operating profit for the year through March rose 6 percent from the same period a year earlier — the result of a 12 percent increase in prices even as volume declined by 2 percent.” READ MORE
ECOMMERCE
Even with Covid fading, online sales of fine jewelry continue to expand: “Olivier Reza, chief executive of his family’s high jewelry brand Reza, said he used the pandemic downtime to create a virtual experience on the company’s website that he called ‘better than a store.’ A potential customer can now use her smartphone to scan a QR code and then go to the ‘virtual try-on’ section of the site to ‘put on’ any one of the 38 pieces found there. Mr. Reza noted that the virtual reality function is more advanced than superimposing static images, as the jewelry is automatically scaled and positioned, and will move with the customer in real time. The feature is used by a quarter of the visitors to the website, he added.”
“While Mr. Reza would not disclose details, he said that online-only transactions now account for 20 percent of his sales and he expects the proportion to grow: ‘When I explain what I’m doing to people over 60, they look at me like I’m crazy. But 20- or 30-somethings are like, Yes, of course.’”
“Threads Styling, an online personal-shopping service based in London with a presence on both WhatsApp and WeChat, said the communication tools have helped its fine jewelry business increase in recent years.”
“And while its average fine jewelry sale online is 3,000 to 4,000 pounds ($3,734 to $4,978), Alyse Chirumbole, the company’s director of fine jewelry and watches, said established clients have used WhatsApp to buy high jewelry worth what she described as ‘millions.’” READ MORE
COMMERCIAL REAL ESTATE
The Plant Chica, which created a safe space in South Los Angeles for plants and people, confronts gentrification: “When Sandra Mejia was searching for a location to open a storefront for the Plant Chica — the flourishing plant business she launched with her husband in 2018 — she looked no further than her South Los Angeles neighborhood. After selling plants on street corners around L.A. and eventually from her parents’ backyard, Mejia said it was imperative for her to keep the Plant Chica in her community, which she describes as a green desert with limited parks and plant nurseries. ‘This is where my roots are,’ says Mejia. ‘I’m very passionate about my community.’”
“With the help of their family, creative friends, and loyal supporters, they were able to transform it into a charming communal space where queer-centered poetry nights, free adopt-a-plant events, yoga classes, art exhibits and kids parties took place nearly every week since opening in 2021.”
“Now, the fate of the Plant Chica is in limbo as developers are planning to tear down the shop for new construction that could take up to two years to complete. After a 90-day notice, the couple has until June 30 to leave.”
“‘I’m not fighting my landlord to stay here,’ she says, adding that she has no issues with her landlord or the property owners. ‘I’m also a businesswoman and I understand it’s business. You have plans for that space — it’s fine.’”
“‘My issue is the fact that there’s bigger developers that own so much land on Jefferson [Boulevard] and it’s sitting empty,’ Mejia says. ‘And when we call, no one answers, and then when someone does answer, they say it’s not available, but they have a for lease sign.’” READ MORE
There’s a ticking time bomb in America’s downtowns: “I asked Tomasz Piskorski, a property market expert at Columbia Business School, why we should care if some downtown mogul—or better yet, the shareholders in a publicly traded Canadian office company—takes a haircut on their trophy building. For that matter, why should we care if they have to hand over the keys to the bank? He gave me three reasons: First, because city property taxes will decline with the value of their office districts, prompting the so-called ‘doom loop’—the downward double-helix of revenue-strapped public services and diminished urban activity, each worsening the other. Second, contagion from abandoned office buildings will spread to retail (no daytime shoppers), restaurants (no daytime diners), and street life (no happy hour!), draining the vitality of urban neighborhoods.”
“Third: Widespread defaults on loans backed by commercial real estate could prompt a crisis at shaky regional banks, prompting tighter credit, bank runs, and ultimately, a financial meltdown.”
“According to data from the brokerage Colliers, almost all of the biggest office buildings in downtown Los Angeles are underwater on their loans—meaning, their owners owe more to the bank than the buildings are currently worth.”
“L.A.’s office towers have, on average, more than $230 in debt per square foot, Bloomberg’s John Gittelsohn reports, and the only building to sell this year went for $154 per square foot. That’s a lot of water. The city’s biggest commercial landlord, the Canadian property giant Brookfield, has defaulted on more than a billion dollars of loans this year.” READ MORE
TAXES
Here’s how the Employee Retention Tax Credit became a magnet for fraud: “In early February, federal prosecutors in Utah accused Zachary Bassett and Mason Warr of cheating the United States government out of millions of dollars. The accounting firm they operated had submitted more than 1,000 fraudulent tax forms to the Internal Revenue Service on behalf of businesses trying to claim pandemic-era stimulus funds, the prosecutors said. COS Accounting and Tax shut down later that month, leaving businesses and taxpayers who had paid the firm to help them claim federal money trying to figure out what had happened and why they were suddenly receiving audit notices from the I.R.S.”
“The money was intended to be a lifeline for struggling companies. Instead, it has become a magnet for fraud, creating a cottage industry of firms that market themselves as tax credit specialists who can help clients — even those who don’t qualify for the money — reap huge refunds from the I.R.S.”
“Although the public health emergency is over, taxpayers can continue to apply for the tax credit until 2025. That has fueled a run for the money and the proliferation of financial service providers, who often charge hefty upfront fees or take cuts of around 25 percent of any tax refund.”
“Mr. O’Donnell warned that those who received refunds but were ineligible for the money would have to repay the funds with penalties. He said the IRS was aggressively auditing taxpayers who collected the refunds and the firms that processed them. He estimated that hundreds and possibly thousands of tax credit ‘mills’ had popped up across the country in the last three years.”
“The fine print that determines if a business is eligible is complicated, and the I.R.S. is concerned that firms that are processing applications for the credit at high volume are overlooking important restrictions in order to rake in bigger refunds and commissions.” READ MORE
FRANCHISING
A plum deal or a false promise? “When Kenneth Laskin flew to California to meet with executives at Burgerim, a start-up chain of restaurants, he was made to feel not just like another prospective franchisee but like part of a family. The company’s executives, he said, made a point one evening of highlighting their common Jewish faith by praying with him in Hebrew. At the time, in 2017, Mr. Laskin believed he was being offered a plum deal. He paid $50,000 for the right to open up as many Burgerim franchised restaurants as he wanted in Oregon. ‘I got an entire state,’ Mr. Laskin recalled.”
“Today, Burgerim has run into trouble, leaving a trail of financial problems, a lawsuit by the Federal Trade Commission and broader regulatory scrutiny of whether protections for franchisees like Mr. Laskin are adequate. The challenges highlighted by Burgerim come as franchising continues to grow as a way that people are choosing to start small businesses.”
“There has been rising concern about whether franchisees need more protection in their contracts with franchisers. That concern has found a sympathetic ear in the Biden administration and in several state legislatures, and has resulted in multiple proposed limits on franchisers’ powers.”
“Burgerim, which boasted of having inventive high-quality burgers, has been criticized by former franchisees for making grand promises and poor disclosure about business risks. Of the more than 1,500 franchises Burgerim sold, most never opened, the commission said in a lawsuit that the agency filed last year against the company and its founder in U.S. District Court in California.”
“‘There are a lot of stories of franchisees buying into a system and then it goes badly for them,’ [Greg Flynn, the founder and chief executive of Flynn Restaurant Group, the largest franchisee in the country] added. ‘I would just suggest that they might have had a similar experience outside of a franchise system.’” READ MORE
INSURANCE
State Farm will no longer sell home or business insurance in California: “State Farm is the nation’s biggest car and home insurer by premium volume. It said it ‘made this decision due to historic increases in construction costs outpacing inflation, rapidly growing catastrophe exposure, and a challenging reinsurance market.’ It posted the statement on its website and referred questions to trade groups. The insurer’s move doesn’t affect existing home-insurance policyholders, whose policies will remain in effect, according to the statement and a representative of the state Department of Insurance.”
“The insurer said it would also quit accepting new applications for business policies, but it would continue selling new personal auto policies.”
“For 2022, State Farm’s auto-insurance companies reported record underwriting losses, totaling $13.4 billion, due primarily to rapidly increasing claims severity. Its homeowners’ business reported an underwriting gain. State Farm is a mutual company, meaning it is owned by its policyholders, and it has deep pockets. It ended 2022 with net worth of $131.2 billion.” READ MORE
SILICON VALLEY
As Elizabeth Holmes heads to prison, have we learned anything? “It’s already clear that Holmes’s conviction and Theranos’s failure have had zero impact on the hubristic culture of the start-up world, tut-tutting predictions to the contrary. As you read this, entrepreneurs and investors who run the gamut from charlatans to visionaries are setting aside business plans focused on vague cryptocurrencies and the blockchain and refocusing instead on generative artificial intelligence. (Sad you never figured out crypto? Don’t be.) VC investments in the technology behind the popular ChatGPT revolution grew more than tenfold to $4.5 billion last year from 2018. A new gold rush has begun.”
“Holmes’s saga was always a Rorschach test for how to think about the valley, a cautionary tale that either exposed the ‘fake it till you make it’ mentality of start-ups or served as a prime example of the deep-seated misogyny in the technology industry.”
“How is it that a woman is going to jail while the Valley, although chock-full of geniuses, still shields a remarkable number of entitled male grifters cashing in on all the ready money?”
“Silicon Valley, in all its brilliance and arrogance, its paradigm-shifting moonshots and its spectacular failures, just keeps iterating, in most ways oblivious to its own shortcomings. The captivating rise and fall of Elizabeth Holmes did nothing to change that.” READ MORE
Thanks for reading, everyone. — Loren