I’ve been saddened to read about Winnipeg business closures due to covid-19. I’ll miss Stella’s on Osborne, and I wasn’t happy to hear about Hermanos in the Exchange District.
Before that, I shed a few tears for Tony Roma’s, Segovia and others.
As news reports of closures in Winnipeg—and Canada—pile up, so do speculative Facebook comments about why these businesses are closing.
I’ll tell you exactly why they’re shutting down.
Winnipeg Business Closures: Models and Math
It should be noted that I’m not referring to our fitness and nutrition business, 204, here. This article isn’t a peek into our small operation. We’re still in business; we just changed our model drastically to adapt to wild times.
This blog is about business in general, and the point is to help people who’ve never run a business understand what’s happening right now. When I read some unkind comments on a recent article about restaurants, I thought I might be able to offer some clarity. I’ll use a few examples from my business just to help paint the picture.
The short story:
The mandatory shutdowns and social distancing of the Covid Crisis have made many business models untenable. And government reopening plans don’t fix the situation.
None of that is a criticism of the government or health-care directives. I’m not a doctor, and I can’t tell you what’s necessary to keep people safe in a pandemic. But I can tell you without emotion or implied criticism that the current plans are forcing some small businesses to shut down. It’s just economics.
Profit and Loss
Here’s the deal:
All businesses have expenses. They add up very quickly. But few people realize that. Most see businesses as cash cows, and a very few are. Most aren’t. They turn modest profits supported by owners who often work well over 40 hours a week. No complaint there. Entrepreneurs signed up for long hours.
Expenses are subtracted from income. What’s left is profit. And the government gets a small but not insignificant percentage. Or, if expenses are greater than income, the business posts a loss.
In some businesses, owners are paid a wage that counts as a business expense. In other cases, owners are paid out of the profit. Either way, after everyone and everything is paid in a profitable business, there a remainder. This is net income. Divide it by revenue, multiply by 100 and you have net profit margin.
Example: $10,000 net income divided by $100,000 gross revenue x 100 = 10 percent net profit margin. Stated another way, the business profits $1 out of every $10 it takes in. The other $9 cover expenses.
For perspective, leading profit margins are in the range of 10-20 percent: Forbes.
Those numbers are glorious and rare. Most industries are well below this. Restaurants in Manitoba average 4.5 percent.
Profit Margins: Every Cent Counts
This is not because restaurateurs and shopkeepers are dumb or frivolous. It’s because income is variable, competition is fierce, costs are high and ever changing, and there is a limit on what you can charge people.
For example, few people would buy a $50 burger. So if the correctly priced burger costs $10, a business night see a net profit of 45 cents. It the price of beef goes up or another burger joint opens next door, that number might become 15 cents. If a pandemic hits, the business might not sell any burgers.
I’ve seen a lot of comments online suggesting business owners should save more for emergencies. While I agree that rainy-day funds are essential, you can see how tough it is to build up a reserve with a small profit margin. That reserve fund is also affected by the cost of replacing or acquiring equipment, moving, expansion and so on. Sometimes businesses have to spend large amounts of money to remain competitive.
The Greatest Costs
For businesses with physical spaces, the greatest costs are usually staff and rent. We’ll look only at rent. Every square foot you lease costs money. Therefore, you must calculate revenue per square foot and attempt to maximize it.
While respecting civic codes, how can you get as many people into a space as possible and provide great services that result in the highest income for the business? Or how can you sell as much stuff as possible with the smallest amount of space?
That’s the general business model.
Here’s what the Covid Crisis did to it and why so many Winnipeg businesses are closing.
Covid Crisis: Profit Down, Expenses Constant
Most businesses in Winnipeg closed in mid-March.
For some, that meant a revenue drop of 100 percent. Zero income. For others, it meant a significant drop of 50 percent or more even if they could retain some income online or through creative means.
In most cases, expenses did not drop at a similar rate. Despite government assistance, many fixed costs still exist. Rent is a big one, and many businesses didn’t get any relief. For a landlord to qualify for rent assistance, the tenant must show an income loss of greater than 70 percent.
That’s a tough number, especially for restaurants. They might actually be able to preserve 30 percent of income through takeout. But then they can’t get rent relief. If they do lose more than 70 percent of income, they’re probably doomed because of other fixed costs beyond rent.
You can see how a business’ profit margin evaporates almost instantly with a dramatic revenue drop. With expenses remaining relatively constant but revenue plummeting, the business starts losing money. That cuts into whatever rainy-day fund exists. A good fund might have three months of expenses. Some businesses have far less.
Lost in Space
Further, your revenue per square foot is crushed because you can’t use the space that is critical to service delivery. The costly thing that would allow you to generate revenue is vacant, but you still have to pay for it. That means you have a huge expense that is generating no return.
In most industries, the whole business model revolves around the use of a physical space. Sure, you can try to deliver cold steak instead of serving it in your luxurious 10,000 square foot restaurant in a prime location, but you simply can’t sell enough takeout steak to balance the cost of the physical space.
And people are losing their jobs or scared of losing them, so they’re cooking at home a lot.
Revenue way down. Fixed costs relatively stable.
Variations of this simple example exist in every industry in which owners cannot use the spaces they lease or pay mortgages on. Think of sports bars, escape rooms, and so on.
With many industries forced to almost totally shut down for two to three months, even the best rainy day funds have been gutted. They are almost empty.
That means decisions must be made.
“But You Can Open Now!”
Finally, the reopening plan for Winnipeg and Manitoba.
With many businesses running out of money, the government’s phased reopening plan with restrictions brings more challenges. Yes, it sounds great to be able to reopen. But there is a cold reality: It’s going to be very hard to profit or break even with capacity restrictions.
Remember that 4.5 percent margin in the restaurant industry? That was based on full capacity operation.
What happens when you can only serve half as many people in your space? Imagine owners know they must operate at 75 percent capacity to break even. Opening restrictions, low consumer confidence and fear of infection won’t allow this to happen.
Other concerns: increased costs related to cleaning and protective equipment. We’ll leave staffing out of this to keep things simple. Just know that staffing a business is never simple. And hiring or rehiring is costly in terms of time and training.
At this point, the owner has to make a decision: Lose money indefinitely with the hope of recovery or close. If the owner chooses to lose money, he or she must find a way to stop the bleeding before the money is gone and the bank starts making all the decisions.
For more perspective on business closures in Winnipeg, check out this article from Tucson.com.
Entrepreneurs, Adaptation and Hope
I’ve seen a few comments suggesting some business owners should have planned better or tried harder. The comments were uninformed. For people who recently shuttered a business, I’m sure they were hurtful.
I understand that people on the outside don’t have all the information, and I hope this blog makes things clearer.
I also know that people are struggling with life stress right now, and the loss of a favourite business is just one more kick in the stomach—a sign that things have changed, and not for the better.
But some of the comments are unkind, and I’d caution those on the outside against venting if they don’t know all the details.
I can tell you that it’s impossible to plan for a pandemic that closes the space in which you generate income. You can plan for a bad month or a summer lull. A pandemic is totally different.
I can also tell you that the owners who are closing have tried very hard. They employ people, they take leases and commitments seriously, they love what they do, they love their clients, and they struggled with their decisions.
The easy path is actually to do nothing and hope things will get back to normal before you bleed out. But with no solid timelines and uncertain business climate, doing nothing in many cases is just a slow death.
Winnipeg Business: What Comes Next?
I hope this helps you understand why some of your favourite places are closing, and I wish their owners all the best in their next endeavours.
Others have chosen to evolve and adapt to the new environment. I thought it was wonderful to hear that Hermanos founders Noel Bernier and Najara Barros planned to start a new venture that helps procure covid-19 personal protective equipment for other businesses. That’s brilliant.
204 hasn’t gone out of business, but we did make a dramatic change by closing our physical space. We’ve used our experiences over the last 10 years to create a new business designed to help people who want to stay fit and healthy at home: online fitness and online nutrition. Will we miss our space? Very much. But we’re certain we can help busy, stressed people get a quick but effective workout in at home.
We’re going to figure out how to operate in the “new normal,” and so will others.
So take heart: This is the pruning before new growth.
I know creative entrepreneurs will find solutions in the coming months. New businesses will pop up and thrive. We’ll figure it out. But right now, tough people have to make tough decisions, then rebuild.