The pandemic introduced new trends and challenges for IT leaders and their teams involved in supporting M&A transactions. From the shift to cloud, talent shortages, and technical debt, IT areas of focus both before and after a transaction have changed significantly over the past few years.

Mike Banks, director of technology consulting in the complex infrastructure delivery M&A group at RSM US LLP, joined the ACG Middle Market Growth Conversations podcast to discuss the evolution of IT, the strategic function IT serves within an organization, and ways to leverage technology more effectively across the enterprise.

This interview has been edited for clarity and length.

Middle Market Growth (MMG): The pandemic seemed to be this kind of wake-up call for business leaders as far as technology goes. They all of a sudden needed to keep their staff working remotely, needed to reach customers when they weren’t in person, and so on. That’s my very nontechnical perspective. So, I’m interested to hear from you as an IT insider. Which developments from the past two years would you say have had the biggest impact on the IT function for midsize companies?

Mike Banks: The increase in remote workers definitely led to many more businesses having the capability for remote work. Many midsize businesses did not have widespread capability for that before the pandemic.

But in addition to that, I’d say moving toward services-based architecture, software-as-a-service systems, was a really big shift. It really lends itself well to remote workers versus having an on-premise infrastructure with services and applications that you’d have to connect to your office to access. Software as a service is kind of like the next step beyond cloud-based architecture.

Another thing is outsourcing—especially outsourcing security, managed service providers, managed SOCs (security operations centers). And with midsize businesses being more targeted by bad actors nowadays, that’s become very important.

MMG: What have some of these changes meant for midsize companies that are having to adopt these new types of systems, switching to a software-as-a-service model? Has this come with the need for greater expenditure, bigger IT budgets? Have they had to reevaluate security measures? What have these changes meant on the ground?

Banks:  IT staffing looks a lot different in that model than it did in the past. It’s a much different skill set we’re staffing for. IT budgets are a lot different than they were with the traditional infrastructure—a lot more opex, a lot less capex. There’s no need in a cloud environment to make large purchases of on-premise infrastructure, servers, etc. All that becomes opex in the cloud, and it’s much easier to rightsize and adjust up and down as needed so that you have a lot more control over your budget.

The application landscape has changed quite a bit. Cloud software as a service, like Microsoft 365, is not a new skill, not a new product—but the amount of people that have moved to services like Microsoft 365 over the last few years is immense. People who have been employed by a company for a long time have to change those skill sets, or those companies have to hire new talent.

I have a client in the Midwest with super-great retention of their employees. They have employees that have been there 20 or 30 years. That’s fantastic—they must be a great company to work for. But it causes problems when technology was fairly consistent for a number of years and had minor changes here and there.

What we’ve seen recently is more of a wholesale change in the way IT infrastructure and IT applications work. Businesses need to understand the impacts of cybersecurity, which is a lot different in an environment of software as a service or cloud infrastructure. There’s no longer a front door that you can lock to keep people out. It’s out there in the world. It’s on the Internet. It’s accessible to a lot of people, especially with software as a service.

MMG: I spoke with your RSM colleague Malia Mason for the cybersecurity episode of this series, and she talked a lot about the talent gap in cybersecurity and people leaving the field. Are you seeing similar trends within IT staffing?

Banks: Absolutely. That’s huge, especially this year. There’s a big gap with IT staffing—the skill sets and the availability of people. Skill sets are a lot different today than they were even a couple of years ago. And there’s just a lot less people in the job market. That’s especially true with midsize businesses in smaller markets—fewer people are available that can do the IT jobs, and they’re more in the larger markets. The cost of IT staff has gone up as well, based on the shortages of skilled people.

MMG: I’m interested in the factors that go into the decision of whether to outsource services or bring them in-house. What are some considerations for midsize businesses as they weigh that choice?

Banks: Managed service provider outsourcing is very common in midsize businesses, especially after a transaction.

A lot of midsize, privately owned businesses insource their IT and have a lot of older technologies in place. When a PE (private equity) firm buys a privately held company, a lot of times there’s that wholesale change in the technology, the move to the cloud. And when that happens the skills they have in-house are typically not up to the task of managing the new technologies, so it makes managed service provider outsourcing a pretty easy choice. Typically they’ll outsource service-desk and user-support components, and monitoring and managing of infrastructure.

But we also commonly see project outsourcing, and there’s been huge growth in the managed security service provider space. Cost for middle market companies is typically lower to outsource than insource, based on the lack of skills, especially in smaller markets, and the cost to employ those people—whereas the cost is spread across multiple companies if you outsource.

Another consideration would be geography. If you have a lot of smaller locations versus one large location, it’s going to be much harder to staff.

Some considerations that might cause you to go in the other direction would be if you have specialized applications that there’s not a lot of skills out in the market for—like manufacturing applications, things in the oil and gas industry, or chemical manufacturing. Those skills aren’t as widespread in managed service provider spaces.

Or if you have proprietary information, like life sciences, you might want to keep that in-house to keep your arms around the spread of that knowledge.

MMG: I would imagine the insource/outsource question is going to be on the mind of a buyer in an M&A transaction as they think about what steps to take with the business after they acquire it. Are there other IT-related aspects that come up during an M&A transaction that either tend to get neglected or maybe don’t get the attention they deserve?

Banks: Absolutely. Almost every transaction I’ve been involved in has had a lot of tech debt. That happens when companies do not have a hardware life-cycle program and they’re not managing their technology to keep it up to date. You have older systems that either don’t have the security features of modern systems or do not have the ability to accept updates to the current system. Those situations can cause security concerns. Essentially, technical debt will end up costing a buyer more money and technology than they had potentially planned on.

Also, some industries, like manufacturing, have a huge amount of applications. A tech business or a bank is going to have a limited scope of applications that are pretty common throughout a lot of industries, but in manufacturing or oil and gas businesses you could have 100 or more applications in the scope of a transaction.

One other thing is shadow IT. Let’s say you’re carving out a division of a large multinational that has a lot of controls on their IT. You might run into some shadow IT people putting their data in Google Drive—something that’s outside of the company control. Industries like tech have that issue as well, because a lot of tech-savvy people go out and find solutions to their problems that the company may not be providing.

MMG: Interesting. How does one go about investigating shadow IT? Is it a matter of talking to employees, or are there other ways to look beneath the hood?

Banks: I spend a lot of time just talking to employees, talking to leaders of different functional areas within a business. And one of the things we often uncover is the shadow IT.

MMG: What about after a transaction? What are some of the best practices around IT that you recommend after a deal closes?

Banks: When we do a carve-out or an integration I see this in sort of distinct phases. We typically do a stand-up, where you’re getting off your TSAs (transitional service agreements). You’re integrating into the existing target operating model and the existing business functions.

The key is getting started as soon as possible. With discovery, you’re planning some TSAs. Allow for an incremental exit so you can exit portions of the TSA sooner than others—a lot of them have financial benefits for exiting before the end of the TSA period.

We focus on what I call a fast and functional IT environment. Our goals are to create infrastructure solutions based on leading practices, industry standards, vendor reference architectures—and focused on a cloud-first strategy according to the policies of the company we’re working with.

After we do a stand-up, there’s typically a period of stabilization where things sink in. Then we move into optimization, where things like advanced security come into play—enabling advanced security features, business continuity planning, disaster recovery planning, overall process improvement. And then looking at rightsizing after you do a stand-up, when we enable cloud services like Azure or AWS (Amazon Web Services), typically with pay-as-you-go pricing.

That’s very typical with implementations across any situation. It’s not specific to a carve-out or an integration. And afterward you can look at either Azure or AWS, which have built-in calculators to help you determine cost-saving opportunities—like reserve instances, where you pay for some compute power ahead of time, in increments of a year or six months or three years, or whatever it is. That can save you some money in the long run, and should definitely be taken into consideration after you complete a stand-up.

MMG: You mentioned a cloud-first strategy. I wonder where the cloud trend, for lack of a better word, goes from here for midsize businesses. Is it just a matter of more companies transitioning their physical systems to cloud-based technology? Or have most already started this process and it’s the continuation of that migration?

Banks: That depends on where the business is and their ownership structure. Most middle market businesses I’ve come across that are privately owned are still heavily on-premise and not as much in the cloud. They have some of the typical services in the cloud like email, but the majority of their systems and applications are on-premise.

When those companies are acquired, they typically do go to the cloud. That is best practice, but also the preference of pretty much every PE firm out there. Larger companies in a carve-out are typically already in the cloud; we’re basically switching like for like in that case.

If it’s a privately owned company that’s been acquired, there’s probably a lot of tech debt and on-premise, noncloud solutions in place. Earlier I mentioned services-based architecture—kind of a SaaS-first focus and one step beyond cloud-first. SaaS-based applications and ensuring the right security features around that—including single sign-on so that the company owns the identity and doesn’t allow the service provider or the SaaS provider to own and manage the identity—is important. Multifactor authentication is important. If you do that, then SaaS-type infrastructure is just as or more secure than a traditional infrastructure.

MMG: What do you mean by “own the identity”?

Banks: Good question. Let’s say you log in to an application like Facebook. Your email address and password are stored in Facebook’s database of user records. If the company manages the identity through a single sign-on provider, that provider is the database of record for the account information.

There’s a reference in the SaaS provider’s system that points back to that single sign-on identity management. That way you have control over the identity management. If, let’s say, one of your employees leaves and that employee has access to key systems, including three SaaS providers, and identity was managed by each provider individually, you would have to go to each system or contact each provider to remove access for that former employee from that system. If you manage the identity in one place, you can disable that account in the system you manage the identity in, which disables access for that user to all of your SaaS providers.

MMG: I see. So a best practice when working with SaaS providers is for the company itself to own the identity.

Banks: Correct.

MMG: Beyond what we’ve talked about so far, are there other things that middle market companies can do to use IT to optimize overall business performance across the organization?

Banks: There are so many businesses looking to use the data they already own, that they already have, as an opportunity for improvement. I’ve done a lot of work in oil and gas, where there’s a lot of information coming from meters and sensors that are out in the field or on tanks or in a lot of different pipelines. All that data is gathered but not necessarily used for optimization or improvement.

Since the downturn in 2009, when oil and gas companies lost a lot of employees, they had to find some areas for improvement and production, not just in IT. This was where IT was an enabler for the business. I had a client that basically put in a wireless network over miles and miles of West Texas where there was no connectivity. They could feed all that information from those flow meters and sensors and different things back into their central systems in their data center and crunch the numbers to use data analytics to improve processes.

MMG: It sounds like the oil and gas sector came to that out of necessity and survival. Are there other industries where you’ve noticed a discrepancy in the level of attention, focus, or spending on IT? Either some industries that are doing a lot of that or others that may have neglected their IT function?

Banks: Overall, industrials—specifically manufacturing, construction, things like that—have a much lower IT spend than other industries. They have thinner margins. They don’t want to spend their money on IT. They don’t look at it as an enabler; they look at it as more of an expense. But some of them are breaking that trend and see the importance of data analytics.

I have a chemical manufacturing client looking to use data analytics to optimize the input of raw materials into their recipes for their final products so they can optimize the use of those raw materials and reduce waste overall. Another example is motors with sensors in them that can report maintenance requirements before they break down—they can save companies downtime in manufacturing, for example.

MMG: It sounds like there’s data available; it’s a matter of making the commitment to harness it. And that, of course, takes investment. And budget dollars.

Banks: It does. I think benchmarks are a good guidepost. I don’t think they really determine anything as far as IT spending. But banking, for example, spends on average 5% to 6% of their revenue on IT. Whereas industrials, including manufacturing, is closer to 1% to 2%.

MMG: We’ve covered a lot of ground today. Are there any other trends you’re watching within the IT space that you expect to impact businesses in 2022, that investors or operators should be aware of?

Banks: We touched on shortages of IT staff—that’s a real problem. Making better use of analytics is a big uptrend right now. It’s been trending for a while, but I think it’ll continue. There are some technologies around data analytics, AI (artificial intelligence) and machine learning that have been talked about for a few years but have not really come to fruition, especially in middle market companies. I would look for that to be on the horizon.

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This article was written by RSM US LLP and originally appeared on May 30, 2022.
2022 RSM US LLP. All rights reserved.
https://rsmus.com/insights/industries/private-equity/from-strategy-to-operations-the-evolution-of-the-it-function.html

RSM US Alliance provides its members with access to resources of RSM US LLP. RSM US Alliance member firms are separate and independent businesses and legal entities that are responsible for their own acts and omissions, and each are separate and independent from RSM US LLP. RSM US LLP is the U.S. member firm of RSM International, a global network of independent audit, tax, and consulting firms. Members of RSM US Alliance have access to RSM International resources through RSM US LLP but are not member firms of RSM International. Visit rsmus.com/aboutus for more information regarding RSM US LLP and RSM International. The RSM(tm) brandmark is used under license by RSM US LLP. RSM US Alliance products and services are proprietary to RSM US LLP.

Business leaders who aspire to operational excellence need a strategic approach to talent management.

Marni Rozen, director of management consulting for human capital at RSM US LLP, joined ACG’s Middle Market Growth Conversations podcast to discuss how organizations can take a more strategic approach to addressing current trends and challenges in talent management.

Rozen describes the Great Resignation’s impact on companies of various sizes and in various industries, along with ways to mitigate the risk of attrition. She also covers how current talent trends are affecting mergers and acquisitions, including private equity, and outlines key post-transaction steps to help smooth the integration.

At a time when human resources departments are under intense strain, Rozen points to outsourcing and other measures to relieve some of the burden. Finally, she addresses wage inflation, and how employers can be proactive rather than reactive when designing employee benefits programs.

This interview has been edited for clarity and length.

Middle Market Growth (MMG): I’ve been starting these conversations in this operational excellence series by asking each of my guests from RSM about the developments from the past two years that have had the biggest impact. In your area, human capital, and talent management, what would you say those developments are?

Rozen: It’s a great question. I think we all have felt some of the impact of the last two years as it relates to the pandemic and the shifts around talent. While many organizations have recovered from that initial impact—from needing to respond to some of that crisis management around the pandemic—and are starting to level out, there’s certainly been a shift from the employee perspective, and thinking about what they’re looking for or what their experience needs to be at an organization, and what they expect from the company they’re working for.

A lot of things have changed around employees’ priorities—like flexibility, career pathing, diversity. That is really contributing to what we’re seeing as most are talking about the Great Resignation. It’s no wonder we’re seeing a flood of individuals leaving—either going out of the workforce or moving to new opportunities.

As we know, there has been the highest churn and attrition in the U.S., as workers are leaving at a rapid pace. Four million workers left their jobs in the summer and fall every single month. So that’s what companies are having to deal with and then wondering how to combat it. It’s very challenging, because when you look at organizations that are facing a lot of attrition, they’re also facing skill gaps internally and trying to determine how they can retain the workforce they do have and ensure an experience that is meaningful, to keep them sticking to the organization.

As for remote work, we are seeing this being something that’s going to stay. A lot of companies that historically hadn’t had any type of remote workforce are now shifting to more of a hybrid model. In the middle market about a third of companies now have some type of remote workforce, and about 50% of those companies intend to keep it long term. How we manage a remote workforce becomes, or can be, more challenging, and finding ways to keep the workforce engaged is something organizations really need to focus on.

There has to be an acceptance for that shift, on how you balance needing to potentially be in the office sometimes, but also employees want flexibility. Those are some of the biggest things that have occurred over the last two years.

MMG: A lot of these, I think, are being felt across industries. You know, certainly, the Great Resignation hasn’t been concentrated in any one place necessarily. A lot of businesses are having to grapple with this, and same with the shifting worker priorities that you pointed to. But I do wonder if you’ve observed any differences across industries.

Rozen: We have seen some differences across industry, but we’ve also seen some differences where you look at the size of company. Where we focus in the middle market, most of the organizations with less than a thousand employees are struggling, particularly in this environment, and not being able to level off in the churn since it’s been surging from 2020 and not being able to catch up to their larger peer group, which is companies of a thousand employees and higher. Those organizations have seen attrition level out now over the course of the pandemic.

Those smaller companies, they face challenges in needing to both attract and retain workers. So particularly in that space, I think we’ve seen a variation. And then when we look at industries, there are a few other unique challenges that companies in manufacturing and distribution are facing. We talk about attrition here, but there’s also the aging workforce.

You see baby boomers on a much higher scale leaving the workforce entirely. Three million baby boomers left the workforce over the last two years. For organizations like manufacturing and distribution companies—where you’ve had that type of workforce and no succession plan—it becomes very challenging and creates these skill vacuums that need to be remediated.

Some other industries have actually fared fairly well—like technology, where those organizations have been used to working remotely and didn’t have much of a shift. But their talent is very in demand, so the turnover rates in the technology vertical are very high. They need to think about how they differentiate. Where some companies in other industries are looking at flexibility and remote work as a bonus and a plus, technology and industries that had previously been remote are needing to find other motivators to bring talent to the organization.

MMG: It seems like over the past couple of years, human capital and culture have just gotten a lot more attention because of the Great Resignation and the difficulties around attracting and retaining talent. I’m interested in whether this has led to any change in the M&A process, perhaps in terms of how buyers are evaluating a target, what they’re focusing on during due diligence. Are you seeing any shifts around M&A?

Rozen: It’s interesting, because most PE firms haven’t historically done operational due diligence. If they are, it’s not focused in HR. And that creates a significant risk, because the most impactful issue to a deal is generally culture. Culture was recognized as the highest risk to integration—and therefore, being able to look at that pre-deal and do due diligence around that on a potential target is really important.

It creates the opportunity to avoid and mitigate some of that risk, while also understanding the business of the target, when it’s really critical to see what leadership is there, what the roles are, and the people that you need for the future, and making sure you have the right people to steer the ship. Doing that on the front end and being able to evaluate that can really help to avoid any of the pitfalls that you would typically see related to people and talent after you’ve actually gone through an acquisition.

MMG: Are any other human capital-related areas critical to focus on during a deal or that tend to get overlooked but deserve more attention?

Rozen: A lot of the work we do with our clients is really to think about—as you acquire and integrate—how you harmonize business processes, policies and technology. There’s not always thought given to that, and you can end up with a lot of disparity where you have—especially in HR—multiple benefit plans and variations of policy and different ways to do things and no accountability for a process. And then on top of that, you have disparate systems.

If you have multiple HR systems or multiple finance systems, there’s no one source of truth. That’s really challenging for PE firms, when they are not able to get data they need and not able to look at even a complete census for employee count. Looking at that beforehand, to harmonize what you need to and build a plan around that Day 1 readiness—and even what you do Day 100 and Day 365—that road map becomes critically important to focus on.

We found that when you do that on the front end and you have a strategy around what the operating model is going to look like—who are the people that are going to be in leadership roles, what you are going to harmonize across businesses—that can enable success and make it much smoother and, in turn, really minimize the disruption to the business.

There is a renewed focus on change management and making sure there is a thought process around that, including how you think through the employee experience and making sure that whatever change you’re going through related to a transaction isn’t going to impact negatively with a ton of change and not being fully thought out and communicated.

MMG: I imagine this would be especially important right now. Change is scary at any point, but especially in a moment like this, I think employees do feel like they are empowered to leave or go find another position. If you don’t handle that well, you’re probably at an even greater risk than you would have been years ago just of folks leaving.

Rozen: Exactly. And a lot of organizations look at things like retention bonuses to be able to keep those key leaders at the organization at least through a deal. But it’s not hugely helpful if they leave as soon as they collect that retention bonus—if they don’t see the opportunity long term of the organization and you lose all of that knowledge.

It really is an investment on the front end, but then has ramifications if those folks actually leave the organization. So it really does need to be focused on.

MMG: Then post-transaction, it sounds like part of the work is implementing the plan that the firm should be coming up with ahead of the deal, with the private equity firm looking at how they can harmonize some of these processes. What else should leaders be doing post-transaction to better leverage human capital as a way to optimize the business after an acquisition?

Rozen: One of the key things is really to think about how to align culture—how you communicate and how your leaders are going to establish what those cultural pillars are, and what is the vision for the future company. Those are areas that maybe don’t have consensus.

Driving communication and transparency and making sure there is a plan around that is key. As you said, when employees feel they have no control or they’re in the dark or they don’t know what’s going on, that can contribute to toxic culture, where they don’t have trust in the organization. They don’t feel they’re supported, they’re afraid of what’s going to happen next.

Giving some thought into the culture you’re going to build in the future-state organization is really important. What are you going to stand for? What are employees going to buy into? We think about it as the employee value proposition, both internally and externally. Those are critical things that are impactful, not only for the folks you’re trying to recruit to the organization, but for the folks you have. They need to be tied into what that employee value proposition is.

MMG: Where does some of the work we’ve been talking about around human capital and talent management fall? How much of that should rest on the shoulders of HR vs. non-HR executives as they lead the organization?

Rozen: As you’ve heard me say, the leadership tone at the top is really important, and HR needs to be a strategic partner to those leaders. It is really important that HR has a seat at the table and is driving that strategy. But they also need to drive accountability with their leadership. HR can help shape and manage those initiatives, put frameworks in place, help define what that vision is, but ultimately there’s a responsibility for leaders and even all the way down to transcending that, to front line managers, to carry those things forward.

Everyone has a role to play. But HR is the glue that keeps it together and needs to be forward-thinking around how they are going to be strategically aligned to the business versus being really reactive. There are times when HR can get stuck in firefighting mode or in the tactical nature of what we see in HR. Being able to have alignment with leadership and really think strategically about what you need in the future, in a year and two years and three years, versus what are we going to transact right now, is the way to elevate HR.

MMG: I’m hearing you suggest HR professionals need to be proactive, and innovative in a way that maybe they didn’t need to be before, or at least there was less pressure. I wonder if you’ve seen any change in the resources allocated to HR or other talent management roles, as human capital gets this greater focus.

Rozen: HR is really feeling a strain right now, because not only do they have their day jobs of helping to run the human resources function of the business, but they also are in crisis mode a lot of the time. They need to respond to the changing regulations, need to manage how you respond to COVID, and COVID tracking and triaging—all the things coming at them constantly.

It becomes very hard to manage the three pieces: the running the business-as-usual tasks, the compliance and the challenges of being able to support the workforce with all the regulatory pieces, and then the strategic pieces that we just talked about, which sometimes aren’t prioritized. So we are really seeing a focus around how you can alleviate some of the mid-, lower-value tasks that HR does.

Some companies are looking at outsourcing to do that and pull in resources from other vendors that can take some of that burden off HR while they invest in other skills for their HR team, including things like wellness and coaching and having HR really be a pillar of that. We’ve seen some organizations add those roles to the HR team, so they can drive what employee wellness is going to need to look like.

The other pieces are within diversity and inclusion and the shifting priorities for employees. Most are now really focused on joining an organization that is diverse, that has inclusive leadership. Those are areas that sometimes, or a lot of times, fall into HR’s wheelhouse. HR really needs to lead on what those diversity and inclusion initiatives are, learn new skills around that, how they can overcome biases within the organization, and drive on those pieces. We are seeing a significant investment around DE&I, ESG programs, that HR has a role in.

MMG: I want to go back to your point about outsourcing. That theme has come up in the conversations with your colleagues in cybersecurity, in IT, in finance. It seems like, across the organization, outsourcing is being used to mitigate some of the talent shortages that companies across the board are facing. I wonder if you could talk about the use of outsourcing as a strategy right now or other techniques that companies are using to bridge the talent gap, both in HR as well as more widely across the organization?

Rozen: Sure. Outsourcing generally has been used in HR to take the burden of the actual transactions, the pressing the button, if you will. So being able to outsource things like payroll administration, benefits administration, a help line for password resets, are some of the things you may have heard my colleagues say. There are other ways organizations are looking to organize around robotics process automation, to drive automation to really enable their team members—not to replace them, but to enable them to take on more strategic functions or focus on higher-value areas.

We’ve seen a lot of organizations deploy bots or co-bots to take some of that burden from their teams. Anything that’s administrative, repeatable, that doesn’t really need to have a focus from a team member, are all great things that can be offloaded and ultimately add a lot of value, not needing a head count to do that. Those are some of the other ways we’re seeing companies respond.

MMG: Are there any other trends beyond what we’ve already talked about within the human capital arena that you expect to really impact businesses in 2022, that investors or operators should be aware of?

Rozen: One in particular is compensation inflation. What we know from surveys done for our Middle Market Business Index is that 59% of companies intend to raise compensation levels, and that is challenging when you are an operator and need to offset some of that cost.

Organizations are trying to think about how to do that. They know compensation really needs to be aligned to market. Being able to think through your compensation strategy is going to come into view. But it’s not only base salary, it’s also incentive programs, equity and total rewards—so benefits is a key driver as well. And it’s not only health benefits, it’s also other fringe benefits—being creative around that and at the forefront of what your employees are looking for.

It’s really important to listen. It’s not always one-size-fits-all. And I think organizations who are seeking out employees to get their feedback on what they want to see can really make good investments around that. Being proactive rather than reactive is where I see us going, so that HR can do some of that work and make sure they’re guiding the organization they work with, in order to focus on what’s most important—because that priority can help retain talent.

MMG: It’s an interesting point about listening to employees, because although it seems obvious, I could imagine organizations trying to implement benefits because other companies are doing it. But if it’s not what the employees really want, it might not be the best-spent dollar.

Rozen: Exactly. You don’t want to throw money at a problem that’s not actually going to solve it. So, measurement. The other piece around that is being able to have touch points where you are actually measuring not only from what employees are saying, but also through data and things like predictive analytics and AI. That’s another area that technology is really evolving in the HR space, where you have predictors of who may leave. Sometimes those are related to being able to look at who hasn’t had a raise in a number of years or who is not necessarily being recognized for work and being able to use some of those data points to see where those gaps are. Also, once you make changes to an organization, actually tracking them. What metrics are you going to use to know if they’re successful? You can think through what the root cause issues are and then know if you’ve actually come out on the other side. Those things are really important.

Podcast originally published by Middle Market Growth.

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This article was written by Marni Rozen and originally appeared on May 20, 2022.
2022 RSM US LLP. All rights reserved.
https://rsmus.com/insights/industries/private-equity/why-organizations-should-take-a-strategic-approach-to-human-capi.html

RSM US Alliance provides its members with access to resources of RSM US LLP. RSM US Alliance member firms are separate and independent businesses and legal entities that are responsible for their own acts and omissions, and each are separate and independent from RSM US LLP. RSM US LLP is the U.S. member firm of RSM International, a global network of independent audit, tax, and consulting firms. Members of RSM US Alliance have access to RSM International resources through RSM US LLP but are not member firms of RSM International. Visit rsmus.com/aboutus for more information regarding RSM US LLP and RSM International. The RSM(tm) brandmark is used under license by RSM US LLP. RSM US Alliance products and services are proprietary to RSM US LLP.

The pandemic introduced new trends and challenges for CFOs and their finance teams. From disruptive technology to executive talent outsourcing, finance transformation today looks different than it did yesterday.

RSM Directors Kristen Oats and Cody Roth joined ACG’s Middle Market Growth Conversations podcast to talk about how finance and accounting departments are adapting to remote work, supply chain disruption, talent shortages, and increased merger and acquisition activity. 

Oats and Roth share how they’ve seen finance and accounting teams bridge their talent gaps, and when to consider temporary or fractional resources. They also discuss how strains on finance departments are affecting M&A activity in the middle market, and what finance teams should focus on post-transaction.

The conversation closes with a look at the trends to watch in the year to come, and how rising input costs, salaries, and interest rates are affecting forecasts.

Middle Market Growth (MMG): Kristen, as we look back on the two years since the start of the pandemic, which developments would you say have had the biggest impact on finance and accounting?

Kristen Oats: Historically when we talked about finance organizations, it has been people, process, and technology. Now it’s starting to transition more toward people, process, technology, and data—and organizations have a large amount of data easily captured, but harder to determine how to use in a meaningful way. Over the past couple of years, the FP&A (financial planning and analysis) function has become more front and center to organizations, becoming more of a business partner to provide insights and more proactive, data-driven reporting for the business to make more real-time decisions.

This shift has continued to drive finance organizations from being less transactional and more of a strategic function. Additionally, finance organizations have invested heavily in technology to help drive efficiencies and support more remote or more of the hybrid work environment—for instance, automating the close process.

Many finance organizations had typically been in person before COVID, and during close, CFOs would walk down the aisle and learn what journal entries had been performed and what was still outstanding. Finance team members used to collaborate in person during the close, and what became a priority during COVID was still being able to close the books in the same amount of time, but more in a remote world. This drove companies to implement automation tools such as Blackline to help CFOs and finance organizations obtain visibility to the close and drive efficiency within the close process.

Other areas companies invested in were quick wins in terms of allowing employees to work more remotely—for instance, transitioning from cutting checks in-office to having the bank cut their checks, or working with vendors to move from paper invoices that would be sent to them in the mail to electronic invoices.

Some areas we’ve seen more recently are specifically around the supply chain. There’s been a lot of unpredictability in terms of when goods are expected, and from a forecasting and budgeting standpoint and impact in terms of how much was expected to be sold versus what was actually in inventory able to be sold. Ultimately, across all industries, it seems as if talent from a retention and hiring standpoint is difficult—and understanding what the future of work looks like going forward.

Organizations are still working on how to manage flexibility, and it’s an evolving process that they are still trying to figure out.

MMG: All of that makes me wonder how prepared finance executives were to deal with these changes, especially coming from all these different fronts. You mentioned technology, but also supply chain and talent. Cody, how prepared were these finance executives, from what you’ve observed?

Cody Roth: That preparedness is dependent a lot on the executives themselves—whether they’re strategic or transactional, as Kristen mentioned. So, transactional: pretty reactive, want to keep plugging away, solve some of the problems by throwing bodies at it, or just buying a technology they thought would help. The strategic, they want to look at their business more as a whole.

Once this new working environment was stabilized, it became an optimal time to invest and focus on how to improve your business. This wasn’t limited to a transaction, necessarily, or where you are; you’re able to do this at any stage.

Then with what’s become a little bit of a war on talent, and these supply chain issues we’re all experiencing, it’s been an unprecedented time, and very difficult to plan. Strategic executives can see a holistic view of the company and understand the dynamics of it, how things are working together, how different employees are reacting to the new environment, and so on.

Some of the issues have been historical knowledge of the company itself. That’s a difficult thing to transition and a very difficult thing to replace. And it’s also led to less ties between the employee and the company. So that retention risk has really been front and center. And again, what Kristen said, (not) being in person has been really detrimental and a big change to finance organizations.

It’s very easy to stand up and shout across a cube or go into an office to understand where people are and what’s being done. It’s been a complete shift on the way work is done, going from all-day workshops to splicing up some of the time and especially the time together. So that’s been a difficult thing to balance when you’re working from home or in a hybrid environment and aligning those schedules.

MMG: Going back to your point on supply chain, in a lot of ways this was unprecedented, and I wonder if this was a major learning curve for CFOs or if they essentially knew what they needed to do. But it became more of a resource question and not having enough people or technologies to manage some of the supply chain disruption.

Roth: Well, in a lot of organizations, the supply chain, I wouldn’t say it was an afterthought for CFOs, but that was something the CIO or the procurement team handled, that finance kind of consumed. And now with planning and forecasting and having to understand when you can’t fulfill a need, that’s been something the CFO has really been pulled into and has to then balance their business, their expectations, their financial reporting as a result.

MMG: Both of you have touched on talent a little. We hear so much about the Great Resignation in a lot of different industries, and job functions are experiencing a shortage in the talent they need to run their operations. Within finance and accounting, I wonder what roles are most in-demand or hardest to find right now.

Oats: It’s really a challenge at every level. If you think about slicing it between your more skilled, experienced, and entry-level employees, at your skilled level, you have your senior accountants, your controllers, CFOs. Organizations—especially that are remote or hybrid—need employees able to come in with the right skill set. If employees came in during COVID, they may lack ties to the organization. With the amount and volume of opportunities out there, it’s easy for them to leave and not necessarily stay with the company as long as they may have previously.

On the entry-level side we’ve seen the pay scale compensation structure has changed, so companies are looking to adjust that. But it’s the same, where employees coming in out of college or in more of an entry-level position may not feel as if they need to stay tied to a company—especially if they came in during COVID, because they don’t feel as attached as they would have if they were actually there in person on a day-to-day basis.

MMG: In this environment of limited resources but high demand, what are organizations doing to bridge that gap?

Roth: Companies are focused on driving efficiencies, how you can do more with less, while also balancing burnout. That can be investing in technology to drive efficiency, or moving to a shared service or an outsourcing model. One thing we’ve seen in the market a lot is temporary staffing. That used to be bridging some gap and just reacting to a situation, and now it’s becoming more of a norm with our clients.

Temporary staffing has been great in the past for some of that entry-level transactional processing—just kind of throwing some bodies at one of the problems. And now we’re hearing that they need more senior-level people, such as interim CFO, chief revenue officer, and so on. Organizations have and will continue to leverage third parties and professional services organizations to help support some of the larger strategic initiatives with these longer-term impacts and planning for the future.

MMG: What are some questions a business should consider as it decides whether it needs a permanent on-staff professional, or if it should utilize a temporary or fractional resource?

Roth: What is the need? Is it a short-term need or a longer-term need? Temporary staffing, historically you’ve had the opportunity to hire that resource full-time if you liked them and the need continued. They have a little bit more power in the business world these days because there’s so much demand for it.

Is it just temporary? You’ve lost a lot of employees and you have to fill the gap and you don’t want to hire just anyone that applies, you want to hire the right person. That could be a good time to use temporary staffing. Other times maybe you just can’t find the resources out there or your pay scale isn’t where you need it to be—and you have to react from that budgeting and forecasting and need to fill in the gap while you’re doing that.

MMG: All the challenges we’ve been talking about are happening against this backdrop of a heightened M&A environment in the middle market. I’m interested to know how these challenges are complicating M&A today.

Roth: They complicate it a lot. It kind of goes both ways. M&A can complicate issues as well. Your execution time on an investment is very fast-paced. We’ve talked before about this, where teams are already stretched, you’re doing more with less. You want to retain talent. Now you’re trying to balance the execution of their day-to-day job with this new transaction.

You’re piling more on top of them, so that’s going to just lead to more burnout. You’re going to have to perhaps staff up. That’s where temporary staffing could help. But you’ve got to have the right people in place as well. And as you’re doing this—using temp staffing or hiring quickly or reacting—having a resource that has M&A experience that can help you go through this transaction becomes a substantial risk and an unknown.

Also, you lose a lot of that institutional knowledge of the company as employees move around and you have temporary people.

MMG: It’s interesting, too, given that so many private equity investing strategies are predicated on the plan that they’ll make a series of acquisitions within a really short time frame. But it’s sounding like, if you don’t have the right people or they’re leaving the organization, it’s going to make that all the more challenging, to achieve what essentially underscored the original investment thesis.

Roth: That’s right. On top of that, the transactions are happening at a near-record rate. There’s a lot of transactions going on in the business. It’s a really good time to do that. Throwing the Great Resignation and retention and all these problems on top of that leads to some large risk potential in these investments.

MMG: Then looking toward post-transaction, Kristen, what types of improvements or changes related to the finance and accounting function should be made after a deal closes?

Oats: One of the main areas is around financial reporting and making sure the books can be closed for a private equity firm to get accurate and on-time reporting. Typically this has been a little bit more flexible in the past. So, understanding the financial close process. And it really is the result of upstream processes. It’s not just a finance function, but very cross-functional, to close the books. So, understanding what are the data, systems, and processes involved and what can be improved to expedite the close.

Also top of mind is typically companies have a lot of data. So understanding what data is out there and leveraging the data and packaging it in a concise and effective format for stakeholders to gain visibility to real-time financials in order to drive revenue and manage costs is critical.

Other areas that we see private equity firms and companies focused on post-transaction is around investments in technology and RPA (robotic process automation). There’s a lot of institutional knowledge, legacy systems and manual processes at organizations, versus private equity firms, are looking to build efficiencies. So standardization in the back office, both from a technology and a process standpoint are top of mind, especially with roll-ups.

Overall, there are two levers. It’s either increasing revenue and stabilizing costs or decreasing costs while maintaining revenue—or pulling on both levers. Evaluating the opportunities based on the PEG (price/earnings-to-growth) strategy is important in terms of determining how to get there. And as Cody alluded to, trying to retain people as you’re driving these efficiencies and they have more to do with less.

Companies are trying to figure out how to make this work. It’s a balance they’re still trying to figure out.

MMG: Of the two levers you mentioned, I wonder if the stabilizing cost option becomes more challenging in a time like we’re in now, where we have rising input costs due to inflation, imminent interest rate increases, salary increases. I wonder if businesses are going to be kind of forced into focusing more on that first lever.

Oats: Exactly. I think it’s still an evolving aspect in terms of what the costs are going to look like over the next year and what the new norm is going to be, especially as we look at interest rates increasing and the impact in terms of compensation and what needs to be provided to employees, either from a hiring standpoint or to retain existing employees.

I think companies are going to need to reevaluate how they were looking at it in terms of are they actually able to stabilize cost as they originally thought or are there other levers they’re going to need to pull.

MMG: Beyond what we’ve talked about so far, which trends within the accounting and finance arena should investors or operators be focused on through the rest of this year?

Roth: All the issues you’re going to see post-transaction that are going to have more of a spotlight on we’ve hit on, I know with the retaining talent. A lot of times you don’t know what you’re walking into through the transaction process. You’re having to quickly assess that at the front end.

You need to identify who knows the critical finance and accounting information. It might be one person knows everything, and that can cause a problem. If you don’t have that person and you don’t have a retention plan in place, you’re going to have to document what’s going on now to reduce risks and really help through the transaction going forward.

That’s the target company having experience with the acquisition process. Have they gone through this before? That’s why so many companies reach out to professional service organizations like RSM, because they may have people that have never done this or done this three times, whereas we have people doing this six to eight to 10 times a year.

So just kind of knowing everything that pops up, what are those first hundred days looking like? And finance and accounting is the ultimate consumer of all the changes and updates that happen through an M&A process. Having that finance and accounting leadership and representation is going to help them understand the downstream effects and the impacts on the business that someone in an operations role may not understand their decisions are making.

The finance and accounting challenges are somewhat dependent on the environment and the transaction. As Kristen alluded to earlier, you could just be getting acquired by a PE firm, and that’s going to change the landscape of your financial reporting, make it much more complex. You may be measuring your business on 10 to 15 KPIs (key performance indicators), and now you’ve inherited a 96-page board deck to report on monthly, and that is a significant bandwidth issue for companies. If it’s a merger of two like companies, how are you looking at the people, the processes, technology, data—how are you merging those? What do those steps look like to get there? And then you could be going public, so you’re going to add regulatory and compliance issues on top of that.

On the talent, what we’ve talked about over and over and we’re just seeing it so much is, what does the wage increase look like? What are those retention bonuses? Who do you need to keep in place and for how long? And how do you incentivize those employees to go through this transaction, and add value, while still doing what they’re expected to do on a day-to-day basis?

MMG: Kristen, any parting thoughts, any things that executives or investors should be keeping an eye on in 2022?

Oats: I agree with everything Cody mentioned. The one point I would add is around the interest rate, in terms of pricing and how much is passed on to the consumer—repricing of goods and services. Also, kind of on the flip side of that, what are the employee salary increases? What’s going to be passed on in terms of the benefit to employees throughout this?

So that’s going to be another variable from a budgeting and forecasting standpoint that organizations are going to be working for this year.

Podcast originally published by Middle Market Growth.

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This article was written by RSM US LLP and originally appeared on May 19, 2022.
2022 RSM US LLP. All rights reserved.
https://rsmus.com/insights/industries/private-equity/how-finance-leaders-are-managing-talent-shortages-amid-increased.html

RSM US Alliance provides its members with access to resources of RSM US LLP. RSM US Alliance member firms are separate and independent businesses and legal entities that are responsible for their own acts and omissions, and each are separate and independent from RSM US LLP. RSM US LLP is the U.S. member firm of RSM International, a global network of independent audit, tax, and consulting firms. Members of RSM US Alliance have access to RSM International resources through RSM US LLP but are not member firms of RSM International. Visit rsmus.com/aboutus for more information regarding RSM US LLP and RSM International. The RSM(tm) brandmark is used under license by RSM US LLP. RSM US Alliance products and services are proprietary to RSM US LLP.

Architecture firms, engineering firms and construction firms (AEC) are becoming more optimistic about their overall growth and performance through the next 18 months despite persistent challenges involving materials and labor. With no relief in sight, and with the Russia-Ukraine war adding to economic uncertainty, AEC firms are coping with rising costs and extended project timelines by looking to digital solutions. Technology not only is helping firms capitalize on mounting demand, it also is expanding horizons using interactive design visualization and the world of extended reality.

Seeing the bright side

AEC executives emerged from the first quarter of 2022 relatively optimistic about where the market is headed. The Engineering News-Record’s (ENR) Construction Industry Confidence Index, which measures AEC executive sentiment about the market outlook for the next three to 18 months, held steady in the first quarter after rising slightly from the fourth quarter of 2021. That modest uptick reversed the index’s decline in the middle two quarters of 2021. Although it may seem like only a small win, it’s a vast shift in optimism levels compared to the same time last year.

Another measure of executive sentiment in the sector, the Construction Financial Management Association’s Confindex, increased 2% last quarter and is up more than 19% over the past year.

The Infrastructure Investment and Jobs Act has boosted this optimism with its commitment to investments in a broad range of infrastructure. Another positive force is the glut of backlogged projects that were pushed forward from last year until now. In the CFMA’s first-quarter Confindex survey, 64% of respondent firms acknowledged a greater backlog of revenue relative to a year ago.

Total construction starts—another sign of optimism—were 9% higher in the first three months of 2022 than in the same period last year, according to the Dodge Construction Network. Nonresidential starts were up 26% and residential gained 3%. Although total construction starts fell 12% in March, variability in month-over-month data is expected, as large starts will skew the data. Overall, there is a strong underlying trend toward steady growth as postponed projects reach their rescheduled date and activity related to the infrastructure package encourages clients to move forward. 

In the uncertain economic climate of 2021, many clients of AEC firms were hesitant to proceed with projects. According to the Associated General Contractors of America’s national survey for its 2022 construction outlook, 46% of respondents had projects postponed in 2021 and have rescheduled them, while another 32% had projects postponed without rescheduling. The top reason for postponements and cancellations? Rising costs, according to 48% of AGC survey respondents.

However, not all disruptions were driven by cost constraints. AGC also reported that 75% of firms experienced project delays due to longer lead times or shortage of materials. Richard Branch, chief economist at Dodge Construction Network, told ENR that nonresidential building projects are taking roughly six months longer to begin construction than they were in 2019. Delays are not seen only at the front end of projects; 72% of AGC’s national survey respondents blamed pandemic-related factors for causing projects to take longer than anticipated in general.

Labor challenges

A critical factor in project delays has been the notable labor shortage. In the CFMA’s Confindex survey, 74% of respondents said they were highly or very concerned about labor shortages, with no immediate apparent solutions. This is aligned with the overall shortage in the entire professional services industry in the United States, in which job vacancies far outnumber offers. 

Amid this labor shortage, firms have started to offer compensation increases that exceed recent industry standards. At the executive level, base salaries increased 4.3% on average from 2020 to 2021, according to PAS, a firm that tracks compensation in the construction sector. As PAS President Jeff Robinson told ENR, the PAS 2022 Executive Compensation Survey for Contractors estimates 2022 salary increases could very well reach 5% for the first time in 15 years.

Expensive materials

Over the past two years, the AEC sector has experienced wide fluctuations in the prices of critical materials, driven by supply-and-demand imbalances caused by pandemic disruptions. As a result, firms have changed the way they plan their projects: 67% of respondents to AGC’s national survey stated they have accelerated purchases after winning contracts, and 23% are stockpiling materials before winning contracts.

Ironically, the attempt to mitigate material price fluctuations and avoid supply chain risks by adopting early purchasing will prolong the issue and keep prices higher by elevating demand in the short term. 

S&P Global Intelligence initially forecast sharper declines in materials prices in 2022 as supply-side constraints return to normal. But uncertainty due to the Russia-Ukraine war has reversed the forecasts, according to John Anton, the company’s expert on steel pricing and purchasing. Materials prices in 2022 now are expected to challenge the peak prices of 2021, Anton told ENR.

Turning to technology

To address obstacles, many firms are planning to implement new technologies, as reflected by the 74% of AGC survey respondents who indicated as much. AGC asked how firms’ investments in 15 types of technologies in 2022 would compare to 2021. The top five technologies in which firms plan to increase investment share a common purpose: using automation to achieve operational efficiencies.

Each one has the potential to automate routine, repetitive or administrative tasks that use precious hours in the day. By automating these tasks, AEC firms can free their professionals to work on higher-value activities, providing some reprieve from current labor challenges.

However, investing in technology does not automatically result in immediate efficiencies. When AGC surveyed firms about their biggest IT challenges, the most common response (41%) was the time needed to implement and train on new technology. The third-most-common (37%) was employee resistance to technology. Some firms are so desperate for resources that the short-term pain of technology implementation or training is simply too much to undertake, even with the promise of operational efficiencies in the long term.

New ways to experience projects

On the more innovative side of technology, interactive design visualization and extended reality (XR) continue to change the way architects and engineers approach new opportunities.

Interactive design visualization technology—including virtual reality and augmented reality—allows firms to provide their clients with an immersive experience. Used as a communication and collaboration tool during design, clients can experience what it feels like to be in a proposed building design, limiting the need for interpretation of abstract concepts.

The American Council of Engineering Companies surveyed member firms in August 2021 about the benefits of three classifications of technology, one of which was 3D modeling and building information modeling (BIM) automation tools, which include VR. The other two groups were engineering collaboration tools and insights tools. 3D and BIM tools were the most commonly chosen type for delivering higher-quality design or construction and higher client-partner satisfaction, and for enabling the respondent firm to remain competitive.

Those sentiments continue to materialize in high-profile examples of buy-in to this type of technology.  The American Society of Civil Engineers has partnered with Experimental, a firm that specializes in immersive design and mixed reality, to build out an XR environment as part of a project called Future World Vision. The environment, called Mega City 2070, resulted from extensive scenario planning and research about infrastructure trends civil engineers must continue to contend with, including climate change, alternative energy, autonomous vehicles and high-tech construction. ASCE launched its Future World Vision desktop app Feb. 22.

Another example is Autodesk’s agreement in late March to acquire The Wild, a cloud-connected XR platform that enables AEC professionals to present, collaborate and review projects together in immersive and interactive experiences.

Adoption of these technologies will accelerate and surpass the efficiencies achieved with more traditional software, such as the types in which AGC survey respondents said they’re increasing investment. They will become a powerful differentiating factor and competitive advantage.

The takeaway

Although the investment and effort to implement and adopt technology is significant in the short term, labor challenges in this space will continue to affect firms in the long term. Firms that can transform themselves to be able to grow and scale with less dependence on labor will reap the benefits for years to come.

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This article was written by Sonya King and originally appeared on May 17, 2022.
2022 RSM US LLP. All rights reserved.
https://rsmus.com/insights/industries/professional-services/architecture-engineering-trends.html

RSM US Alliance provides its members with access to resources of RSM US LLP. RSM US Alliance member firms are separate and independent businesses and legal entities that are responsible for their own acts and omissions, and each are separate and independent from RSM US LLP. RSM US LLP is the U.S. member firm of RSM International, a global network of independent audit, tax, and consulting firms. Members of RSM US Alliance have access to RSM International resources through RSM US LLP but are not member firms of RSM International. Visit rsmus.com/aboutus for more information regarding RSM US LLP and RSM International. The RSM(tm) brandmark is used under license by RSM US LLP. RSM US Alliance products and services are proprietary to RSM US LLP.

American consumers continued to spend more at retail stores in April despite inflation as lower gasoline prices helped to boost spending on discretionary items. But it won’t last long as gasoline prices reached a record high in May.

Retail sales in the United States rose by 0.9% in April from a month earlier, the U.S. Census Bureau reported on Tuesday. With inflation running at 0.3% on the month, our estimate for sales volume pointed to a more modest increase at 0.6%.

April’s solid spending growth won’t likely change the Federal Reserve’s decision to raise rates by 50 basis points in each of the next two meetings. Instead, it will help to alleviate some of the recession concern that might stem from increasing interest rates.

Sales at retail stores showed hints of the continuing shift from spending on goods to services as purchases at restaurants rose on the month. But that data likely understated increases in overall consumer spending because it does not include spending on airline fares or transportation services, which had soaring demand and prices.

The increase was driven by a sharp 2.2% increase in sales at auto dealers, accounting for about 19% of total sales. The figure aligned with earlier data from the Bureau of Economic Analysis, which reported 880,000 additional vehicles sold in April on an annualized basis.

But April’s auto sales remained about 3 million units below the five-year average of 17.5 million from before the pandemic as the chip shortage continued to hamper supply. We do not expect the shortage to ease anytime soon, and it might last well into 2024, according to a recent interview with Intel’s chief executive, Patrick Gelsinger.

Sales at gas pumps fell by 2.7% in April mostly because of the decline in gasoline prices, which fell by 6.1% on the month, according to last week’s Consumer Price Index data from the Bureau of Labor Statistics.

But those prices are already increasing. Weekly data from the U.S. Energy Information Administration is pointing to record high gasoline prices in May at $4.59 per gallon, 4% higher than March’s peak.

The control group—which includes all categories but autos, gasoline, restaurants and building materials—posted a 1.0% increase on the month. The increase was enough to offset core inflation in April, which came out much higher than expected at 0.6%.

That implies a solid month of spending growth as the group will feed into the calculation of gross domestic product for the second quarter.

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This article was written by Tuan Nguyen and originally appeared on 2022-05-17.
2022 RSM US LLP. All rights reserved.
https://realeconomy.rsmus.com/u-s-retail-sales-a-solid-month-of-growth/

RSM US Alliance provides its members with access to resources of RSM US LLP. RSM US Alliance member firms are separate and independent businesses and legal entities that are responsible for their own acts and omissions, and each are separate and independent from RSM US LLP. RSM US LLP is the U.S. member firm of RSM International, a global network of independent audit, tax, and consulting firms. Members of RSM US Alliance have access to RSM International resources through RSM US LLP but are not member firms of RSM International. Visit rsmus.com/aboutus for more information regarding RSM US LLP and RSM International. The RSM(tm) brandmark is used under license by RSM US LLP. RSM US Alliance products and services are proprietary to RSM US LLP.

Price stability is a precondition of maximum sustainable employment, sustainable growth at the long-term rate of 1.8% and financial stability.

The Federal Open Market Committee’s decision on Wednesday to increase the federal funds rate by a half-percentage point to a range between 0.75% and 1% in tandem with the publication of the central bank’s strategy to reduce its balance sheet imply that the Fed intends to achieve that overarching objective despite the risk of a higher unemployment and a hard landing of the economy.

From our vantage point, the reduction of the balance sheet is indicative of the necessary hawkishness that now permeates monetary policy and will result in a general tightening of financial conditions that will neither please investors nor other policymakers as the economy cools.

The reduction includes monthly caps of $30 billion in Treasury securities and $17.5 billion in mortgage-backed securities beginning in June that will slowly increase to $60 billion and $35 billion, respectively, in three months

Forward-looking Fed policy and rhetoric have already led investors to price in these changes, resulting in a 10-year Treasury yield hovering around 3% and mortgage rates floating between 5% and 5.5%. These higher rates will cool the red-hot housing market, so we do not anticipate any major resetting of market rates in the aftermath of Wednesday’s decision.

Targeting inflation

The unenumerated target of all this policy is longer-term inflation expectations, which remain remarkably well anchored. Our preferred indicators are the five-year, five-year forward breakeven, which sits just below 2.5% despite the consumer price index hitting 8.5% and the policy-sensitive core personal consumption expenditure deflator reaching 5.1%.

If the Fed is able to retain that rate, it will obtain its policy objective. If it does not, that will require much higher rates, a quicker drawdown of the balance sheet and a much harder landing of the economy than is generally acknowledged.

It is critical for the Fed to follow through on its policy path to restore price stability, even as top-line inflation noticeably eases later this year, and for the Fed to resist the temptation to please fiscal policymakers in the throes of another polarizing political season.

While the utility function of politicians is re-election, central bankers must restore price stability to ensure stable growth and strong employment gains over the coming years, even as the economy is challenged by an unfavorable demographic shift with an aging population and continuing challenges to global supply chains because of geopolitical tensions.

In addition, given the surging costs of shelter and rising wages reflected by the 4.5% increase in the employment cost index on a year-ago basis, the strongest increase in the 20-year history of the metric, the hard-line policy out of the Fed is necessary to keep those expectations anchored and return price stability to the economy.

We expect the Fed to increase its policy rate by an additional 50 basis points at its June meeting and provide an update to its summary of economic projections that will reflect the cooling in the economic activity that lies ahead even as top-line inflation eases noticeably later this year.

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This article was written by Joseph Brusuelas and originally appeared on 2022-05-04.
2022 RSM US LLP. All rights reserved.
https://realeconomy.rsmus.com/fomc-decision-policy-price-stability-and-balance-sheet-strategy/

RSM US Alliance provides its members with access to resources of RSM US LLP. RSM US Alliance member firms are separate and independent businesses and legal entities that are responsible for their own acts and omissions, and each are separate and independent from RSM US LLP. RSM US LLP is the U.S. member firm of RSM International, a global network of independent audit, tax, and consulting firms. Members of RSM US Alliance have access to RSM International resources through RSM US LLP but are not member firms of RSM International. Visit rsmus.com/aboutus for more information regarding RSM US LLP and RSM International. The RSM(tm) brandmark is used under license by RSM US LLP. RSM US Alliance products and services are proprietary to RSM US LLP.

It has been a year since inflation in the United States started to become a dominant economic issue. Now, with rising prices proving to be stickier than expected, business leaders have been facing a challenge: how to set prices in a highly inflationary environment.

In many industries that are heavily dependent on commodity prices, like food suppliers and energy producers, there is little choice but to peg prices to the overall market. The costs of making their products are tied too tightly to commodity prices.

But in other industries, the answer is not so straightforward, and those businesses have been grappling with a classic economic trade-off: higher prices mean lower sales.

That’s because lower sales often lead to less market share, which erodes market power and profit margins in the long run. In addition, profit is not always the primary business objective, especially for businesses that prioritize growth or long-run sustainability.

What, then, is a business to do? We examine three important factors that could help business leaders make better pricing decisions: demand forecast, market competition and business objectives.

Building demand forecast methods

To protect total profits, businesses should prioritize developing data-driven demand forecast methods that can help to quantify the trade-off between prices and sales.It’s not an easy task, but those methods do not have to be as sophisticated as the approach at Amazon, with its hundreds of economists dedicated to designing pricing and demand algorithms.

Smaller firms can look to high-level macroeconomic data as the foundation to forecast underlying economic trends. The Federal Reserve’s plan to raise interest rates to tame inflation is one example of what can affect overall market demand, as higher interest rates would drive demand to moderate.

Data on consumer income, spending and retail sales—which are released every month and are available at the industry level—is also essential to help predict demand trends.

For example, producers of durable goods are seeing their demand dwindling quite rapidly because consumers are moving away from spending on durable items to services as the impact of the pandemic retreats. The risks of losing demand while raising prices will undoubtedly be much higher for goods producers than service providers.

Studying microdata on past and current customer behaviors is the next step to improving a business’ demand forecast. For industries where demand often fluctuates because of seasonal factors, capacity constraints or product cycles, dynamic pricing models that incorporate data on demand volatility and consumer sensitivity to price changes can help businesses more nimbly adjust their prices.

For industries where price changes are less frequent, like manufacturing or wholesale, the decision to raise prices should include both short-term and long-term impacts on demand. It is often much more sensitive to prices—the reason why changes in prices are less frequent in the first place.

Lower price variability also means fewer data points to predict demand. Market testing and implementing “what-if” scenarios can provide data-driven and informed solutions to pricing decisions that are less biased than the traditional rule-of-thumb or experience-based pricing methods.

Building a data-driven model to forecast demand can improve upon itself when more data is collected. And that is the reason why companies should start investing their resources early, no matter how limited those resources might be.

Understand your competition

The second factor that forces businesses to think twice about raising prices is market competition. The risk from higher prices is not only lower sales but also reduced market share, especially when competitors do not raise their prices. This often happens in markets where products are less differentiated, and profit margins are large enough to compensate for higher input costs without raising prices.

Moving first to raise prices in these markets would be a disadvantage unless the company is a dominant player with a high enough market share. Companies that do not have that luxury will have to base their pricing strategies on their competitors’ pricing responses.

That requires a certain amount of data on competitors’ prices, market share and products to monitor those responses and act quickly. Leveraging publicly available data on competition is a must before making any pricing decisions.

Equally important is identifying the company’s specific comparative advantages and the market’s barrier to entry. For example, raising prices to protect profit margins would invite innovations and entries from competitors that could chip away market share. Those risks can sometimes be hard to envision yet can seriously affect a company’s survival in the long run.

Market competition can also happen at the supplier level. If there is a dominant firm that supplies input materials for the entire market, chances are your competitors are facing the same problem. Your pricing decisions again should follow your competitors’ reactions closely.

But upstream competition can open the door for new opportunities like strategic partnerships, vertical mergers or acquisitions. Instead of fighting higher input costs, companies can take matters into their own hands by having more control over their suppliers. That control can be further expanded into downstream market power by eliminating double marginalization and becoming more efficient.

Align pricing decisions with strategic goals

There is no one-size-fits-all solution to pricing decisions in a highly inflationary environment. The risks that come with higher prices can affect various parts of the business that might not always support the company’s strategic goals.

Protecting profit margins may be less pressing for companies that prioritize growth than protecting market share and locking up more customers. Omnichannel companies that focus on customer experience and direct sales may also need to be more careful when raising prices because of potential customer adverse reactions to higher prices.

But for companies that prioritize recouping profit quickly for new products or face capacity constraints, raising prices should be an easy decision.

Most companies do not rely on a single strategic goal but rather a combination of priorities and business plans. Pricing decisions then become more complex than a simple yes or no question; those decisions also include questions like by how much and for how long.

The takeaway

While these three factors are important to consider in an inflationary environment, they can also work well even when inflation is not a problem because they lay out the principles behind every pricing strategy.

By building a strong foundation with the help of data-driven studies to understand the risks, benefits and opportunities around pricing strategy, businesses will be better prepared to make sound decisions. That includes the uncertainties around inflation that might take months or even years to subside.

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This article was written by Tuan Nguyen and originally appeared on May 02, 2022.
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