In 2022, middle market businesses are cautiously optimistic

Even before the conflict, middle market business owners expressed a dual economic view: positivity about their own companies’ success potential, contrasted with uncertainty about the U.S. economy at large. They focused on their eagerness to resume normal business operations and plans to invest in growth – all while keeping a careful eye on supply chains, rising inflation, and a highly competitive labor market.

Middle market businesses are bullish despite persistent uncertainties in 2022

Compared to the fourth quarter of 2021, slightly more middle market business leaders (77%) reported having an excellent or very good outlook for their company’s financial performance over the next 12 months. Larger companies ($500 million to $2 billion in revenue) and those in the construction industry were particularly optimistic about their prospects for 2022, with more than 80% of survey respondents in both categories reporting an excellent or very good outlook. However, as was the case in late 2021, significantly fewer business owners and executives (55%) expressed the same levels of optimism about the broader U.S. economy – especially among those who rated their own company’s outlook as fair or poor.

While two-thirds of respondents reported being somewhat or fully back to normal business operations since the onset of the pandemic, other factors contributed to uncertainty in the middle market. Thirty-nine percent of middle market executives said that supply chain disruptions are currently having a negative impact on their business, and 32% expected these issues to continue over the next 12 months. About the same number (38%) said they were already feeling the negative effects of rising inflation, with about 43% expecting inflation to impact their businesses in 2022.

Despite these uncertainties, middle market businesses started the year off with plans to expand the scope of their operations. Half of those surveyed anticipated bringing on new employees within the next six months, and nearly as many (47%) plan to further invest in technology/automation. A quarter (24%) said they were considering an acquisition; among companies in the $500 million to $2 billion revenue range, that number climbed to 31 percent.

“M&A activity is robust right now,” observed Lamirand. “Multiples are super high, even in the lower end of the market. It reminds me of the hot housing market – before you even get to see a place in person, it’s gone.”

As the pandemic fades, consumer restrictions lift, and economic activity picks up, middle market businesses are eager to use available cash to seize opportunities for growth. But uncertainty persists, especially when it comes to supply chains, inflation, and the labor market.

Supply chain disruptions continue to impact the middle market

The havoc wreaked on global supply chains during the pandemic continues to ripple through the economy. Of the executives Key surveyed, nearly half (44%) reported that supply chain issues had negatively impacted their business within the past 12 months. Among those reporting a neutral or negative outlook on the overall U.S. economy, that number increased to two-thirds, suggesting that supply chain woes have significantly contributed to economic pessimism in the middle market.

Digging deeper into the supply chain dilemma, the cost and availability of raw materials as well as the loss of key suppliers continued to rank as survey respondents’ top three concerns. Of those who reported that supply chains had negatively impacted their businesses, 55% have experienced a decrease in the efficiency/productivity of their business operations. Nearly half (47%) reported both lower revenues and thinner profit margins because of supply chain difficulties.

In response to supply chain disruptions, the middle market businesses impacted are working to identify alternative suppliers (44%), passing increased costs on to their customers (42%), and carrying excess inventory as a buffer (42%). In addition, 43% expect to update their supply chain information/management systems – compared to only 23% who planned to take that approach last quarter.

Fortunately, lack of availability and long wait times for raw materials seem to be abating: 61% of respondents said they were experiencing these problems in Q1 of 2022, compared to 76% the previous quarter.

A recent report from Moody’s Analytics stated that the greatest risk to global supply chains is no longer the pandemic, but the war in Ukraine and its resulting geopolitical and economic uncertainties. Companies that rely on energy resources will be especially affected, according to the report.²

Rising inflation and interest rate hikes loom large for the middle market

In the first quarter of 2022, inflation emerged as a broad concern among middle market businesses – and especially among the 45% of survey respondents with a less optimistic economic outlook. Sixty percent of these skeptical middle market business leaders cited higher rates of overall inflation as a contributing factor to their concerns about the economy, along with higher costs for labor and raw materials. However, as Lamirand observed, businesses in sectors where demand remains high can pass those price increases along to customers.

“With demand remaining strong, companies can increase prices and maintain their margins. Businesses that are sitting on excess inventory are seeing even greater profits when they can pass along those price increases to customers.” That said, Lamirand is also cautioning clients that strong demand won’t last forever, especially if prices stay high. “The correction hasn’t happened yet, but at some point, it will. It always does.”

Regardless of their economic outlook, 43% of business owners and executives surveyed anticipated that an overall increase in inflation will have a negative impact on their businesses within the next 12 months – more than any other factor listed. More than a third (38%) reported that they are already feeling the effects of inflation.

Middle market businesses are certainly not alone when it comes to apprehensions around rising inflation. Driven primarily by rising food and energy costs, the U.S. inflation rate climbed to 7.9% in February, a level not seen in decades. Economists anticipate that Russia’s war in Ukraine could push prices even higher, exerting additional upward pressure on the rate of inflation in the U.S. and around the world.³ In an effort to slow inflation, the Federal Reserve announced its first interest rate hike since 2018, to be followed by additional increases throughout the year. However, NPR reports that the Federal Reserve is “walking a tightrope” in trying to bring inflation under control without dealing too large a blow to the country’s economic growth.⁴

In a tight labor market, flexibility is crucial

Current conditions in the U.S. labor market are complicating the picture for middle market businesses. In February, the unemployment rate fell to 3.8%, edging closer to its pre-pandemic level of 3.5 percent.⁵ As a result, competition for qualified workers remains high.

Middle market business leaders are acutely aware of the tight labor market: among the 50% who plan to hire over the next six months, more than 6 in 10 anticipated some degree of difficulty hiring skilled workers, non-managerial professionals, and managers. When asked to identify the main obstacles to filling their hiring needs, they cited scarcity of qualified workers, high salary requirements, and the length of time required to identify and hire qualified workers.

To attract and retain talent in this tight labor market, middle market businesses planned to offer competitive wages, flexible working hours, and comprehensive benefits packages.

“You’ve got to have the best people, and businesses are willing to do whatever it takes to get them on board,” said Doyle in Cleveland. “Companies with strong profits can be very competitive when it comes to attracting and retaining talent and may be more aggressive with signing bonuses and profit-sharing. Many have a surplus of cash – giving that back to employees in some way can be a strong tactic in this labor market.”

Survey results also show that for many businesses, the shift toward remote work is here to stay. About one-third of business owners and executives said they will continue to hire remote employees even after they have fully resumed normal operations, and many anticipated reconfiguring (30%) or reducing the size of (21%) their offices or facilities. “We are confident that pandemic-driven flexibility measures are here to stay,” said Lamirand.