Why the Service Industry is not Recovering ...and it's not just Because of the Delta Variant
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Last week, I went with my two teen-aged kids to pick up some fast-food at franchise restaurant. I did not want to spend too much, so I just ordered a large fry for myself. Despite my frugality, the total came to over $40! Granted the kids added a few extras to their meals, but $40 is a bit steep for unhealthy fast-food. To top it off, they were still hungry afterwards.
Last month I requested some plumbing quotes for a kitchen sink-aerator, two faucets and a shower that needed repairs in our home. The estimates were all over the place and it was clear that some plumbers were clearly padding the numbers: $120 to replace the hoses & valves to the wall (“because they were old, and they just couldn’t guarantee the work otherwise”). I had replaced those myself just a few years ago and I knew they were fine. The prices for the in-sink aerator were all over the place too, ranging from $140-250, not including labor. I ended up doing most of the work myself.
A good friend of mine needed to replace a garage door spring that had broken. Again, the estimates were all over the place up to over $1000 (I once did this myself for a total of $60 in parts, but that was years ago). As expected, he was also confronted with the parts debate: “oh this is a custom spring and will cost extra” and the inevitable “we’ll need to replace those as well” discussions. He eventually settled on what seemed to be the most honest contractor at a fair price, but not being an expert, he is really at their mercy.
Not just a trend
I have noted the same process taking place elsewhere. My auto-mechanic wanted to charge me $430 to replace the visor in a Honda. My neighbor complained that her gardener raised his monthly fee by a whopping 40%. The local coffee shop that I frequent (because it is not a large corporate “Starbucks” shop), has increased their prices notably. The graphic designer that I hired for a small logo-design job on Fiverr raised his prices as well – wait, wasn’t the whole idea of Fiverr that small jobs were going to cost 5 bucks?
You get the idea.
Many of you have probably had similar experiences from people you have hired in the past, from carpet cleaners to alarm system installers to bookkeepers for your business. Maybe you are used to it. However, there seems to be a big jump in prices and variability now that the economy is opening again. Prices are much higher than before and being able to negotiate a good deal is a bit less likely.
The Service industry in a post-COVID economy
Yes, prices have gone up. Supply chains have been disrupted, inflation has devalued the dollar, and parts of the economy are struggling. This is also true for the service industry, and service providers have increased prices to cover their own rising costs. But is that all there is to this?
Perhaps, small-time service providers are also raising costs just because prices are going up elsewhere. Perhaps they are increasing prices as padding for an uncertain future? Perhaps higher prices are a bit more arbitrary now. Perhaps this upward trend is less driven by actual supporting data and more by feelings and fears.
While there have been many reports of a dramatic post-pandemic growth in the service sector, there have also been signs of trouble. In June, there was a noted slowing down of the service industry in June.
It seems as if the exuberance of an opening economy is coming face-to-face with the reality of rising costs. If ever there was a trickle-down effect, rising prices in the supply-chain have certainly proven the concept, especially so for small business owners.
Lacking the bean-counting and high-priced research that large corporations can rely on, small businesses are left with the unenviable recourse of raising prices in a similar fashion. The difference being that it is a gamble for small businesses, a guess, a speculation. There is uncertainty in the future that they can’t plan for in the same way, so they are padding prices where they can.
It is not that this is completely willful price-gouging. Price-padding has been a reality in the small business service industry almost as a norm, and consumers of those services have had to cope with it as best as they could. Some customers simply did not care enough and just paid the price. Every industry has a history of some padding.
However, in the face of so much uncertainty and after a devastating economic downturn that we still have not completely recovered from, the need for price-padding has become acute. Almost every one of the 5 plumbers we asked for quotes padded prices, so much so that I did not hire any of them. This seems like a new low-bar to me. I do not want to blame them entirely because I understand the realities of the larger economy, but it just seems like this is a new normal and that is problematic.
How Customers Respond
As I mentioned above, many customers swallow the jagged pill of higher prices. However, there are many who do not. Me, I decided to do most of the plumbing work myself. It was not easy; it took time and I have a couple of bruises to show for it. However, I also saved hundreds of dollars in the process.
The question is how many people are doing the same thing? Are they doing the work that pre-pandemic was being done by contractors? One possible clue may be seen in the impressive revenue growth of Home Depot and Lowes, recently.
Certainly it would seem that more people are purchasing goods from those hardware chains and that some of that is the result of people doing their own repairs.
In contrast, a supplier that typically caters to contractors rather than the customers directly, Grainger, saw a 2% dip in its second quarter growth numbers. Its stock price has also been flat or down since May of this year, despite the opening up of the economy and contractors going back to work. Perhaps this is indicative of slowing sales to contractors, unlike the resounding success of the direct-to-consumer competition.
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An entirely different industry that I follow closely, is graphics design and website management. While it is a different industry than hardware, it shows a similar trend. Contractors who typically sell their services to others, are purchasing less while the customers themselves seem to be purchasing more.
Squarespace is a completely self-managed and fairly simple-to-use website hosting and designing application has seen better growth in the past quarter than it did in 2020. Squarespace is geared more towards small businesses whose owners manage their own sites. Their growth suggests that more small business owners are opting for that option rather than hiring a contractor to do this for them.
WordPress, a much larger company but in the same industry, is a more complicated website hosting and design application that is typically managed by third parties for other small businesses. It has seen a small dip in usage in the past quarter. Whereas it grew 5% in 2020, it has slowed to 4% this year; essentially it has stagnated.
While small business owners also use WordPress on their own and Squarespace is sometimes managed by third party contractors, there is a noticeable discrepancy in their adoption rates over the past quarter.
The story appears to be the same in the graphic design software industry.
Canva is a simple template-driven application for creating simple logos, banners, and advertisements. It has also grown tremendously in the past year. While it had a market valuation of $6B in 2020, it has now reached a $15B market valuation, more than doubling in less than a year!
While the company prefers to tout its enterprise (i.e. corporate) vision for graphic design, the company’s rise is based on a much more humble idea of creating a simpler and more accessible application for graphic design, the kind that better serves small businesses and gig workers. One of the company founders said that they were looking for an application that was unlike industry leaders “InDesign and Photoshop — software that people found hard to learn and even harder to use.”
InDesign and Photoshop are from market-dominating Adobe, who’s higher-priced offerings cater to professional graphic designers from small contractors to large design firms, that is, those that typically are hired by small business owners because small businesses do not have the skills in-house.
While Adobe saw its stock price rise significantly in the first half of 2020, it has been relatively flat in the second half of 2020 and the first half of 2021. To their credit, Adobe has managed to pivot. Stock price rose sharply at the beginning of the summer, and I believe this is in large past to a renewed focus on smaller customers, especially the work-at-home type of small businesses.
Adobe is not blind to the success of smaller companies like Canva. They have renewed emphasis on products like Adobe Spark, a direct competitor. Likewise, they realized very quickly that B2C (business to customer) sales are just as important as their B2B is to their bottom line.
Adobe is a nimble company and understands that there is a shift in who their customers are. It is a shift that Canva has capitalized on heavily, but that Adobe can quickly capture as well with it’s much larger catalogue of products, including simpler products like Spark.
I realize that these are very superficial market trends in the very broad service industry. However, are they indicative of a larger trend? Where is this headed?
The impact on the larger economy
Here is my simplistic view of how this trend can have a more drastic impact on the economy as a whole. I am not an economist, and I do not have access to all the data, but I can clearly see that there is a new normal when it comes to prices and what people are willing to do about it. I believe there is an explanation for this change in attitude.
During the pandemic, many people stayed home. Incomes dropped and people needed to become more frugal. They had more time and they learned to repair their own faucets, make their own food, and maintained their own websites. They made do with less.
Many of these people also lost their jobs and so necessity forced them to adapt. Not only did they become more frugal, but many also started home-based businesses. Because their children were learning online, they also started to acquire business skills online. Not only did they learn to repair things around the house, but they also learned to become more business-savvy – they learned many of the price-padding techniques used by other small businesses who used to do work for them.
As a result, they became smarter consumers of those services. So, this was a one-two-punch in the traditional service industry: they needed less, and they accepted it as the new normal. I firmly believe that this will have a wide-ranging impact on the economy as a whole.
Instead of trickling down, this will trickle up. These smarter consumers will not only buy less services, but they will also buy less in general. Not only will they stop paying higher prices for a latte at the local mom & pop coffee shop, but they will also stop paying for it from Starbucks.
Right now, economists and politicians are intently focused on the supply chain issues, but there is an unseen problem coming up from the consumer side of the economy that is not garnering the same attention. Small businesses and gig workers are expressing their frustrations by raising prices, and what I believe is a rise in price-padding, but this trend is not isolated to just them.
Price-padding is happening in all industries, and it is not being absorbed the way it traditionally has been – by consumers who do not care enough. There is a wide-spread uncertainty about the entire economy, and it is not just coming from the top.
This leads people to hoard even more, become even more self-sufficient, and to spend even less. This downward pressure is what is causing the slump we are seeing now, even though the economy should be booming right now.
Conclusion
I realize that other factors such as inflation, geopolitics and the Delta variant, that are also impacting the economy negatively, but those only add to the concern. All these factors together point to a significant impediment to the economic growth we should be seeing. Consumer behavior towards the service industry only exacerbates those.
However, here is the kicker: this issue is artificial, or at the very least, has a simple remedy. This is because the slow-down in consumer purchasing is because people are not willing to pay high prices for services they can do themselves. Yet, this is only true up to a point – the point when their skills are no longer enough.
I experienced this myself. While I was able to replace the faucets and the in-sink aerator myself, I was not able to fix the leak in the shower. I still needed a plumber to do that. Likewise, managing a website and creating effective advertisements will at some point also require professionals. Those professionals have the right tools and the experience to do it at a higher level, for a better ROI.
There will need to be some give-and-take and negotiating, since consumers now need professionals a bit less than before, but they will still need them. Eventually, this will also drive professionals to provide better services and become more competitive, so the quality of their work should also increase over time. There is a light at the end of this tunnel, but it will require some flexibility from all sides.
Just as Adobe was able to pivot when it noticed a quick change in their customer-base, so too will nimble small businesses need to change to meet the needs of their customers. All small businesses from individual Lyft drivers to plumbers to franchise stores need to adapt to this new normal. Consumers managed to adapt during the pandemic, so businesses should be able to now that we are coming out of the lockdowns.
