Inflation is the No. 1 factor negatively affecting middle market business, according to the a new quarterly Middle Market Sentiment report from Cleveland-based KeyBank, which has its local office in Southfield.
Almost half (46 percent) of middle market business leaders reported that inflation was having a negative impact on their businesses when polled in the third quarter of 2023. At year end, inflation was still the top negative factor, but the number fell to 38 percent. Higher labor costs, interest rates, and health care costs also are prime concerns.
Less worry about inflation aligns with economic data reports, according to KeyBank analysts. Inflation rose 2.6 percent in December from a year earlier as measured by the Personal Consumption Expenditures Price Index, a marked decline from the 5.4 percent increase at the end of 2022. The six-month annualized inflation rate decreased from 4 percent in the first half of 2023 to less than 1.9 percent during the second half of the year. Businesses are clearly still experiencing the effects of inflation, but some may be starting to feel relief as it eases.
“For a while, everyone understood that inflation was rampant, and businesses could pass along price increases to customers,” says Daniel R. Dower, northwest Ohio market president and commercial banking leader at KeyBank. “As inflation cools, businesses need to focus on efficiency to preserve their margins.”
In response to inflation, 38 percent of business leaders plan to increase their sales and marketing efforts to generate more revenue during the first half of the year. Just less than one-third (31 percent) of respondents plan to increase automation to improve productivity. That percentage, however, climbed to 39 percent among business leaders who have a less optimistic company outlook for 2024. An increasing number of respondents said their companies plan to increase R&D efforts (24 percent) and carry excess inventory (23 percent) due to inflation.
Concerns about the costs of labor, health care, and rising interest rates are emerging as watchpoints for 2024.
The number of business leaders who said higher interest rates were having a negative impact on their bottom lines increasing from 22 percent in Q3 2023 to 26 percent in Q4. In addition, 11 percent anticipated that access to capital and credit will have a negative impact on their business operations within the next 12 months. Among those, more than three-quarters (78 percent) expect to see those negative impacts within the next six months — a 7-percentage-point increase over the previous quarter.
Business leaders who reported these concerns are looking for alternative sources of capital and credit via private equity firms (47 percent), private debt lenders (42 percent), and new commercial lending relationships (41 percent). The business leaders anticipating issues with cash flow in 2024 are concerned about finding financing or credit options, as well as their ability to finance growth.
“Among the businesses we talk to, a primary concern is how quickly rates will come down,” says Erica Choi, Albany, New York commercial sales leader at KeyBank. “I think we’ll see some pent-up demand for access to capital because of their desire to fuel growth. But they want to do so at rates that they can stomach.”
Concerns about the increasing cost of health care also are on the rise among middle market business owners and executives. Among the 22 percent of survey respondents who expected higher health care costs to have a negative impact on their bottom lines in the next 12 months, the vast majority (84 percent) expect to see those negative effects within three to six months, a 19-percentage-point increase from the prior quarter.
At the same time, health care benefits ranked as the top benefit desired by hourly employees applying for a new role (cited by 62 percent of middle market business leaders). Despite the importance of these benefits to workers, the number of middle market business leaders who said they were considering implementing or enhancing health care benefits to attract talent dropped from 53 percent in Q3 of 2023 to 44 percent in the fourth quarter.
At the end of 2023, middle market business leaders’ confidence in their companies’ prospects remained unshakeable, according to KeyBank, and their outlook on the overall U.S. economy improved slightly. Yet most still expect to see an economic downturn in 2024, and a quarter of those surveyed in November and December said they believed the economy was already in one.
In looking at the overall U.S. economy, the number of middle market business leaders who characterized their outlook as excellent or very good increased 2 percentage points to 49 percent at the end of 2023. Respondents in the South and West regions were more optimistic, with 55 percent and 56 percent reporting a positive outlook, respectively. Among business leaders of the largest companies in the sample, with $500 million to $2 billion in revenue, 62 percent expressed positive sentiments about the U.S. economy. A higher-than-average proportion of respondents at publicly owned companies reported a positive outlook for the overall economy and their businesses (62 percent and 85 percent, respectively).
“The consumer continues to be really strong,” says Ryan P. Hartzell, director of Consumer and retail investment banking at KeyBanc Capital Markets. “By most forecasts and estimates, holiday spending either met or exceeded expectations. The business community’s biggest fears about an economic pullback have not come to pass, and I think the worst is behind us.”
Measuring the prospects for their own businesses, nearly three-quarters (73 percent) of business owners and executives reported an excellent or very good company outlook for 2024. This level of confidence remained steady throughout 2023. Business leaders in the South (79 percent) and West (77 percent) regions were the most optimistic, and positive sentiment in the Midwest jumped 6 percentage points between Q3 and Q4. Eighty-four percent of survey respondents in the construction industry reported an excellent or very good company outlook for 2024.
KeyBank’s latest Middle Market Sentiment survey asked 400 owners and executives of businesses with $10 million to $2 billion in annual revenue about their outlook for the year, the challenges currently affecting their businesses, and their growth plans for 2024.
To review the full report, visit here.
