Looking back, 2004 was a mixed bag. Gross domestic product expanded at the fastest rate since the 1990s, but the war took a turn for the worse, the deficit widened, and oil prices skyrocketed. Assessing the year that was inevitably raises questions about the year that will be. These issues are poised to shape 2005:
1. High prices on raw materials.
Remember the good ol' days when the U.S. sucked up all of the world's metal, ore, and oil at slightly exploitative prices? Not anymore. A construction boom in developing Asian countries has helped to drive up steel prices 46% over the past 12 months. Lumber prices are up 25%. And cement is in such short supply that builders in the mid-Atlantic and southwestern U.S. have a difficult time finding it.
"Projects have been delayed because I've had to renegotiate prices on steel," says Jeff Intoci, vice president of Avino Construction in East Northport, N.Y. "I now shop around to multiple vendors, whereas I used to use only one." Like most builders, Intoci is adding clauses in contracts that allow him to account for the rising costs. But because he does a lot of work for the government -- and those contracts are ironclad on price -- there's a limit to how much he can charge. "It affects the bottom line and it hurts us competitively," he says.
How will entrepreneurs cope? "I see small companies doing more with alliances and associations to try to gain buying power," says Stephen Spinelli Jr., an entrepreneurship professor at Babson College in Wellesley, Mass.
2. Logistical problems resulting in long lead times.
For more than a decade, American business has relied on just-in-time delivery of inventory and components to improve efficiency, reduce lead times, and trim costs. Now, the physical limits of the global distribution network are being tested. "If you're waiting for anything offshore, the ships in Long Beach are so backed up you can walk to China on them," says Jack Stack of SRC Holdings, a manufacturer in Springfield, Mo.
Any new port-security regulations, which were much discussed during the presidential campaign, could further exacerbate the situation -- particularly if Congress mandates measures but does not provide federal funding for them.
All of this could portend a return to the days when companies tied up too much of their capital in warehouses. "Lead times have already doubled in a lot of cases," Stack warns, "and it is going to get more difficult."
3. Benefits driving up labor costs.
Any talk of labor costs inevitably turns to health care, so we'll start there. For entrepreneurs who have less buying power, double-digit increases in health care premiums are becoming as predictable as death and taxes. They jumped 11% on average in 2004. Keith Whitener, the president of Milestone Construction Services in Sterling, Va., says the cost to insure his 36 employees has gone up 20% annually the last few years. "Every year we have to look at new plans," he says.
An effort to allow small businesses to band together to negotiate cheaper rates for insurance through association health plans, or AHPs, is likely to remain stalled in the Senate in the coming year. In the meantime, Whitener and many others are turning toward providers that offer higher deductibles. "Companies did that in the 1980s, but we are seeing it again," says Bobbi Butler, vice president of the Savitz Organization, an employment benefits consulting firm based in Philadelphia. "It can save companies a lot of money." Savitz also expects that more employers will adopt health savings accounts, in which employees contribute pretax dollars to fund health expenses, to make up for the higher deductible.
Health care isn't the only benefit that companies have to watch out for. Employers will increasingly find themselves reworking benefits packages to cater to what demographers have dubbed the "sandwich" generation -- people who are responsible for both a child and an aging parent. These employees will demand a slew of new benefits such as flextime and child and elder care programs.
Constantijn Panis, an economist in Deloitte & Touche's Los Angeles office, estimates that, so far, only 3.5 million people belong to this group, but the ranks will swell as the baby boomers hit their golden years. Employers will have a hard time resisting the sandwich generation's demands because fewer people are entering the work force each year. "Where there is a shortage of workers, employers may find they have no choice but to provide those added benefits," Panis says. "In certain industries it is already a problem."
4. Struggling state economies.
Facing massive fiscal crises in 2001, governors and legislators in many states were forced to slash budgets. That hurt the thousands of companies that supply states with goods and services. And it shifted the burden and expense for activities like worker training onto local business leaders.
Fast-forward to today and state revenues have rebounded, but spending remains well below average and many states still face budget holes, incurred by borrowing money or dipping into reserves in previous years. "It would take three or four years of above-average revenue growth for this problem to go away," says Elizabeth McNichol, a senior fellow at the Center on Budget and Policy Priorities, a Washington, D.C., think tank.
While other states struggle with their budgets, California and Florida face unique burdens. The fate of these states is critical to the national economy given that they have historically been hotbeds of entrepreneurship. One fifth of this year's Inc. 500 companies hail from California and Florida. The states are also home to large Hispanic communities, which are increasingly important in terms of new-business formation.
After a quartet of hurricanes battered Florida in 2004, "businesses that do anything relative to cleanup have so much work they can't handle it," says Bill McDermott, director of economic development for Seminole County, "but there are a plethora of businesses sitting around and waiting for customers to come back."
Low-cost loans from the Small Business Administration will sustain companies in the short term. But a big storm can have long-term economic consequences as well. People may move out of a hard-hit area, transforming the work force and tax base. That happened in Homestead, Fla., following Hurricane Andrew in 1992.
Meanwhile, California Gov. Arnold Schwarzenegger is managing his own cleanup of sorts. To appease disgruntled business owners, he's attempting to reform laws such as those that deal with workers' compensation. "The jury is still out," says Jack Kyser, of the Los Angeles County Economic Development Corp., "but the small-business community feels that they have a friend in Sacramento."
5. The return of early-stage deals.
Some good news: A surge in funding for young companies is likely. Venture capital investments increased to an estimated $25 billion this year, according to the National Venture Capital Association, an industry trade group."VCs have been out raising money and they need to put that capital to work," says Tracy Lefteroff, global managing partner of venture capital at PricewaterhouseCoopers in San Jose, Calif. "And the valuations now are more favorable toward the entrepreneur."
There are some caveats. More than ever, investors want to be geographically close to their investment, according to Babson's Spinelli, so businesses in Silicon Valley and Boston will have the upper hand when it comes to landing money. (Live somewhere else? See "Main Street VCs," page 40.)
Also, funds will come in dribs and drabs. "Businesses will see financing in smaller bids and will have to prove a concept before securing more," says Spinelli. With so many other costs ballooning, entrepreneurs will gladly take what they can get.