Eskom increases give SMEs no wriggle room in harsh economy, writes Hendri Pelser

Eskom's tariff increases for business users have been unveiled and the news is not good.

While increases for homes were made public in February, business energy users had to wait a little longer to find out exactly how hard they would be hit.

From April 1 SMEs that get their electricity directly from Eskom will be paying 23.5% more on average in urban areas and 18.7% in rural areas.

Unfortunately, businesses buying power from municipalities are in for an even bigger shock: a 28.9% increase.

Municipal increase

Based on Eskom's price hikes, municipalities across South Africa have until April 30 to apply to the National Energy Regulator (Nersa) for tariff increases.

If approved, the increases will come into effect on July 1.

Nersa says that municipalities which implemented a 34% electricity-price increase in the last financial year will only be able to push up their prices by 15.33%, 16.03% and 16.16% over the next three years.

But, because of the differences in the financial periods between Eskom and municipalities, the 15.33% increase needs to be recouped in nine months, resulting in the 28.9% hike. Those municipalities that did not up fees by 34% last year can apply for different - and possibly higher - tariff increases.

Nersa spokesman Charles Hlebela says that 40 municipalities did not apply for increases last year and only six applied for higher increases.

Because business users generally pay more than residential users, SMEs in these municipalities can potentially see significantly higher increases than the three-year guidelines set out above.

Charles says that municipalities deviating from the guidelines will have to hold public hearings and justify their recommendations to the regulator.

How to kill a business

Obviously, business owners are not happy with the increases, saying that higher input costs will place them in a tricky situation.

Tony Afonso of TJ's Convenience Store in Roodepoort, west of Johannesburg, says that shoppers are attracted to his shop by the fresh bread made on the premises, and cheap milk.

But the prices of these low-margin items will suddenly increase because the oven and fridges will cost more to operate - and he is unsure how to manage subsequent price increases.

"It is pathetic and crazy: it is going to push our costs through the roof ... I can't predict what will happen to the prices."

Tony says that if his prices increase, he won't be able to compete against larger retailers in the area, and he will have fewer customers.

And he cannot absorb increased operational costs for too long - as this will threaten the business.

Finally, Tony is worried about the effect the electricity increases will have on his customers' disposable income - and therefore on his profits.

"We have to try to be competitive to survive. We will see if we can change our ovens to more electricity-efficient models or use solar power," says Tony.

"The electricity price increases will affect everybody but it is more difficult for smaller, independent retailers to survive because we don't get kickbacks or good credit terms."

The big squeeze

Whereas Tony receives his electricity from the local council, clothing manufacturer Michael Rademeyer gets his directly from Eskom.

Rademeyer, the owner of Michael Luke Clothing, which trades in Hammanskraal, about 40km north of Pretoria, says that any rise in input costs immediately eats into profit margins.

To absorb the increases, he will either have to sell goods of lower quality, or increase his prices.

He says, however, that in this economy, it will be extremely difficult to hike his prices enough to completely cover the more expensive electricity.

"It is going to come down to cost cutting: either the guys are going to retrench people or you are going to start turning some machines off."

Justice Nkawe owns a Chicken Licken, a butchery and a bottle store in Dobsonville, Soweto, and largely serves a low-income market.

"There is very little I can do. I have a generator, but obviously you cannot use it all the time.

"It will be very difficult for me to increase my prices. My clients are going to run away to the competitors selling third-grade meat, whereas I sell A-grade meat," says Justice.

"It is a dilemma we face and I still have to find a way to tackle this. It is a big, big problem.

''I am still doing my sums, but I do not know what to do. If you do not increase your prices, you take a knock. If you increase your prices you might take a bigger knock, as customers run away to competitors."

Consumers and inflation

Michael McDonald, manager for economic and commercial services at the Steel and Engineering Industries Federation of South Africa, says the increases are making a tricky economic situation more difficult.

He says that manufacturers have increased output and are building up stock, but that the buying power of consumers and retailers is still lacking.

Once the electricity price increases come into effect, less money will flow through the economy, and this will obviously affect demand, hurting manufacturers trying to recover from the downturn.

"I think it will be quite devastating. We think it is going to be quite difficult for our members. The increases are quite substantial."

The South African Chamber of Commerce and Industry has estimated that about 250000 jobs will be lost through Eskom's increases. While it is difficult to say exactly where these jobs will be shed, the assumption is that the SME sector will be the hardest hit.

Economists.co.za's Mike Schüssler says that the electricity price rises for consumers will affect their spending, and thus the SME sector.

"There is very little SMEs can do. They should pass the increase on to consumers if they can. They should also look at their pricing carefully."

He adds that inflation will break through the Reserve Bank's upper target range later this year as the direct and indirect effects of the increase works its way through the economy.

Carmen Nel, a senior economist at Rand Merchant Bank, says that the most recent Business Confidence Index - which jumped 15 points during the first quarter of 2010 - does not reflect the electricity increase announcements, as the poll was completed in February.

She thinks the effects of the announcements might be reflected in the next index. Carmen says that the real impact on the economy will only be felt later in the year once municipal increases have kicked in.

"It will certainly have a huge impact on SMEs and the question is: can they pass on the increase in their pricing? If they can't, there will be a huge squeeze on margins."

What to do?

Besides reworking margins and pricing structures, experts say there is little SMEs can do.

As a result, mitigation is key. Gustav Radloff of Energy Cybernetics - a company which tries to improve energy use in business - says they have already seen a significant increase in the number of SMEs approaching the firm.

Gustav says, however, that a lot of anger in the market is misdirected at Eskom: "The increases are here to stay and are necessary to stabilise the network and avoid power outages ...

"For most SMEs electricity has been an invisible input so far: you get the bill at the end of the month but while you use it you have no idea of what you really use."

Gustav adds that the average SME can look at a 10% energy saving by optimising their use of electricity.

Generally, the saving repays the cost in about two years. "But this is if there is zero electricity inflation."