It’s Adapt or Die in the New Saudi Economy

(Bloomberg Businessweek) -- Just off the busy boulevard that runs through central Riyadh, an Italian restaurant called Forchetta lay empty and dusty for months. Less than a year after it opened, the branch succumbed to Saudi Arabia’s economic slump as disposable income fell and unemployment climbed to the highest level in more than a decade.

A few doors down, Draft cafe looks right out of Brooklyn or Beirut. Women smoke cigarettes on the terrace as a soundtrack of American pop music plays in the background. A medium espresso costs the equivalent of $2.90, while a quinoa and beetroot salad is $7.70. Forchetta used to charge $13 for a Margherita pizza.

“People are still going to have a cup of coffee even when the economy is bad,” says Wadha Al Rashid, the 34-year-old businesswoman who opened the cafe in July last year and recently added a second location. “We kind of serve a niche for the young creative individuals. I think that really serves us as well.”

The stark contrast of failure and success is an increasingly familiar sight in the Saudi capital as the 86-year-old kingdom undergoes the biggest upheaval in its modern history to adopt a Western-style model of capitalism. Since the government trimmed subsidies and costs rose, the survival of businesses is being determined by different market forces.

Managers complain they can’t keep up, even as the state backtracks on some spending cuts to keep the economy growing. Vacant storefronts pockmark Riyadh’s main thoroughfares. Inevitably there are winners, though, as savvy millennials look for ways to capitalize on the economic and social changes that have shaken the conservative authoritarian country over the past two years.

The message from Saudi Arabia’s powerful Crown Prince Mohammed bin Salman, 32, is that resistance isn’t an option. Independent clerics, royals accused of corruption, and others deemed opponents of the new order have found themselves behind bars. Some business owners are vainly hoping the government will reverse course, says Abdullah Al Fozan, chairman of KPMG LLP in Saudi Arabia.

“You either adapt or you disappear,” says Al Fozan, whose firm audits thousands of Saudi companies, sitting in his office overlooking the beige sprawl of southern Riyadh. “To make people change, you have to shock them.”

Spurred by the oil price rout of 2014, the de facto Saudi ruler is trying to diversify the petrodollar-dependent economy and repair state finances while creating enough jobs for his growing population. For companies it means the era of cheap labor, subsidized energy, and easy government contracts is over.

Gulf Restaurants & Parks Co., which runs Forchetta along with several other restaurant chains, has dismissed 500 employees in the past few years, reducing its workforce to 700, says operations director Rabih Ghostine. The company closed about five restaurants, the new Forchetta branch among them.

“We didn’t feel the crisis until maybe the middle of 2017,” he says, adding that sales dropped 20 percent to 25 percent at some restaurants. “We need to stop the bleeding, as simple as that.”

The challenges faced by managers like Ghostine are formidable. This year alone, the government raised electricity and gasoline prices, introduced a value-added tax, and required companies to pay extra fees to employ foreigners, many of whom receive lower salaries than Saudis.

Hundreds of thousands of foreign workers have left the country, shrinking the customer base for not only restaurants and stores but also private schools and telecommunications companies.

The economy expanded at an annual rate of 1.2 percent in the first quarter after shrinking 0.9 percent in 2017, buoyed by higher oil prices and government spending on wages and social benefits to soften the impact of its shock therapy.

But businessmen say it could take years to fully recover—and it’s unclear what will remain when the dust settles. The International Monetary Fund expects the economy to expand 1.9 percent this year, with growth accelerating gradually to 2.3 percent by 2023. That’s substantially lower than during the boom years of high oil prices.

The Saudi economy “is a big ship,” says Karen Young, a senior resident scholar at the Arab Gulf States Institute in Washington. “It’s not going to turn easily.” The burst of trendy businesses, such as food trucks and women’s gyms, won’t be enough to transform the kingdom’s private sector, she says. “I still see the state as central to the broad trends of economic activity.”

Another risk is that the plan would widen disparities between rich and poor as well as those between the conservatives and the cosmopolitan elite. Already, there’s grumbling over rising prices, and unemployment among Saudi citizens is approaching 13 percent.

Hamdi AlZaim knows just how big a revolution is needed to ensure survival. At 31, he’s business development manager for his family’s company, Gulf International Contracting & Real Estate Co., which deals in building materials and construction equipment.

Construction was one of the sectors hardest hit by the downturn. As the state reined in spending, the flow of contracts decreased, and officials delayed payments to contractors. Giant companies floundered or collapsed.

Just as AlZaim was coming of age, the business was at risk of becoming a dinosaur. So he set about overhauling the company’s investments and surveyed the local landscape for new opportunities.

It invested in a Swiss company that makes an energy-efficient desalination device and was able to persuade Saudi Arabia’s Saline Water Conversion Corp. to switch to the new technology in one of its plants. In the old kingdom, efficiency wasn’t a priority; now it’s a potent selling point.

“It took us a while to comprehend this and understand that this is a new reality we’re in,” says AlZaim, dressed in a crisp, pale blue thobe—a variation on the traditional white dress for men—sitting next to a stack of books with such titles as Change Management and Talk Like TED. “It’s a huge mind shift. You have to come and say: I’ve been working in this market for 20 years—maybe it’s time to move on.”

Young Saudis like AlZaim are crucial to Crown Prince Mohammed’s plan to remake the economy, which also includes loosening the Islamic kingdom’s social restrictions. In the past few years the government has curbed the powers of the religious police, ended a ban on women driving, and allowed cinemas. While music was rarely heard in public before, now the state is sponsoring concerts.

But youth also present the prince’s biggest challenge. About 70 percent of the 21 million Saudi population are under 35, and more are entering the labor market.

As the government tries to control its spending on wages, the burden of job creation has fallen on private businesses and startups. They first need to put money into areas most likely to succeed, says Saleh Alothaim, chief financial officer at Othaim Holding Co.

“People need to take risks in industries that are not very high-risk,” he says. “The private sector cannot just sit and watch what the government does.” He predicts many smaller businesses will close as they struggle to adjust.

At the new Prince Mohammed bin Salman College of Business & Entrepreneurship, on the Red Sea coast, students are preparing for an economy that’s totally unlike the one their parents knew.

One of them, Abdulrahman Al Saati, quit his job as a doctor to start a company called Saati Adventures. A 29-year-old Syrian who grew up in Jeddah, he plans to offer adrenaline-raising tours at sea and in the desert, perhaps even sky diving—banking on the new enthusiasm the government has shown for tourism as it tries to diversify the economy.

“The good thing is all of these things happened as coincidence at the same time,” says Al Saati. “The opportunity was amazing.”

Back at the Draft cafe, dozens of customers sink into soft gray couches and chat on the sunny terrace. Mugs for sale are emblazoned with slogans such as “feminist” and “free spirit.” Wearing a pale linen robe, with short hair and wrists full of bracelets, Al Rashid attributes at least part of her cafe’s popularity to the spreading social change.

As for the closed Forchetta, a new business is moving in: an Egyptian restaurant called Nile Palace.

“Because of where Saudi is heading now, and the new direction and everything, people are just more open to new things,” Al Rashid says.

To contact the editor responsible for this story: Cristina Lindblad at mlindblad1@bloomberg.net, Rodney Jefferson

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