IT MAY BE too early to say that a corner has been turned. Many have spoken about green shoots in the past only to find themselves embarrassed as their grand proclamations appeared naïve – plain wrong – just days or weeks later.
But many will still hope that the climate to do business is improving.
What we can be more definitive about are the decisions made and strategies followed to get through a very tough, recessionary, five-year period that has lasted since the credit crunch.
And if a corner has indeed been turned – what shape have those decisions left UK business in?
Our joint survey of more than 200 FDs and CFOs by Financial Director and Manchester Business School found that lowering head office costs, reducing wages and employment have been the most popular methods of cost control in the past five years.
Meanwhile, classic cost control measures – shortening debtors and the frowned-upon lengthening creditors – were used by 30% of the respondents.
But that doesn’t signify completely negative tactics. Nearly half of the FDs surveyed (48%) said their companies increased their prices during the recession – a policy that can be implemented quickly.
Many others have disposed of assets and increased short-term borrowing. While nine out of ten of the smaller companies interviewed indicated that they had suffered during the recession, 65% said they were able to increase their short-term borrowing – which contradicts what other surveys as well as anecdotal evidence have shown.
Back to the knitting
“It has definitely been a case of ‘getting back to the knitting’,” explains BDO partner and manufacturing specialist Tom Lawton.
The manufacturing industry has been “buffeted” during previous recessions, making it more hard-nosed and ready to act, which was what happened five years ago – industry made cuts early on in the recession, with Lawton suggesting that the sector, which still represents 12% of UK GDP, acted in 2008 and early 2009 to restructure its cost base.
As a result, it feels like “there hasn’t been much going on in the sector for a few years”, he adds.
Banks have generally been satisfied to maintain funding for businesses, but the challenge for FDs will be taking the first step towards a growth strategy – and how that affects their working capital and banking facilities.
And employment has held up during the five years – we have been nowhere near traditional job-cutting during negative periods. Compulsory redundancies were used by only 17% of the FDs we surveyed, with 12% opting for voluntary redundancies. Some 16% have redeployed staff into other roles.
This relative lack of redundancies has been “very important” and could have significant implications if UK business is to pick up its productivity levels, according to Deloitte’s UK chief economist Ian Stewart.
“While GDP has fallen, employment has fallen very little. The implication is that companies may be able to cope with the growth – there is scope for gains in productivity,” Stewart believes.
However, Lawton says it is “quite hard to get to the reality” of the employment situation, but he suggests an answer.
He believes that employers – using manufacturing as an example – have tried to play a longer game in terms of managing their available skillsets so they can be more agile and better prepared for an upturn in fortunes.
“Manufacturers are conscious of skillsets. Maybe they’re not currently operating at full capacity, but it’s a reluctance to lose skills that you might find difficult to replace,” he says.
“Some of my clients have taken the longer-term view. Most stakeholders – even around listed companies and in private equity – [have taken on board] that there’s no point cutting so hard that you don’t have a business when the upturn comes.”
Focusing the minds
There are other instances where cost cutting is shown to focus the minds of FDs and their fellow board members – so that the tough decisions that must be made still remain within a more overarching strategy.
Outsourcing, a term that has been known to chill the blood of board members and back-office functions, has been utilised more than ever during the recession. While the larger consultancy houses have worked with major companies on shared services, the removal of back-office staff and provision of better datasets to FDs, smaller companies are moving into the cloud.
The increasing capabilities – as well as the all-important low cost – of running systems and applications through the cloud has been a boon to many SMEs, explains the finance director of a small but globally expanding high-end restaurants and bars business.
‘Off the shelf’ online applications will now do “95%” of what most finance directors would expect – and while others may “delude themselves” in looking for a closer fit to their business, “95% is enough”, the FD says.
Such an application allowed the finance director in question to move payroll out of house. The application can also produce rotas.
“It saves money and you have better information,” he says. The company strategy has also extended beyond traditional areas of outsourcing, with it calling in procurement specialists to help look into its purchasing practices. “Food costs are a big impact on the bottom line – these guys can come in and do far more [to advise on lowering costs], but we can only scratch the surface.”
The FD concurs with Lawton, in that the best move seemed to be “making fairly deep cuts” soon after the credit crunch of 2008: “We made them sufficient to make a difference. Several rounds of cuts is demoralising. We looked at variable costs, ‘nice-to-haves’, marketing, and then asked, ‘What can we reengineer?’ We suddenly had a much better business.”
Much more active working capital and cash management have been the cornerstones of the financial management strategy taken to stave off the recession. While this has no doubt helped keep many businesses out of insolvency, there are now suggestions that it has gone too far.
Indicative of this are the findings of Capita Asset Services cash survey of the FTSE 100 last month. The survey reveals that a staggering £166bn of cash and equivalents is being held by the FTSE 100 – the amount by which that figure has increased in the past five years alone (£42bn) would be enough to fund the proposed HS2 high-speed rail link.
In order to hoard such an impressive pile of cash, some of the biggest companies have eased back on external funding and cut investment.
But we have been here before. As Deloitte’s latest quarterly CFO survey shows, the gap between expansionary strategies and defensive strategies is converging, and likely to cross in its next report (with priorities moving to expansion). This is promising – but the two made the same crossover at the end of 2010, only to be reversed in the first half of 2011 as the euro crisis and US debt strategy concerns began to severely affect markets.
However, the pressure will be on finance directors to sign off expenditure. Capita’s commercial director Justin Damer – on the back of the cash survey – has called on business to loosen the purse-strings (see also the Secret FD column page 18).
“They have continued to hoard cash even as the economy has gone up through the gears, and this will prove unpopular with investors, who resent companies sitting on huge cash piles earning low returns,” explains Damer.
“With the economy back on its feet, the key question is what companies will do with their cash reserves – whether they will seek to boost investment, fund mergers or acquisitions, or return the money to investors. If the cash piles do go unspent for a prolonged period of time, there is the risk that government will turn its eye on them for some form of additional tax. While unlikely, there is certainly a precedent, as investors in North Sea oil will remember.”
And while concerns about a mass tax take may seem hyperbolic, advisers expect investment and capital expenditure to ramp up.
Deloitte’s Stewart believes that spending on plant machinery, employment and premises is to come. “The figures suggest that there is more productivity to be had in the UK – and an argument that there is a pressing need for UK capital stock [to be invested in],” he explains.
Lawton concurs, saying that there are “an awful lot of manufacturers looking to invest in capital equipment, hopefully made in the UK”.
As Deloitte’s CFO survey suggests, it appears that expansion is to be the net position taken by UK FDs. Expanding by acquisition is a focus for 21% of its respondents, compared to 17% in Q1 2013. Market expansion and new product lines are a focus for 38% of FDs, compared to 35% in the previous quarter.
Stewart says that while the eurozone’s travails have had a big negative impact on the UK economy, the recent stiller waters (with the euro’s breakup less likely) conversely mean that business must again turn its head to across the channel, despite being tempted by more exotic fast-growth locations around the globe: “I think we’ll see a tilt back to Europe, given that it’s our biggest export market.”
Both Lawton and Stewart suggest that the growth might come slowly – and that might not be a bad thing.
Into the light
Concerns still persist about the ability to access finance, even if there are indicators that this has eased, and upturns following recessions normally see ambitious businesses overstretch themselves – overextending credit – and stumble into insolvency through cashflow problems. The threat of another banking shock, or geo-political disaster, makes it more likely that FDs will try to lead their companies tentatively out into the light.
“Optimism is a wonderful force, and people start to make different decisions,” says Lawton.
He predicts a “broad increase” in activity levels in manufacturing, but modest. But its modesty makes it less likely that FDs and boards will get too carried away and over-reach: “That’s still a risk but less so, as it’s not a huge bounceback … it should be manageable.”
Stewart cites the Great Depression of the 1930s as an example of how FDs’ mindset will play a big part in the near future of the UK economy. While many think of post-recessionary periods as times of great expansion, he points out that many of the executives in place during that period remained conservative in their thinking.
What this will mean for the UK is pure conjecture, but there is the possibility, as both Lawton and Stewart suggest, that baby steps will be made in the short-to-medium term.
“The legacy of this huge economic weakness will be a continuing focus on cost reduction,” says Stewart.
While Financial Director’s findings show a deep, and often negative, impact on UK business strategies and subsequent performance, this has not been the case for all.
Duncan Payne-Shelley, finance director at IT supplier Novatech, says that the recession forced the company to reconsider its business model and structure. Rather than leave the business in a position to fend off the recession, it is looking to operate outside of it.
“When I joined I thought, ‘What’s my team? Will we be able to get a buyout in place [in the future]?’ This was selfish,” he says. Then the credit crunch occurred, and the plan changed.
With the consumer technology market moving so quickly, Novatech instead leaned on its core product manufacturing and after-sales service ethic to focus on B2B. While a huge market, it is ultra-competitive. But Novatech’s manufacturing capability in Portsmouth equates to better margins than competitors, making it easier to manage quality and stop its service business eating the margin.
As BDO’s Lawton said, keeping the right people has also been key – and this has been a focus for Novatech. It restructured its benefits packages and staff incentives, working hard to communicate with staff quickly.
That isn’t to say the recession hasn’t been painful, as the recent closure of several of its retail stores can show. But for Payne-Shelley, the business has changed for the better: “We let the recession go on around us, and take consumers away from us.”
A final note of warning comes from Lawton, whose clients are increasingly worried about the UK skills infrastructure – or lack thereof. While global events now affect UK business much more, a longer-term concern is one much closer to home – as failing to have the right people to do the work will stunt growth.
“Sometimes even at apprentice level, manufacturers are struggling to recruit – it’s an oddity, where the economy suggests that there should be enough of a workforce to fill gaps. The future of UK manufacturing will have traditional industries, but broadly there will be a move into higher and higher skillsets – design, engineering, materials. We need a reasonably skilled workforce,” he says.
MANCHESTER BUSINESS SCHOOL ANALYSIS
Analysis written by Dr Nick Collett, senior lecturer in financial management, Manchester Business School
The UK recession: its place in history
The UK recession has been the deepest since the Second World War.
It started in the second quarter of 2008. Manufacturing output fell by 8% in that year. Financial services and construction suffered particularly badly and continue to suffer.
Indeed, while a triple-dip recession might have been narrowly avoided during 2012, few would argue that the significant impact of the recession has yet to go away.
National statistics show contractions in the last quarter of 2011, and again in second quarter of 2012. By early 2013, GDP was still 3.9% below the early 2008 level, which highlights the severity of the contraction.
Of course, this has been the first UK recession since the one that occurred between 1990 and 1992, and the country is generally far wealthier than it was then.
On another positive note, unemployment has risen to a peak of 8.1% of the working population in this recession against a peak of 10.7% in the last one.
However, it has been suggested that companies have retained labour, perhaps cutting hours or wages, and that people who have lost their jobs have set themselves up in sole-trading roles, potentially meaning that new job formation will be slow if the economy continues to recover.
Despite the competitive environment, 48% of companies have increased their prices during the recession. It is a common strategy for companies pursuing a turnaround, partly because it can be implemented quickly. It is likely that our companies have raised their prices on some of their product lines but not all, taking into account perceived price elasticities of demand.
Companies have also disposed of assets and increased short-term borrowing. 65% of companies increased their short-term borrowing. A disproportionate number were small companies (41 % for small companies v 27% for large companies), consistent with the 92% of small companies reporting a negative impact of the recession. The fact that 65% have been able to increase their short-term borrowing suggests that banks have been prepared to help their corporate customers through difficult times.
During the recession, most companies in our sample (58%) imposed wage freezes on a substantial part of their workforce. Pay cuts were less common, with only 14% doing this. 34% of those that cut pay did so for more than 12 months and pay cuts continue for 40% of those that cut pay. Reassuringly, almost no companies which have not yet cut pay or frozen wages see the need to do so in the future.
In terms of financial decisions, increasing prices was common in business services companies (29%) and production and manufacturing companies (39%). Increasing short-term borrowing was also important, with 31% of business service companies, 39% of production and manufacturing companies, 52% of construction companies and 31% of finance and insurance companies taking this action. Disposal of assets was prevalent in the production and manufacturing industry (41%) and construction 48%). Sale and leaseback and rescheduling of debt were not common in any industry.
59% of companies have introduced new product lines or services within existing product markets. This strategy is almost twice as popular as any of the other strategies. 32.6% of companies introduced new product lines or services into new product markets and/or withdrew from supplying product lines or services from some product markets. While companies do concentrate on their core business, they are actively changing their products and services in a short period of time to try to remain competitive.
Overall, across all the industries it seems that companies adopted defensive strategies in the face of the recession. Only in business services (29%) and manufacturing (28%) was there a conscious effort to introduce new products in new markets. Similarly, in these two industries, about twice as many companies introduced new products into existing markets. In these industries, there was strong evidence of product / market reconfiguration because 26% of business service companies and 25% of manufacturers withdrew from supplying product lines or services from some product markets.
There was not very much variation across industries when it came to cost cutting. Encouragingly, cuts to research and development and marketing and promotion were at a very low level. Even training – which is normally seen as a sacrificial expense during a downturn – was not cut significantly in any industry except business services (21% of companies).
Employment reductions were highest in business services (31%), production and manufacturing (36%), and construction (37%). Wage reductions and head-office cost reduction also featured notably in these industries. Finally, production and manufacturing companies did take the opportunity to scrap outdated machinery.
The response rate to planned investment questions was quite low at just under 30%. Significantly, companies brought forward their investment in R&D, and their new product and new process innovations. They tended to abandon or postpone their investment in plant and machinery and buildings. More companies postponed marketing expenditure than brought it forward. Clearly, short-term investments, partly defensive to maintain sales, dominated the long-term investments which are not needed until clear signs of growth return to the economy.
Keeping costs down
The three most important cost-control measures are reducing head-office costs, reducing wages and reducing employment. 46.9% of our companies have reduced employment, which is a much higher proportion than the national picture would suggest.
We comment later upon which sectors have suffered the largest declines in employment. Only 10.2% have reduced R&D, suggesting that large and small companies protect their innovations, knowing that future success depends upon maintaining R&D spend in a competitive and tough environment.
Compulsory redundancy was used by 17% of companies, with a similar percentage opting for early retirement and 12% opting for voluntary redundancy. 16% of companies engaged in redeploying part of their workforce into different jobs.
During the recession, most companies in our sample (58%) imposed wage freezes on a substantial part of their workforce. Pay cuts were less common, with only 14% doing this. 34% of those that cut pay did so for more than 12 months and pay cuts continue for 40% of those that cut pay. Reassuringly, almost no companies which have not yet cut pay or frozen wages, see the need to do so in the future.
33% of production and manufacturing companies and 33% of construction companies closed one or more establishments in reaction to the recession. Companies in these industries tended not to be very ambitious in their strategies for survival, with 90% of construction companies and 67% of producers and manufacturers focusing on the core.
Contracting out was popular in these industries and also in business services where one third of companies engaged in it. Rationalising the product lines was most popular in manufacturing and construction and the industry with the highest proportion of companies that tried to develop overseas markets was manufacturing, suggesting that these companies did try to take advantage of the significant depreciation in the value of sterling.