Businesses to pick up the baton from UK consumers

EY ITEM Club UK Spring forecast

An uncertain outlook…

The economic news has been generally gloomy in recent months and it was no surprise to me that the EY ITEM Club Spring forecast suggests that the UK economic outlook has weakened significantly since the turn of the year. EY ITEM are now forecasting GDP growth of 2.3% for 2016, compared to the forecast of 2.6% in January. Drawing on the public data and commentary, EY ITEM feel that business confidence has fallen as a result of concerns about the weakness of the global economy and the upcoming referendum of the UK’s membership of the European Union (EU). UK exports have also disappointed in part due to the slowdown in emerging markets. Consumer spending continues to grow but the forecast reflects the fact the economy is running on this one engine and that there are a number of factors which will cause it to slow as we move beyond 2016.

EY ITEM Spring Forecast chart

…but still time to think longer-term…

It would be easy for UK businesses to get caught up in the economic gloom and embark on very defensive strategies. However, there a broader set of economic challenges facing UK businesses which require attention. The most important of these are:

  • A slowing in the rate of the increase of consumer spending as a result of a fall in the rate of growth of real disposable incomes and a likely reduction in the high rate of job creation seen in recent years, as the higher costs of employment start to bite;
  • An increase in operating costs due to the combination of a declining pound which means import costs will increase, the return of inflation and, once again, the higher costs of employing people due to the introduction of the National Living Wage, the Apprenticeship Levy and the Single Tier Pension.

In parallel, technology continues to develop meaning there is an increasing potential to use it to disrupt current business models. At EY, we continue to see technology deals as the largest category of M&A activity in both the UK economy and the global economy.

With the consumer still likely to provide reasonable support to UK economic growth in 2016, now is the time to look beyond short-term concerns and focus on positioning the business as effectively as possible for the long-term.

…about the business model.

The UK recovery has been characterised by extremely high levels of job creation facilitated by increased labour supply and relatively restrained wage increases. With output growth increasing at a slower rate than the workforce, productivity has fallen, leading to a view that labour may have been used to substitute for capital. With labour becoming relatively more expensive, it is time to evaluate the relative balance between capital and labour in the business model and work through the implications for capital investment.

Enhancing operating efficiency is not the only way that investment can drive productivity. In a challenging economic environment, there is a need to look to new sources of revenue and here digital technology may have a positive contribution to make either in facilitating new forms of customer engagement or enabling the creation of new products and services. Looking to get more from the existing workforce by growing the top line rather than a focus on cost reduction could be a winning strategy.

But be prepared for June 24th.

The EY ITEM Club forecast, like that of the Office for Budget Responsibility, is constructed on the basis of ‘unchanged government policies’. It is therefore based on the assumption that the UK will remain part of the EU. This assumption sees business investment bouncing back after the EU referendum and therefore underpins growth of 2.6% in GDP in 2017. Business investment alone is expected to add 1.2% to GDP in 2017.

UK Business investment & GDP

The UK could choose to leave the EU on June 23rd at which point the economic outlook would be uncertain during the period of transition. I was struck by the wide range of outcomes for the key drivers of the UK economy outside of the EU and hence the large number of possible scenarios. Against this uncertain backdrop, it seems to make little sense for companies to undertake detailed planning now. It is better to wait for the vote and respond as the details of the future environment become clear. However, a sensible approach would be to have a short-term plan on how to manage through the initial period of a leave scenario. The focus should be on stabilising relationships with customers, partners, suppliers, employees and shareholders, buying time to develop more detailed plans over time.

 


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