EEF blog

Competition in UK SME banking has been weak for some time, well before the financial crisis. There is a staggering fact that only one new bank has opened on the High St in 100 years. Competition has been the subject of a major review by Don Cruickshank in 2000 and various other OFT and Competition Commission reviews since.

In the run-up to the global financial crisis, relatively easy credit masked these structural problems in access to finance for SMEs, and perhaps made it easy to ignore the consistent conclusions of these reviews that the market was uncompetitive. Arguably the easy credit actually worsened competition problems further by allowing banks to supplant non-bank sources of finance.

The impact of the financial crisis has been to increase the relative cost, decrease the availability, and at least initially worsen the terms and conditions associated with credit for SMEs. Although these impacts were to some degree inevitable given the unsustainable easy credit and occurred in many other countries - they were exacerbated in the UK by our (un)competitive context.

This matters because of the impact on investment and growth. Our own manufacturing surveys and economy-wide surveys like the SME Finance Monitor indicate viable investments are going unfunded and companies with growth intentions are citing access to finance as a barrier. ONS estimates of investment remain well below pre-crisis peaks in contrast to investment intentions.

Our view is that we need a much more diverse and competitive access to finance landscape. This will mean encouraging the development and growth of new sources of both debt and equity beyond banks. But given the overwhelming dominance of banks in SME finance it must also mean a more diverse and competitive banking sector.

Current goverment efforts to improve access to finance have three main strands:

1. Funding for Lending, which offers banks access to cheaper wholesale funding but links this to how much they increase their net lending, with a recent new emphasis on SMEs;
2. Diversifying the access to finance landscape for SMEs for example by coinvesting with the private sector in funds offering non-bank products like mezzanine finance; and
3. The Independent Commission on Banking, which as well as making recommendations for how to make banking in the UK safer, also had thoughts on how to increase competition.

Funding for Lending is lowering costs fundraising costs for banks with an explicit incentive to grow net lending - and especially net lending to SMEs. To grow this net lending, banks are expected to lower costs for SMEs (and households). However, this is a temporary intervention, largely introduced because of the strained fundraising environment faced by banks.

Diversifying the finance landscape for SMEs has proceeded under a range of schemes that bring together government and private money to invest in new types of finance, often addressing particular gaps or market failures. While welcome, some perspective is needed. In 2012, bank overdrafts were used by 22%; credit cards by 18%; bank loans by 10%.

No other form of external finance had more than 6% of SMEs reporting usage. Banks are the most important source of external finance for SMEs by some distance.

With the importance of banks in mind the third strand of government action would seem arguably the most important for delivering change over the medium term. And that's why it's concerning that this strand appears to be the poor relation.

Last month we had the news that the Co-Op deal to purchase 632 branches from Lloyds has fallen through. Yet this divestiture was the central part of the Independent Commission on Banking's competition-focused recommendations. While there are success stories of smaller banks in the UK - an effective divestiture was essential to create a true 'challenger'.

With the Co-Op deal a new challenger with a 7-8% market share would have been created. Without it, an IPO, as planned by Lloyds, is likely to leave it with a share closer to 5%. The ICB said that a minimum of 6% market share was necessary for the new entity to be an effective challenger to the dominant incumbents.

At the same time we have had a NIESR paper looking at bank lending to SMEs in the UK from 2001-12. This analysis controls for risk characteristics (worsened by the financial crisis) to look at the cost and availability of finance for SMEs.

As expected, controlling for risk characteristics, conditions have tightened relative to the 2004-07 period - during which there was undoubtedly an unsustainable boom. But worryingly conditions have also tightened relative to the 2001-04 period, suggesting a potential overcorrection on the supply side.

The clock is ticking until 2015 when the ICB recommended the government look at whether there's a case for making a referral to the Competition Commission. With a key plank in the government's strategy for increasing competition looking wobbly, I would suggest the government needs to be thinking now about what more can be done to boost competition.

Today the IMF released a concluding statement of its Article IV UK consultation. Many of the things they said in their consultation resonate with what we have previously said about the context the government is currently operating within.

This blog gives a short summary of some of their recommendations.

On fiscal strategy the IMF said:

The government’s commitment to the fiscal plan they set has given them credibility with markets.

Government has been flexible in its budget approach.

But consolidation will drag on growth and the government needs to balance their aim of reducing debt with promoting growth.

The government needs to take some action now including:

• Bringing capital investment forward where possible;
• Changing the composition of consolidation to boost growth; and
• Addressing some concerns raised about the Help to buy scheme.

They also recommend some structural reforms to help the rebalance over the medium term into a more dynamic, balanced, and robust economy. These structural reforms included:

More infrastructure investment;

Reducing concentration of the banking sector - something which we have been calling for in the SME banking sector for some time; and

More support for retraining opportunities.

Yesterday I attended the National Manufacturing Debate at Cranfield University. The topic of this year’s debate was whether or not we need a national strategy for manufacturing.

Professor Rajkumar Roy started the day by suggesting that an important part of such a strategy would be to have an ambitious target. He suggested the goal that manufacturing would account for 20% of UK GDP by 2020.

While attendees quickly pointed out that it was unlikely manufacturing would reach this level – either we’d need unprecedented growth, or something close-to cataclysmic would have to happen to the service industries – the idea of a target as a way to focus policy resonated with the audience.

In EEF’s report, The Route to Growth, we outlined four ambitions for the economy that we think would focus efforts on achieving sustainable growth. These are:

• More businesses bringing more products and services to market
• More globally-focused companies chosing to locate in the UK
• A lower cost of doing business
• A more productive and more flexible labour force

So how do we achieve these ambitions?

A growth strategy has to be part of achieving our ambitions. Looking at the existing policy framework, the government’s growth partnerships and resultant sector strategies are an important component in addressing some of the long-term challenges faced by UK industries. But how do we get the most out of these strategies?

To ensure value for money:  there needs to be greater clarity around the challenges the strategies are designed to address. This is particularly relevant given the squeeze felt by most areas of public spending.
To ensure longevity: A much fuller body of evidence is required to demonstrate why certain sectors have been prioritised. This will aid a widespread understanding across government and a long-term commitment to the sectors identified. As one panellist pointed out yesterday, a solid evidence base is one way to ensure sector strategies aren’t held hostage to political cycles.

The sectors that have been identified as priorities have published, or will publish, strategies that lay out their priorities for investment in the coming ten years. This is a step towards building the evidence base necessary to understand which areas require investment. However, some sector strategies have already been released and funding committed in the absence of details on the requirements of other sectors that are yet to release strategies. A budget of £1.6bn has been set aside for sector strategies, but, after the release of only four out of eleven strategies, most of this has already been committed. This leaves very little for the remaining strategies.

Unless it is prepared to increase the funds available to sector strategies post 2015/16, the government should wait until all strategies have been produced to understand which proposals will garner the highest return for the economy and make some tough prioritisation decisions.

These recommendations form part of our Spending Review submission, which we will publish in full of the 3rd June.

Our Guest Blog is from Toby Peyton-Jones, UKCES Commissioner and Director of HR at Siemens Plc

UK manufacturing is fighting back.  With growing interest in high-tech components and intellectual property the UK has much to offer on the global circuit.  But making the most of the opportunities coming up will only happen if firms have the right people with the right skills. With the government’s spending review around the corner, it’s a good time for the sector to examine how it can build on its strengths.
 
Today, manufacturing accounts for over half of all UK exports. Having consolidated its position, it is now one of the most productive sectors in the UK economy.  Investment in innovation and technology has also risen, with 75 per cent of UK R&D being spent on manufacturing.  It’s clear that the sector is hungry for a win at an international level. 

So-called STEM skills (science, technology, engineering and mathematics) are the lifeblood of the sector.  But they’re also in high demand in other areas of the economy, including high-pay sectors like banking and accountancy. Figures show that 40 per cent of STEM graduates go into non-STEM roles. 

With this shortage so well documented, it’s surprising that  a significant number of engineering and manufacturing firms are less likely than average to spend time and money developing the skills of their staff - one of the prerequisites of a good job as far as I’m concerned.  Findings from the UK Commission for Employment and Skills, where I am a Commissioner, show that training expenditure in the sector is lower than average.  And while many employers do train their staff, this only reaches a minority of the workforce. In part, this is due to the need for highly specialised skills, which take time and resources to develop.  But I also wonder if other, cultural, factors are at play here.   

As Director of HR at Siemens plc, I know that a mix of skills is required to achieve effective business performance.  Many engineering companies have strong graduate programmes, but what about non-graduates? This is where apprenticeships and their new siblings, traineeships, can help, as new entrants are able to learn and apply technical skills on the job.  Employment projections show that skilled trades and operatives will be in demand to replace those leaving or retiring from the sector.  It is therefore more essential than ever that businesses invest in their apprenticeship talent pipeline and build in traineeships that give young school leavers a step ladder and the aspiration to take up a career in manufacturing and engineering.

Small firms also have specific challenges when it comes to keeping up the pace. For many of them, thinking strategically is difficult when survival is what matters and costs are rising.  Although engineering is traditionally a fiercely competitive sector, collaboration with other small firms might prove to be a lifeline here.  Collaboration can help businesses gain bigger contracts, invest in equipment and provide essential bespoke training for staff.  

The Employer Ownership of Skills initiative (EOS)  is a useful way for employers to work with others in their area, locality or supply chain to get the skills their business needs for growth.  At present, UKCES has invested some £90 millon in employer-led programmes designed to boost growth through people. But although this has shown that there is an appetite from employers to take ownership of their skills needs, competitive funds like this are always changing and so I see that EOS is just a stepping stone to a more long term sustainable solution .That’s why I’m backing the recommendation made by Doug Richard in his recent review of apprenticeships, that the government’s apprenticeships funding should be routed through employers in the form of tax or NI breaks and  that is why I am also so pleased to see in round 2 of the EOS so many employer led Industrial Partnerships emerging.

In essence, it’s clear that the sector has made considerable changes already, and is moving up the leader board.  But to keep winning consistently, firms will need to work together, and seek out any promising opportunities in next month’s spending review.  Investing in skills, apprenticeships and collaboration will ultimately ensure that the sector doesn’t just fight for survival – it thrives too.    

If exports meant points in Eurovision – who would we be giving ours to when it comes to the Grand Final tomorrow? Let's have a look at the amount we exported to the Eurovision country finalists in 2012.

12 points – Germany – £32.56bn
10 Points – Netherlands – £23.68bn
8 points – France – £21.98bn
7 points – Ireland – £16.91bn
6 points – Belgium – £13.9bn
5 points – Spain – £8.29bn
4 points – Italy – £7.95bn
3 points – Sweden – £5.59bn
2 points – Russia – £5.52bn
1 point – Norway – £3.64bn

No points for the remainder of countries in the finals I’m afraid – Denmark (£2.65bn), Finland (£1.51bn), Hungary (£1.07bn), Romania (£944m), Greece (£845m), Ukraine (£581m), Azerbaijan (£509m), Malta (£396m), Lithuania (£371m), Estonia (£281m), Iceland (£201m), Belarus (£123m), Georgia (£56m), Moldova (£41m), Armenia (£15m).

Good luck to all for tomorrow (go Bonnie)!

Source:HMRC uktradeinfo

The weekend is around the corner, which means it is our special Sector Friday again! Our focus this week is Textiles! Don’t go just yet as textiles aren’t only about fashion, yarns and shoes. It also covers areas which involve advanced technology (think spiderman suits) and cool gadgets (electric shock underwear anyone?) –  READ ON!

The sector covers yarns and fabrics preparation, textile mill products, the production and development of new fibres , wearing apparel-  no surprises. But 49% of the sector is the dressing and dyeing of fur and processing leather into goods and final products.

I say Fun Facts, you say Key Stats:

• UK textiles accounts for 2.5% of worldwide sector GVA at values of £11.5bn. In the UK it accounts for 3.4% of total manufacturing.
  
• The sector employs 118,810 people in the UK across 7796 firms.
  
• R &D spend growth in 2011 was 18%. 
  
• Capital spending grew by 69% in 2011, reaching £232m worth. This is over double that of 2009.
  
• Significant production is located in the East Midlands, Yorkshire & Humber, North West and Scotland.
  
• Some well-known British brands which produce in the UK: Aquascutum (16% UK production), Mulberry (approx. 30%), and John Smedley (100%, all production pulled back to UK from 2009). Some pioneering UK technical textiles manufacturers are: Eleksen, Fibretronic and Peratech.

Where are the products going?
13% of output is exported, whilst 76% of output goes to households.
Nearly £9bn worth of output was exported in 2011, accounting for 3.4% of UK manufacturing exports.
Our biggest export markets are Germany and Ireland. In 2011, there was healthy growth in exports worldwide, notably to North America and Eastern Europe.

Technical textiles
UK based textile manufacturers tend to be focused on high-value, design-led and knowledge-intensive niche products, e.g. companies based in the North West are particularly successful in technical textile markets. Short cut fibres for example, are widely used in a range of industrial applications.

Constant product and process innovation are very important to enhance the competitiveness of UK textiles, as well as investment in technologies. The Textiles Centre of Excellence in Huddersfield has been set up to provide training, production facilities and development support. 

Revival of textiles manufacturers?
There has been a lot of media coverage on reshoring recently, e.g. a major high-street stalwart announced a 3 year contract with British Fashion Council in Feb 13, to collaborate on new collections which feature sourcing and production in the UK. It is forecast that the industry will grow and increase jobs in the next 5 years.
Some other clothing retailers are considering bringing production lines back to reduce the total cost base, ensure a quicker turnaround time, more flexibility, and to improve the quality and consistency of output.
But with some textiles-specific skills lost after significant offshoring, the sector may come up against challenges.

Future challenges and opportunities:

• The British heritage and glamour
  Emerging economies have triggered demand for luxury goods using premium-grade material produced by UK manufacturers. The prestigious status, history, product excellence and ‘Made in Britain’ design is a major selling point of the goods.
  Currently, around 90% of high quality UK textile production is targeted at export markets.
• The next generation of textiles
  The developing technical and performance textiles have great potential, e.g. the field of ‘wearable electronics’, i.e. interactive textiles embodying sensors, actuators and logic circuits built into the structure of the fibres and fabrics. This may also build a new export base for the UK.
  There are key concerns about intellectual property of products and processes, and maintaining global competitiveness of our textiles products.  It is also critical to link the expertise of UK academic research in textiles to commercial manufacturing in order to maximise growth in technical textiles markets.

Today’s inflation report brings a more positive tone to the future outlook than has been seen for a while, with both the output and inflation forecasts having been revised in a positive direction. The improvement was driven by signs of early momentum picking up in the wider economy. We look at some of the reasons behind each of the revisions in turn.

Output forecast revised up

The upside surprise of 0.3% growth in the first quarter of this year underpins a number of other indicators that give rise to the expectation of stronger GDP growth over the course of this year. Demand and supply are expected to pick up gradually with a number of factors contributing to this change in view. While employment has fallen back somewhat, it is expected to pick up more than previous estimates, household real incomes have led to some up-tick in consumption and the extension to the Funding for Lending Scheme is expected to ease credit conditions and boost demand.

Risks do remain, however, and the recovery, though slow, will depend on how households and businesses respond. The international environment will continue to weigh on sentiment, particularly those risks pertaining to the Eurozone.

Inflation forecast revised down

In the past couple of months inflation remained sustained but for the first time in a while the forecast has been revised down though it will still take the best part of two years to return to target. The slow return to target is expected as administered and registered prices are to remain elevated.

The improvement in the overall forecast was driven by expectations of external price pressure being lower and higher labour market participation dampening down domestic pay pressures.

All in all, the picture is somewhat more positive but the overall trends are not much changed. Inflation will continue to remain above target for some time and, while the economy will remain subdued, it will be growing. As we have mentioned in an earlier blog we want to see the government doing everything possible to support growth, by providing more certainty to business that they have a plan get the economy growing again and ensuring decisions, such as the upcoming spending review, do everything possible to support growth.

The politics of the UK’s relationship with the European Union is front and centre in the press once again. Commentators and politicians are making their positions clear on what it should look like early and often. Furthermore, resolving the actual timing of any public vote on the matter is also becoming a matter of urgency.

Tomorrow, the House will debate an amendment to the Queen’s speech, which ‘respectfully regret(s) that an EU referendum bill was not included in the Gracious Speech’.

All these public declarations may well be valid, but the UK’s starting point is a four-decade long relationship with our European neighbours, which has – for good or bad – led to stronger trade links, a strong European voice on global issues such as security and climate change, and a leveling of the competitive play field in areas such as employment rights.

There is no shortage of campaign groups setting out why the huge cost and regulatory burden stemming from Europe means we should get out AND, in the other corner, the benefits of influence, trade and investment mean we’d lose if we weren’t in.

With our economy still struggling to get back on a stronger growth path, it is surely critical that significant long-term decisions (like that of our relationship with Europe) that have implications for certainty, confidence and ultimately much needed investment across UK businesses are a little more thoughtful.

Perhaps, therefore, an amendment which

‘respectfully regrets that the debate on an EU referendum bill lacks any clear evidence base on the advantages and disadvantages of membership, quantification of the wins from renegotiating any part of the UK’s relationship with the EU and clear priorities for future reform of the EU’.

While the headlines would not be as eye catching, it would at least demonstrate that there is a clear understanding of the issues that both the public and business need to hear about.  In order to decide what is in the UK’s long-term economic interests we must start by presenting some level headed answers to the following questions (although I’m sure there are plenty more)

• how have the recent pressures from the eurozone crisis changed the economic and political dynamics of the region and what does this mean for the UK?
• with the rest of the world forging closer links as economic blocs on trade, investment and technology, where does the UK fit into this picture?
• what is the real size of the prize  from opting out of EU-generated regulation , how much would need to be replaced by domestic regulation and how much impact would this have on how business operates?
• in key areas of policy and regulation could the UK do more to be influential leaders or are we happy to be followers?

If we get some answers to these questions in tomorrow’s debate I’ll be back on Thursday with an update. If not Thursday, it will need to be soon.

If you have any thoughts on where our relationship with the EU goes from here and, specifically, what it means for business let us know as part of our EU Challenge

Last week Rachel blogged about some of the trade-offs the government faces in the upcoming Spending Review. She argued that more government spending must be prioritised towards those areas that drive growth and boost the long-term competiveness of the UK. One of these areas is innovation.  

Innovation is vital to the long-term competitiveness of individual firms, and the UK economy as a whole 

But innovation is risky, and requires resources that companies – particularly SMEs – do not always have access to

As a result, Government must step in as an active partner

This is something that government already does, and the focus of support is right, but the level is insufficient 

Despite recent new initiatives, the level of support for innovation is low, especially when compared with support for science.

Both science and innovation require some public investment to deliver the optimal level of total investment.  But while the UK’s science base is highly successful, as an economy we have not always succeeded in capitalising its outputs. Innovation is necessary to do this. Without sufficient support for innovation, we risk an economy that is “all engine, no transmission”.

Recommendation: The TSB – and its budget – should be moved into the science ring-fence to create a protected “science and innovation” pot of approximately £5bn at current levels of funding. We would advocate a modest increase to the TSB’s budget of £43mn resource funding p.a., but at the very least the innovation budget should be protected.

Additional money for innovation should be used to strengthen the Catapult centres and increase support for SMEs:

Two of the key barriers companies face when innovating are access to facilities and expertise. Catapult centres help address this, but we have concerns that they neither have sufficient funding to keep their facilities at the cutting edge, nor to keep their research focused on innovation (rather than focusing on more commercial projects).

Recommendation: Double operational funding for the High Value Manufacturing Catapult

Almost all barriers to innovation are felt most acutely by smaller companies; as such it is important that there is sufficient support directed towards SMEs. The Smart grant successfully boosts innovation in smaller companies, but despite recent increases in budget – the grants are oversubscribed, “highly competitive”   and consequently have a low success rate of only around 20%.

Recommendation: The funding for Smart should be increased from £40mn to £50mn to make the success rate more comparable with other TSB schemes.

Universities, Catapult centres and other research institutes offer facilities and expertise and can be a vital support for innovative companies. Innovation vouchers are an effective way to increase SMEs’ access to the research base. The scheme has recently been reintroduced but it could be better aligned with other innovation support.

Recommendation: extend Innovation Vouchers to align them more closely with the technologies currently covered by Catapult centres; the budget should be increased by ½mn p.a. for each of the Catapult areas not currently covered, at a total cost of £3mn p.a.

The TSB must remain the responsible agency for innovation support

The TSB is currently the primary agency for dispensing innovation support. In general it does so successfully, despite some concerns about relatively complicated application processes. As such we have some concerns about possible changes to the innovation support landscape.

Proposals to integrate the TSB into the Business Bank risk adding an unnecessary additional layer of bureaucracy to application processes for innovation support if access to support was dependent on a generic diagnosis of needs.

The TSB is not a natural candidate for inclusion within the Business Bank. It offers different support from some of the other programmes that might be included, meaning it is not clear how companies would benefit from a unified front end.

Recommendation: The TSB should remain separate from the Business Bank

The move towards delivering innovation support through a national agency was a positive one, as it removed confusing regional support and reduced the potential for duplication of efforts – something that is particularly important given the small budget for innovation. As such, we are concerned that innovation funding could be channelled through LEPs. LEPs are likely to develop expertise that could help to shape and inform how the TSB allocates its funding, but the ultimate decision should lie with the TSB, which has oversight of national priorities.

Recommendation: Innovation support should be distributed at a national level

Future sector strategies must deliver maximum value for money

The growth partnerships and resultant sector strategies are an important component in addressing some of long-term challenges faced by UK industries. But we need to ensure the spending prioritised through sector strategies delivers maximum value money for the economy as a whole. A budget of £1.6bn has been set aside for sector strategies, but – after the release of only four out of eleven strategies – most of this has already been committed, leaving very little in the pot for the remaining strategies.

Recommendation: Decisions around sector strategies will face the same squeeze as everything else. Unless it is prepared to increase the funds available to sector strategies post 2015/16, the government should wait until all strategies have been produced to understand which proposals will garner the highest return for the economy and make some tough prioritisation decisions.

It is right that sector strategies should interact with the support the TSB offers and that some of the TSB’s competitions should be influenced by these priorities, but the strategies should not imply new constraints on the competitions the TSB runs. In order to provide flexibility for the TSB to support new technologies and supply chains that are not directly covered by sector strategies, decision-makers at the TSB must ultimately be the ones who allocate competitions.

Recommendation: The TSB must also be allowed to run its competitions independently of the government’s sector strategies

It’s Friday, so we are back to our weekly look at sectors. This week, with trade data out today (see my previous blog post) we thought a look at the export performance of different sectors would be interesting.

What we know from previous Sector Fridays…

- Nearly 30% of basic metals’ output is exported
- 83% of UK produced cars, 57% of commercial vehicles and 62% of engines, are exported
- Approximately three-fifths of food and drink exports go to the EU
- Pharmaceuticals is the second most export intensive manufacturing sector with half of output exported
- 53% of electronics exports went to non-EU countries in 2012, the first time a greater proportion of exports went outside of the EU

Let’s go a bit wider and look at (nearly) the full range of manufacturing sectors.

Exports according to sector, £million exported in 2012

Source: National Statistics

Motor vehicles topped the tree last year, with goods worth over £30.6bn exported, the chemicals and mechanical equipment sectors take second and third place with exports of £28.5bn and £28bn respectively. Today's trade data showed the value of automotive exports at its highest since at least 1998 (when the data series starts); the exposure of the sector to markets outside of Europe are holding it in good stead, around 45% of UK exports are to EU countries, compared with 70-90% for Italy, France and Spain, where the motor vehicles industry is looking less rosy.

The food and drink sector's output is mainly domestic consumption, with about 10% exported but the sector still boasts a healthy £16.8bn worth of exports in 2012, of which around three-fifths was destined for EU markets. Half of UK pharma output is exported and the sector runs a trade surplus with non-EU countries and a deficit with the EU.    

Given the UK's governments target for export performance - doubling exports to £1trn by 2020 - let's look at how sectors have fared in the past ten years.

Percentage change in export value by sector, 2002-2012

Source: National Statistics

This is a chart I like - with nearly all sectors showing positive growth in the value of exports in the past ten years. Only electronics posts a negative change in exports, with 2012 values 39% down on 2002 values. Consumers demanding lower cost options has driven a lot of production to be located in low cost countries, but the UK does benefit from being known as a niche manufacturing location and has a competitive advantage in the production of precision/high value instruments, it also has a strong research community and is home to 40% of Europe’s electronics design industry.

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Whilst I'm on the subject of exports - next week , 13-16 May 2013, is Export Week and UKTI are running events throughout the country to promote exporting to businesses. Seminars and events are being held to offer advice on how to go about doing business across the world, especially the fast-growing markets. Take a look at the dedicated website for more info and also follow #exportweek on Twitter.