Your articles - Dec 2009

Catching the next boom

David McClelland (MBA 1999)

With the UK economy emerging seemingly from recession, now might be the time to lay down plans for catching the recurrent tide. But if the slump did not get you, uncertain and lumpy recovery might. How best to apply diligence to markets of choice? What revised growth drivers will determine attractiveness?

A picture of UK economic imbalance and slow recovery

Most pundits are forecasting growth of about 1 per cent in 2010, rising to 2 percent in 2011. One approach to measuring and quantifying growth, as measured by GDP, is the expenditure method, whereby GDP = government spending + private consumption + gross investment + (exports – imports). Running through some of these key elements, it can be seen that the after‐effects of the Government’s fiscal pump priming will almost certainly weigh heavily on the economy for several years. A clear priority of future government will therefore be the focus given towards broad public sector reform and cost reduction. One key outturn may be the accelerated introduction of competing private company providers into the healthcare, welfare and education arenas creating long‐term, opportunities for private suppliers as a result of deregulation and policy change. However, in practice we see public sector bureaucracy, slow decision making and long leadtimes making the desired level of public‐private partnership difficult to achieve. Additionally, programme amendments that focus on cost reduction often have a bearing on regional employment ‐ an indigestible issue for most politicians. We predict that the political issues at stake will remain sufficiently contentious and deep set as will inhibit effective public sector change, especially in the near term.

Business investment tends to respond to growth, not lead it, and will remain constrained

Business trading during the early stages of the downturn was hit by a headlong rush towards destocking. Companies can only operate on run down stock levels for so long and must now be looking to restock, aiding demand. However, business investment in capital goods tends to respond to growth and not generally lead it. The greater driver of growth, leverage, will continue to remain constrained for some time as the banks take time to redress balance sheets before recommencing lending once again. Constrained of market pull and in the absence of basic debt funding, we see corporate productivity remaining muted.

Consumer spending: hamstrung by personal indebtedness, unemployment and taxation

The pattern of consumer retail demand will likely continue to reflect the ongoing high level of indebtedness endemic in the UK population.
Unemployment, which generally lags a market’s return to growth, will continue to rise in the short to medium term. Correspondingly, wage constraint will serve to limit disposable incomes and therefore suppress high street sales ‐ despite the impact of low mortgage rates, presently.
Ultimately, consumers spend what is in their pocket.
Here the omens are not good: a recent rise of 2.3p per litre in car fuel duty, the end of the Stamp duty holiday on properties under £175,000; VAT, a tax on consumerism, put back to 17.5% after a temporary ‘market‐boosting’ spell at 15% and a new 50% rate of income tax on high earners.
Only much further into recovery, would we anticipate increased labour market mobility and housing activity kick starting demand for household goods ‐ especially ‘bigger ticket’ items, such as carpets, furniture and electricals.

Slow recovery will rquire prudent business judgement and diligence

All told, we think the macro‐UK situation points towards a slow climb out of recession. Control of the public finances will be slow; liquidity will remain on short supply and business development correspondingly cautious. Additionally, as a predominantly low‐exporting economy, the greater impact of the softer pound will be on imports, priming the potential for returning inflation. It is said often that as many companies get into financial difficulties rising from the ashes of recession as going into one. Consequently, we conclude by listing six early questions that one may well consider:

1. Business collapses can traumatise some business owners and managers. Has the company still got the management, with the necessary motivation and strategic thinking, to take the business forward?
2. Can the old business plan be truly resurrected? Is it a case that even an upturn cannot revive a tired formula?
3. The recession will cease at different times in different sectors. Would formal, ‘pipeline analysis’ as determined by in‐depth customer referencing or other market survey technique provide clarity about the returning order of demand?
4. What will be the impact of returning business volumes when industry pricing remains an issue? Will competitors aim for a land grab, in which margins are trampled underfoot?
5. What has been the impact of recession on the industry supply chain or, more specifically, the suppliers and their materials that have to be depended upon?
6. What are the implications for cash flow and working capital? Is there enough headroom to avoid breaching bank covenants and other lending terms?

For further information please contact the author:
David McClelland, Director, Carlton Strategy Advisors Ltd.
Email: david@carlton‐advisors.co.uk

CSA is a commercial due diligence transactions services and business strategy advisory firm.