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  • Writer's pictureStephen Plimmer

The economic outlook, and antidote for SMBs

Updated: Sep 7, 2023

There is no sugar-coating it: the economic outlook for the next 1-2 years is not great as we collectively tackle the legacy of COVID and the effects of the Ukraine war. It's timely, though, to remember that economic adversity has always brought opportunities for smaller and medium-sized businesses. We look at the economic outlook, and then the advantages gained by small and medium-sized businesses that build so-called dynamic capabilities, which increase their ability to seize opportunities and steer away from risks




The state of play

The effect of recent shocks on our economy - namely COVID and the Ukraine war - is evident and stark, as demonstrated by the UK's GDP performance since 2007. The last published values in August put monthly GDP at an estimated 0.8% above its pre-coronavirus (COVID-19) levels (February 2020), though recovery remains painfully slow.


Figure 1: GDP: Monthly Index - January 2007 to June 2023 (ONS, 2023)

Change in GDP 2007-23

This year’s SME Report, published in July by Simply Business, chronicled the extent of the challenges of running a business in such a climate.


Unsurprisingly, ‘rising costs’ remain the biggest concern for SMB business owners (44%), followed by ‘finding and retaining customers’ (26%) and ‘accessing funds’ (25%). Nearly 2 in 3 (65%) are facing late payments (65%). Nearly 2 in 3 (62%) are also challenged by rising taxes, interest rates and inflation. Nearly 1 in 3 (32%) report that customers are spending less.


Consequently, more than half are planning to put up prices (62%) - which also reflects the nation’s difficulty in tackling inflation - and holding off buying new equipment or recruiting staff (52%).


In a further survey into business sentiment, the Institute of Chartered Accountants in England and Wales (ICAEW) publish a quarterly business confidence tracker which includes changes in the perceptions of growing challenges compared to 12 months ago. In Q2-2022, the fastest growing challenges compared to Q2-2021 had been 'the availability of non-management skills' and 'staff turnover', but both of these had reduced by Q2-2023. The issues now growing compared to 12 months ago are ‘regulatory pressures’ and ‘consumer demand’. 'Bank charges' and 'tax burdens' had also become more important than in Q3-2023.


Several years of severe disruption have taken their toll on business owners too. In the Simply Business survey, more than half reported that they have suffered from anxiety (59%) and poor mental health (56%). More than 1 in 3 say that financial worries are the single biggest effect on their mental health (41%) and that they have experienced depression (38%).


In the short term, 52% of businesses expect their performance to “remain the same” according to the Government Business Confidence Survey (ONS). In August 2023, the CBI reported that In August 2023, more manufacturers thought that output would fall over the next three months than thought it would rise. The difference was -3% of manufacturers, down from +9% in July.


All that said, the Simply Business survey suggested business owners remain optimistic about their longer-term future - 26% are ‘very confident” and 51% fairly confident about their prospects.


So, what comes next?


The Economic Outlook to 2025

Business conditions remain difficult. Interest rates have been increased to 5.25% by the Bank of England to tackle inflation. Inflation is starting to reduce, as indicated by the Consumer Price Index (CPI) and the Owner Occupied Housing Costs (OOH), shown in Figure 2, but it was still 7.9% in June, well over the Bank of England target level of 2%, which is only expected to be reached by early 2025 (Bank of England).


Fig 2: Inflation indicators: The Consumer Price Index (CPI) (%) and Owner-Occupied Housing Costs (OOH) (%)

UK inflation 2013-2023

Most economic forecasts consequently suggest that inflation will continue to hamper UK growth for at least the next 1-2 years. The consensus is that the economy will only grow by a fractional 0.3% in 2023, and somewhere between 0.5% and 1% in 2024.


Table 1. Predictions for UK GDP in 2023-24

Prediction

2023

2024

Date

PWC

0.3%

1.1%

June 2023

Bank of England

0.5%

0.5%

August 2023

British Chamber of Commerce

0.3%

0.6%

June 2023

IMF

0.3%

1.0%

July 2023

OECD

0.3%

1.0%

June 2023

In fact, the Bank of England has forecast that growth will be barely discernible going forward as far as 2026, with a reasonable probability that the economy either won’t grow at all or even decline. (That said, the Bank of England significantly under-estimated the performance for 2023 in 2022, by predicting a 1.5% decline).


Fig 3: Bank of England outlook for GDP changes to 2026


Additionally, historical trends might indicate increasing unemployment, while the gradual rise in the nation’s tax levels is nothing new, as the longer-term data shows from 1970 in Figure 4.


One feature of the graph is that there are several points where a spike in inflation was followed by a rise in unemployment - in the 1970s, early 1990s and, to a lesser extent, after the banking crisis in the late 2000s. If unemployment doesn’t fall, then it may well be because the Government have increased taxes to, effectively, protect businesses, and subsidise employment. This itself is becoming a growing drag on the economy. A small increase in unemployment was seen in the last quarter.


Fig 4: Long-term trends in unemployment, national tax revenues (as a % of GDP) and inflation (CPI) - all shown as percentages

Long term UK tax, inflation and unemployment trends 19702-2023

Dynamic capabilities as an antidote

Despite the overall landscape of a struggling economy, there are indicators of how SMBs prosper in such conditions and the differences in approach with the ones that decline or fail.


Fundamentally, the “Schumpeterian theory” proposes that small businesses have opportunities in times of economic downturns, through the process of “creative destruction”: new technologies and markets replace old ones as the means of economic development and recovery. The theory's abiding message is for small businesses to embrace innovation and entrepreneurship: seeking out new markets, relentlessly seeking better ways to address unmet consumer needs, becoming more adaptable and resilient, and creating financial contingency plans.


Conducting research using the ‘UK Longitudinal Small Business Survey 2015-2021, the UK Enterprise Research Centre (ERC) produced an analysis that supported this theory. Both the innovation activity of small businesses and their activity within networks were found to produce superior results in the aftermath of COVID-19.


As the UK emerged from COVID in 2020, it was understandable that the ERC’s study found that a third of organisations that carried out innovation responded to the downturn by reducing their R&D activity. In reality, the likely options would have been stark for decision-makers facing the options of laying off staff and/or cutting back expenditure in other areas. However, across the world, organisations that survived best were the ones to have adopted technology, continued to innovate and been able to adapt their ways of working (e.g. Adam 2021, Katare, 2023).


A study of successful and unsuccessful SMBs in Australia, operating during the downturn created by the financial crash of the late 2000s, highlighted the importance of a slightly broader set of success factors, in the form of so-called “dynamic capabilities”, which subsume innovation (Weaven et al, 2021).


One of the leading thinkers in the area is David Teece, who defined them as “the firm’s ability to integrate, build, and reconfigure internal and external competencies to address rapidly changing environments” These are not capabilities that we understand a business to possess in the traditional sense, such as the capability to manufacture certain products, or operate a just-in-time supply chain. They are the capabilities to change what the company does and how it does it.


The application of "dynamic capabilities" thinking is itself a management trend: Our bibliographic analysis of the topic of dynamic capabilities in the business management field found 116k publications with 2.3m citations. Measured by these two metrics, interest in the topic has about doubled since 2014.


Weaver proposed that there are three types of dynamic capabilities: i) sensing capabilities (information acquisition and business assessments), ii) seizing capabilities (business investment decisions in technology and people to "seize" opportunities), and iii) reconfiguring capabilities (where resources are re-organised through innovation, and the decentralisation of decision-making, supported by knowledge management).


So how do these capabilities enable a SMB to perform better? Across a plethora of research studies, companies with greater dynamic capabilities naturally have several advantages when applying efforts to winning and retaining customers most profitably during times when the rules of the market game change:


Decision-making: They can make faster decisions. This might allow them to quickly change the markets that they can operate in and therefore outmanoeuvre others in the market.


Innovation: They can innovate more effectively and more quickly, by having data more readily to hand, putting together the jigsaw pieces of new products and services, while integrating third-party services.


Efficiency drives: They can more quickly reconfigure their existing capabilities to drive efficiencies, such as by dialling up the use of external flexible staffing resources or using third-party services.


New opportunities via partnerships and alliances: They are more able to enter into strategic partnerships and alliances, which allows them to jointly solve emerging customer problems, or take advantage of the weaknesses of other companies.


Improved brand and marketing: By understanding consumer behaviour and needs, they are able to learn from marketing performance, and apply the learning, so that they can adapt their messages and targeting.


More effective risk management: They have a greater ability to identify risks and act on them quickly, such as by diversifying their portfolio of suppliers.


Speed: Decentralised decision-making allows staff on the front line or at the coal-faces to take action without bureaucratic delays. As well as making for more motivating work for individual members of staff, the organisation takes more right steps than wrong.


Structural agility to improve the effectiveness of change: They can more quickly move people across teams and change the organisation’s structure while retaining the buy-in of staff and having staff able to contribute effectively.


The adoption of remote technology by SMBs, during the recent periods of lockdown, is an example of acquiring a new capability (and arguably a “dynamic capability”. since remote working models offer the ability to reconfigure an organisation’s structures and resourcing models in all sorts of ways). However, the bigger lesson is to focus on a more systematic programme to build a range of dynamic capabilities over time.


This requires that dynamic capabilities are considered an integral part of business planning, with an associated audit and analysis on which capabilities would be most valuable to develop.


In the short term, while the economy remains flat, such capabilities build the means to work more quickly. In the long term, they are the means to adapt to new emerging competitors or industry business models, invariably being created out of the current economic crisis and technological advancements.


While lockdowns are (hopefully) behind us, the lessons of survivors are enduring.


About our approach at X2Y

At X2Y, we help SMBs navigate their future market environments, to contribute to their longevity and success. While we don’t believe in the ability to accurately forecast the future in most instances, we think that businesses can prepare for it, by exploring different plausible and possible scenarios - grounded in data - and by positioning themselves to have the best chance of excelling in each scenario and adapting as the world changes.


We consider dynamic capabilities in many of our services, notably our “Sustain” service where we help organisations to develop their own foresight capabilities. However, we found some of the terms used in formulating dynamic capabilities were a little vague, so developed our own ten-dimensional framework which we’ve called the Future Readiness Organisational Model, to help businesses audit their strengths, weaknesses, and options

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