Change or get left behind: Businesses adapt their plans as storm clouds gather, risks rise, and business confidence drops

Customers report difficultly in securing regular supply of materials and manufactured goods. Logistics and freight delays remain a key issue in terms of supply of goods and the costs of transportation remain elevated by high fuel and labour costs. That sentiment came through loud and clear in our survey, where most respondents flagged supply chains as the dominant risk for 2022. 
 

Some businesses are turning to onshoring or diversification to manage rising uncertainty – and in some cases, to address Brexit-related logistics challenges and administrative headaches. However, many have turned to stockpiling to combat supply chain disruption and uncertainty of supply. Often, this is stretching business models (especially in non-seasonal sectors), boosting demand for storage facilities, and driving a huge increase in working capital finance requirements.

Most businesses we spoke with see a lack of available labour as a critical constraint on growth, with shortages of between 6-12% of their usual employee numbers. Wage increases have not helped, as all employers are increasing wage rates.

There were signs that some companies were investing to replace increasingly expensive labour, but that is yet to be replicated on a widespread basis. If it does become widespread, it would have a negative impact on labour markets. Combined with broadly lower confidence in the UK’s economic prospects, this confronts many employers with a Sophie’s choice: invest in increasingly expensive labour despite (actual and anticipated) thinning profit margins and price pressures, or, reduce or replace employees and incur higher upfront costs – contributing to further weakness in economic activity longer term.
 

Cost-price inflation is running well in excess of 10% and businesses have endured energy bills rising by multiples of pre-covid levels, as gas and prices have increased. The surge in oil prices has also prompted a cost increase in fertilisers and red diesel, and for some, feed has increased because of higher demand for other oils.

Most businesses don’t see those price pressures easing any time soon: nearly 40% of survey respondents think we won’t get any respite from high inflation until the second half of 2023 at the earliest, and 25% think 2024 and beyond.

Concern over exchange rates has risen up the agenda for most clients, who are more uncertain about when to hedge, how much to do, whether to break with policy, and what constitutes a good Budget rate amidst the current turmoil.

Most businesses that bought US dollars or euros indicated that they were well hedged for the near term (next 3-6 months), but hedging tenors were becoming shorter because customers are not enthused to buy at current levels. As a result, most aren’t hedged to match monetary policy forecasts for 2023 – opting instead to sit on the side-lines until rates improve. But all of this clearly reinforces the need to get in front of the volatility with a well-structured hedging programme.

The outlook for most of the businesses that we spoke with was described as challenging: price issues, labour shortages (short and longer term), covid, geopolitical risk, and a decline in orders or expected orders over the months and quarters to come all conspire to create a difficult operating environment for businesses. There are also concerns that weakness in the underlying economy will continue to weigh on consumer (and business) confidence, and a drop in real household income due to inflation will harm discretionary spending, leading to an evaporation of order visibility. This comes at a time when cost pressures are forcing many businesses to consider raising prices if pressures are sustained.
 

Businesses were not, overall, downbeat about their prospects, albeit confidence has definitely taken a hit. Many feel that they had already made sufficient alterations to business plans to weather the coming storm, but there was a fear that, should the Bank of England continue to raise interest rates, at a time when the economy was already slowing, that could extend and intensify the downturn to come. The next few months will be crucial for the UK economy.

View a one-page summary of the survey findings (PDF, 152KB ).

Source: Graphics are from NatWest Markets SME Survey H1 2022.