One of the great privileges of working in business transactions day-in, day-out, is that you develop an antenna for how a particular industry or sector is doing.
As you would imagine, this “nose” becomes honed with anecdotal stuff: the volume of emails in the inbox, the passing conversations with clients and others in the professional community, the approaches from potential investors and their investment criteria, the number of new client or new project enquiries coming in, the nature of such projects…
For all kinds of historical and geographical reasons, transport, logistics and supply-chain is a hugely important sector for Scrutton Bland. So, it is only right that we occasionally take pause to try and make sense of these empirical experiences, not least as they impact our own business and strategy. Luke Morris, Corporate Finance Partner explores this in more detail. I have been looking at some recent UK industry data and reports published by analysts at IBISWorld. IBISWorld collates data from published sources for an industry (history) and the considered risk and macro-economic factors to analyse where that industry may be heading (future).
But with such a cornucopia of data available, where to start? I have gone back to received wisdom. The origin of the phrase, “turnover is vanity, profit is sanity, cash is reality” is lost to the winds of time. But it pragmatically suggests that a sane place to start is with profit. The last decade or so has been characterised by eroding profit margin in freight road transport – now apparently stabilising at around 10%. But it has not been a steady decline: the more striking visual image is the volatility rollercoaster showing how this profit margin has eroded. (By the way, if you think 10% looks like a decent margin compared to your own operation, keep in mind that 12% of the analysed market share belongs to DHL, Wincanton, XPO and Stobart, so this inevitably skews the overall average…).
So, what has influenced this volatility? Two main factors I think: fuel price and customer demand.
Fuel
Fuel price fluctuations raise volatility. We know that prices have surged since Russia-Ukraine, that costs are passed on to customers, and that impacts demand and revenue levels. According to the Office for National Statistics (ONS), motor fuel prices dropped by 9.2% in the year to January 2024. However, prices remain highly volatile, being the largest upward contributor to the CPI in April 2024. Below is what the analysts think: and you can see that historic price per litre reflects profitability above. But will future volatility disappear as the analysts appear to believe? I am not so sure. So, what can you do? Much of this cannot easily be handled proactively. It is the speed of
reactivity that is key. If you are in the industry then I have no doubt that you are already watching this, and watching your contracts, like a hawk.
Customer Demand
Wider economic conditions and changing customer demand have also inevitably played a role in volatility. It’s axiomatic that business confidence and industrial production are highly dependent on the economic climate. A climate which has faced the headwinds of Brexit, of the Government’s response to COVID-19 and (I argue) the corollary of severe inflation. This has damaged industrial production and reduced freight road transport spend. It is the main cause of the red-line roller coaster above. I have been saying for some time that we are not yet, in my opinion, out of the woods with inflation. High living costs are now baked in and continue to tighten consumers’ budgets.
So, what can you do here? This one is trickier.
Economists have wrestled with the UK’s “productivity puzzle” for as long as I have been following the numbers. And that is before the “black swan” events of the past few years. (Black swans that are feeling as common as white swans!).
Many theories around the productivity puzzle abound, but seemingly no silver bullets identified as to “why” and “what can be done about it”. It has been a feature of the UK economy since I have been tracking the data. That said, I read an interesting article this week commenting on the quality of UK business management and I wonder if that offers some kind of explanation.
A recent ONS study has indicated a marked improvement in the average quality of UK management. Don’t ask me quite how this is measured. However, the study, published in May, found that the average quality of management improved from 0.49 to 0.55 between 2020 and 2023. This is on a scale of 0 – 1.0, with 1.0 representing the “full implementation” of structured management practices. It seems firms have become better at managing staff performance and promotion and, in particular, more effective in dealing with underperformance.
The ONS does not offer reasons for the improvement. My hunch is that as the postpandemic jobs boom fizzled out, the balance of power in the jobs market shifted from workers to companies. With the labour market cooling, and the UK in recession in the second half of 2023, companies seem to have tightened up on performance management. Management quality has a huge effect on productivity, natch. (This helps explain the surge in a company’s share price when a new, highly rated CEO is appointed – and the depressant effect of the loss of a well-regarded CEO.)
Research by Professors Bloom, Van Reenen and Sadun found that management practices explain 55% of the difference in levels of productivity in the UK and the US. In the UK, management scores vary enormously across different types of business. The ONS finds that larger businesses do better than smaller ones in terms of management quality. Foreign-owned companies appear to outperform UK-owned businesses. Family-owned or managed businesses tend to underperform on management…
So, the form of ownership apparently has a huge effect on productivity. Previous ONS research found that in the same sector and region and with companies of the same size, foreign-owned businesses were 74% more productive than UK-owned businesses. Are you a UK owned UK business with a foreign owned UK business competitor? Does this ring true, anecdotally, to you?
Furthermore, a working paper published by the UK’s The Productivity Institute earlier this year found that private equity ownership tends to raise productivity noting that, “active investors, such as Private Equity (PE) and venture capital, provide important boosts to managerial skill sets and effective governance”. This is interesting to me, as we see PE dipping its toe into the sector.
Some important messages come out of all of this. First, and obviously, management quality is a crucial driver of productivity. Second, operating in the same environment some types of businesses – larger, foreign or PE-owned businesses – seem to outperform in terms of management and productivity. Third, businesses can move quickly to sharpen management practices, as apparently happened in 2023.
Unlike so many of the solutions touted for Britain’s productivity problem, management practices can be improved quickly, at relatively low cost and by the owners and senior management of the business. Perhaps there
is no need to wait until the UK sorts out its infrastructure, vocational training or any of the myriad of other factors that have been blamed for Britain’s low productivity growth, and have hurt the sector in particular?
The fact that foreign-owned firms get this right or that active investors can drive improved management quality, shows that this is a “portable” advantage. The rise in the UK’s ranking in the ONS survey last year demonstrates that change can happen quickly. With a fairly anaemic macro-environment forecast for the coming years for the sector, sharpening management quality seems like a good place to start. We are working actively with clients on these sorts of projects, so let us know if you would like to discuss. Reach out to Luke or a member of the team by calling 0330 058 6559 or emailing hello@scruttonbland.co.uk