The current UK economic outlook for SME's | Costs to prices

In this series of articles, we aim to provide a brief overview of the UK economic outlook and the potential implications for small to medium owner-managed businesses.  Utilising Business Insights and Conditions Survey (BICs) data from October 2022 we’ll be looking at a variety of topics across four weekly articles. Our first article kicks off the series with a focus on price increases, with future articles covering:

• The extent of which UK businesses expect to cease trading
• The impact of UK supply chain disruptions
• UK businesses’ future turnover expectations

Headline inflation figures reached 10.1% as of September 2022, presenting a multi-faceted challenge for UK businesses. We therefore explore here the extent to which increased business input costs are impacting product and service pricing decisions.

Within this article we will explore and discuss the following:

1. An overview of the inflationary outlook
2. A review UK inflation sentiment
3. Examining the extent of cost to price changes

An overview of the inflationary outlook

Producer price inflation (PPI) is a measure of inflation from the perspective of industry and business. This provides a measure of price changes prior to being purchased by consumers, allowing us to closely examine inflationary pressures impacting UK businesses. Below we will review changes in input prices used to produce goods (“input PPI”) as well as the output prices of produced goods (“output PPI”). This is important as it allows us to review the extent to which cost changes for businesses impact the output prices of produced goods.

We can see from the chart above that there has been a significant appreciation in both input & output PPI from April 2020 – July 2022 with input PPI showing the sharpest appreciation. The implications of rising input costs for businesses potentially risk restricted profitability, as well as directly influencing product pricing decisions. We can generally see a sizeable proportion of rising input costs are being passed to prices as reflected by simultaneously consistent increases in output PPI (the price of goods). Although, output pricing is not increasing to the same extent which, given the current supply chain issues, is unlikely to be due to businesses offloading increased stock levels but more likely to be business owners being unable (or cautious not to) pass the costs on, as we will analyse further below. However, the decreasing growth rates for Output and Input PPI as well as a tightening divergence between the two hint that cost and pricing pressure may have peaked currently.

The extent of current cost to price increases and a review of UK inflationary sentiment

PPI figures show us that prices have generally risen drastically for producers with some marginal relief as of September 2022. Below we review this in greater detail through examining the current extent of cost to price increases, and inflation sentiment sourced from UK business owners; categorised by business size (employee number) and industry. Through reviewing BIC survey results from UK businesses, we are able to identify the lived experience of business owners and understand market sentiment for how they expect prices to change in to November 2022.

A sizeable proportion of businesses are yet to pass higher costs to consumers through price increases.

This is particularly apparent for smaller businesses as those within the 0-9 and 10-49 employee ranges are passing the lowest relative proportion of cost increases to prices. This finding falls in line with recent reports outlining that smaller UK SMEs are struggling to compete with the lower prices offered by larger businesses, with many avoiding passing on the increases for fear of tainting customer relationships.

Higher employee businesses show the highest (relative) proportion of cost increases being passed to prices whilst reporting greater uncertainty.

Interestingly higher employee businesses within the 50-99 and 100-249 ranges show the highest relative proportion of cost increases being passed to prices. Furthermore, recent figures indicate that larger employee businesses within the 100-249 and 250+ ranges are the most uncertain of the extent increased costs will be passed to prices.

Uncertainty in this circumstance may be due to the fact that for the larger businesses there is an increased likelihood that they will be able to benefit from economies of scale and resource capacity. Therefore, some businesses may not be seeing the same direct increase to costs and have sufficient agility afforded to them through purchasing power and resource-rich operational models to push back cost increases to suppliers, rather than pushing them on to customers. While those larger businesses that are needing to push prices on to customers are doing so effectively, likely due to lower concentration risk across their customer base and greater stock reserves.

Below we review how this translates to the inflationary sentiment of UK business owners for the next 30 days (November 2022).

Recent figures reflect the view that, largely, SMEs expect that prices will remain broadly the same, particularly for larger employers.

This trend is most prevalent within the larger 100-250+ employee ranges, perhaps once again signalling that inflationary pressures are not felt as strongly in this category, to the extent that 55%-57% don’t anticipate increasing prices further (if they have at all).

This is further supported by the 16% of 250+ employee businesses reporting a relatively higher degree of ‘not sure’ responses regarding the future price outlook compared to their smaller peers. As with the Sept-Oct price increase data above, it is reasonable to assume that larger SMEs may not have an as direct correlation between increased costs and price increases to their customers.

However, given the political shifts experienced in the UK during the weeks preceding the latest wave of BICS data, it is interesting that the proportion of businesses that are unsure of how prices may change in the coming month is not higher across all SME sizes.

While it may be good news that sentiment towards increased prices is not overwhelmingly the majority, it does seem that current high prices are here to stay for the foreseeable and that the inflationary outlook is far from over for businesses across the UK. We explore this further below by segregating the data by industry.

Figures suggest that the ‘pause’ in price inflation is expected across all sectors too.

The data shows that inflationary sentiment remains prominent with the highest degree of price stagnation shown within other Service Activities, Arts, Entertainment & Recreation, Education,  and Professional, Scientific & Technical. Interestingly, historical data showed that these industries were also reluctant to pass cost increases to prices.  For businesses that are unwilling or unable to pass cost increases through to prices, if their expectations live out, this may lead to sustained increases in costs and subsequent losses of profitability.

High Cost of Sale industries expect significantly greater price increases relative to price decreases.

The industries displaying the most severe inflationary sentiment include Accommodation & Food, Wholesale & Retail Trade,  Manufacturing, and Construction, which is unsurprising given supply chain disruptions, materials and food shortages experienced in these industries in recent months which is likely to have a significant impact on cost of sale and profitability.

In September – October figures, Manufacturing, Construction and Accommodation & Food have reported the greatest susceptibility to passing increased costs to prices, with 40%+ of businesses surveyed in those industries saying they had passed at least some cost increases on to prices.

If this industry outlook is reflected through price increases in November and sustained, this may weaken demand which could hinder turnover performance due to increased costs for consumers. Unfortunately, the potential implications span further on the supply side as inflation within the supply chain can lead to price increases which can in turn worsen supply chain inflation. At greater risk in this circumstance is the Health & Social work industry. This industry has a different relationship with supply, demand and how prices play into the equation compared to most other industries, as businesses in this industry do not generally have as much control over cost increases or how they operate as a result. It will be interesting to see how the sentiment here plays out during an already difficult time across the sector.

In contrast, a weaker expectation of further price increases can be seen in other Service activities, and Professional, Scientific & Technical. If this expectation lives out in November this may encourage demand or at least provide some relief from current demand pressures resulting from inflation.

Pricing pressure for UK businesses is being driven by rising energy and raw material costs across April – November 2022. This is widely recognised to be the result of supply restrictions for oil and gas resulting from the Russia/Ukraine conflict with little signs of relief in sight.

The Bank of England recently suggested that 6% of the overall inflation rate is due to energy price increases. The data presented above would appear to support that finding. Overall as seen across featured employee ranges, prices for consumers are largely expected to remain at currently inflated levels in upcoming weeks meaning that any price relief for end users is unlikely to be imminent. However, this general trend in sentiment has held over time from the the 1^st April – 30^th November 2022.

The general trend of prices being expected to remain at inflated levels has held across April – November 2022.

Overall, this displays certainty of inflationary pressures from the perspective of UK businesses, and suggestions of a reluctance to increase prices beyond a certain point, across the last 6 months with a similar outlook reported for November 2022. Overall, inflation expectations are showing little signs of relief as of currently and will remain a pervasive commercial issue heading into 2023.

Key takeaway points

• Both output and input PPI growth rates have consistently and sharply appreciated from March 2020 – June 2022, treating a worrying inflationary outlook for the UK. Nevertheless, July-September 2022 shows some relief through consistent decreases in the Input PPI growth rate since its June high with the output PPI growth rate falling for September relative to its August peak.
• Current inflation expectations for larger businesses across industries are geared towards prices remaining at current inflated levels, perhaps due to reduced exposure to cost increases for these businesses. Supported by the finding that that inflation for SMEs is expected to rise.
• Larger SMEs with 250+ employees are likely to have greater purchasing power afforded to them by access to economies of scale, and benefit from higher stock and resource capacity which may explain why these larger businesses are reporting greater ‘uncertainty’ within their inflation expectations relative to smaller SMEs, as the cost to price relationship is less direct.
• Many UK businesses across industries are yet to pass increased costs to prices as businesses with fewer employees reported the least willingness to do so.
• The current pricing pressure for UK businesses resulting from increased costs is driven by rising energy and input prices with little signs of relief being shown as of currently.

In next week’s article we explore those businesses that have ceased trading in recent months, and examine the trends that exist on a size and industry basis to understand those most at risk, and those that are proving resilient through current economic climes.