SME Inflation Report produced by the Centre for Economics and Business for Aldermore Bank

1. Aldermore SME Cost Inflation Index
Q1 2013

2. Executive summary 2
UK economic overview 3
SME cost inflation trends 6
SME cost base analysis 9
SME credit conditions 10
UK business insolvencies 11
Contact 12
Contents
2
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for Economics and Business
Research (Cebr) for Aldermore.
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the Financial Services and Markets
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3. • Annual cost inflation
among SMEs fell to 1.1%
in Q1 2013, its lowest level
since Q4 2009.
• Business services SMEs
faced the lowest annual
cost inflation, with no
change in total costs in Q1
2013 compared to a year
before.
• Retail SMEs faced higher
cost inflation, at 1.0%.
• Falling wages restraint and
declining commercial rents
have helped curb cost
inflation in recent months.
Executive Summary
3
Annual cost inflation for the average UK small and medium
sized enterprise (SME) continued to fall back in the first
quarter of 2013 to stand at 1.1%. This is down from 1.3% in
the previous quarter, and 2.0% in the same quarter a year
before.
Of the sectors considered in this report, cost inflation was
highest in the retail sector in Q1 2013. This reflected rising
input costs for food, tobacco, textiles and computer & electrical
equipment. For other sectors, such as business services &
finance, falling average total salaries on the back of a weak
economic environment helped to bring down inflation.
Despite falling cost inflation, the business environment for
SMEs remains challenging. Insolvency levels are still much
higher than before the financial crisis, with company
liquidations in Q1 2013 21.8% above that seen in Q4 2007.
Access to credit also remains an issue, though there are
tentative signs emerging that the Funding for Lending Scheme
(FLS) from the Bank of England may be feeding through into
lower borrowing costs.

4. UK economy flounders amid income squeeze and sluggish
export growth
4
• The UK economy grew by just 0.3% in 2012
as a trade-led recovery proved elusive.
Exports of goods and services contracted by
0.2%, bearing down on economic expansion.
• Growth is expected to remain just below the
1% mark this year, as a slowdown in
consumer spending growth and economic
weakness in our biggest export market – the
Eurozone – hold back prospects.
• The consumer-side of the economy is being
held back by extremely weak earnings
growth which is trailing behind inflation. ONS
average earnings data for the three months
to February showed annual regular pay
(excluding bonuses) growth of just 1.0% - the
lowest growth rate since this data series
began in 2001.
• Structurally tighter access to credit, ongoing
competitiveness issues and fiscal austerity
all mean that the pace of UK economic
expansion will be weak over the coming
years
UK annual GDP growth
Source: ONS, Cebr analysis
-5%
-4%
-3%
-2%
-1%
0%
1%
2%
3%
4%
5%
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013Forecast

5. Decline in the price of oil helps curb some input
costs, though sterling weakness partly offsets this
5
• Factory gate price inflation for manufactured
goods slowed in the first quarter of
2013, with annual price inflation standing at
2.1% - down from 2.3% in Q4 2012.
• The price of oil has fallen sharply in recent
weeks. The price of Brent crude oil fell from
over $110 per barrel at the start of January to
close to $100 per barrel by mid-April.
• Lower oil prices should place downward
pressure on input costs.
• However, any decline in cost inflation will be
moderated by the depreciation in sterling
seen since the start of the year, which will
place upward pressure on import costs; on
1st January 2013, a pound could buy $1.62;
on 1st April it could purchase only $1.52.
Sterling has also weakened against the euro.
UK annual factory gate price inflation
Source: ONS, Cebr analysis
-2%
0%
2%
4%
6%
8%
10%
2000Q4
2001Q4
2002Q4
2003Q4
2004Q4
2005Q4
2006Q4
2007Q4
2008Q4
2009Q4
2010Q4
2011Q4
2012Q4
2013Q4
Forecast

6. SME business confidence picks up
6
• Business confidence picked up across all
sizes of business in the first quarter of 2013.
• Confidence among SMEs remained higher
than among large and very large businesses.
Confidence among SMEs has been higher
than among larger businesses since the start
of 2011.
• Strong confidence among SMEs is
particularly important for the UK economy;
these businesses employ more than half the
workers in the private sector and account for
just under half of private sector turnover
and, as such, are a key engine for growth in
the UK economy.
Business Confidence by company
employment size
Source: ICAEW / Grant Thornton Business Confidence
Monitor
-15
-10
-5
0
5
10
15
20
25
30
Q12010
Q22010
Q32010
Q42010
Q12011
Q22011
Q32011
Q42011
Q12012
Q22012
Q32012
Q42012
Q12013
SMEs (0-249) Large (250+)
Very Large (1000+)

7. Cost inflation falls back – partially driven by ongoing pay
restraint and falling commercial rents
7
• Annual SME cost inflation stood at 1.1% in
Q1 2013, down from 1.3% in the previous
quarter and 2.0% at the same time a year
before.
• This decline in the rate cost inflation this
quarter compared with Q4 2012 was driven
by slowing wage growth across the
economy even falling total pay in the
business services & finance and
construction sectors.
• Commercial rents also continued to see
year-on-year declines in Q1 2013, falling
annual decreases throughout 2012. This is
likely to be partly driven by elevated office
and retail vacancy rates at present.
• Gas prices remain an ongoing cost
pressure for businesses – particularly those
in the manufacturing sector for whom it is
an important input into many production
processes. Prices were on average 12.6%
higher than a year ago in Q1 2013.
SME annual cost inflation rate
Source: Cebr analysis
-1%
0%
1%
2%
3%
4%
5%
6%
Q12002
Q12003
Q12004
Q12005
Q12006
Q12007
Q12008
Q12009
Q12010
Q12011
Q12012
Q12013

8. Costs for finance & business service firms drops back due to
falling total pay
8
• Of the sectors considered, cost inflation was
lowest for business services firms in Q1
2013, at 0.0% over the past year.
• Year-on-year average pay growth in the
financial and business services sector was
estimated to be -1.0% in Q1 2013. With
employment costs accounting for over half
(roughly 54%) of total business services
company costs, pay restraint helped curb
cost inflation in this sector.
• At the other end of the scale, cost inflation
was highest in the retail sector in Q1 2013, at
1.0%. This was mainly driven by the rising
cost of physical business inputs, such as the
products needed to stock retail outlets. In
particular, the cost of manufactured food
products rose year on year by 3.5% in Q1
2013, placing upward pressure on the costs
of supermarkets and other grocers.
• Note that the chart opposite is of selected industries
only and is not exhaustive of the entire SME
economy. The overall SME inflation index presented
on page 7 does, however, cover all business types.
SME annual inflation rate by selected
industry
Source: Cebr analysis
-6%
-4%
-2%
0%
2%
4%
6%
8%
Q42001
Q42002
Q42003
Q42004
Q42005
Q42006
Q42007
Q42008
Q42009
Q42010
Q42011
Q42012
Manufacturing Construction
Retail Business Services

9. The cost of physical inputs is producing the greatest upward
pressure on business costs
9
• Of the 1.0% headline annual SME cost
inflation rate in Q1 2013, 0.3 percentage
points were contributed by physical inputs.
• The costs of manufactured products such as
foodstuffs and machinery & equipment
(including computers) continued to rapidly
rise year on year in Q1 2013.
• However, falling wage inflation has helped to
bring down the overall rate. This
quarter, employment costs contributed just
0.1 percentage points to SME
inflation, down from 0.4 points the previous
month.
• At the other end of the scale, declining
rental costs helped contribute downward
pressure to SME cost inflation. Commercial
rents in Q1 2013 were 0.3% lower than in
the same quarter a year ago.
Contribution to headline annual
SME inflation rate
Source: Cebr analysis
-0.05%
0.00%
0.05%
0.10%
0.15%
0.20%
0.25%
0.30%
0.35%
0.40%

10. Employment costs and physical inputs make up the bulk of
average SME costs
10
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
All SMEs Manufacturing Construction Retail Business
Services
Employment costs Physical Inputs Business services*
Construction Transport & Storage Commercial rent
Energy & utilities Other services
• Purchases of physical inputs and labour
costs are the largest costs for
SMEs, accounting for some 20% and 30%
of total businesses expenses for the
average SME.
• On top of this, a further 21% of total costs
are spent on business services such as
legal & accounting, advertising, IT &
telecommunications.
• SMEs in manufacturing are heavily
weighted toward physical inputs – more
than 50% of total cost is on these
intermediate goods.
• SMEs in retail have a strong transport and
storage weighting in their cost profile.
• Meanwhile, over half of the costs for
business services SMEs are on
employment.
Breakdown of business costs, % of
total, by SME type
Source: Cebr analysis
* inc: finance, legal & accounting, IT & telecoms

11. Tentative signs that FLS may be reducing business borrowing
costs
11
• Interest rates and spreads on new
variable-rate facilities to all small and
medium-sized enterprises (SMEs) have
been broadly stable in recent
months, according to survey data from the
Department for Business, Innovation and
Skills.
• Some major UK lenders have reported
that the Funding for Lending Scheme
(FLS) had led to some downward
pressure on borrowing costs for smaller
businesses.
• However, the latest data continue to show
that the spread between the Bank of
England Bank Rate and median interest
rates for SMEs – particularly smaller
SMEs - is wider now than in mid 2009.
Median interest rates on variable-rate
facilities and Bank of England Bank
Rate
Source: Bank of England, Department for Business, Innovation and
Skills. Smaller SMEs are those with annual debit account turnover on
the main business account of less than £1 million. Medium SMEs are
those with annual debit account turnover on the main business
account of between £1 million and £25 million.
0
1
2
3
4
5
6
Nov-08
Feb-09
May-09
Aug-09
Nov-09
Feb-10
May-10
Aug-10
Nov-10
Feb-11
May-11
Aug-11
Nov-11
Feb-12
May-12
Aug-12
Nov-12
Feb-13
All SMEs Bank rate
Smaller SMEs Medium SMEs

12. The number of business failures has been falling back
12
• There were 3,700 company liquidations in
Great Britain in Q1 2013. This is 20.2%
below the same period a year ago.
• However, reflecting ongoing weakness in
the UK economy, the level of liquidations
remains some 21.8% above that seen in
Q4 2007
• Business insolvency numbers are likely to
remain elevated compared with before the
financial crisis this year, reflecting
continued weak economic conditions.
• The recent decline in insolvencies was
surprising given the weak economic
conditions that persisted throughout last
year. It is quite possible that there are a
significant number of near-insolvent
“zombie” companies at present, only able
to pay interest on debts (and not the debt
itself). R3, the Association of Business
Recovery Professionals, has estimated
that there could be as many a 160,000
such businesses in the UK.
Total number of GB company liquidations
Source: Insolvency Service
0
1,000
2,000
3,000
4,000
5,000
6,000
Q12004
Q12005
Q12006
Q12007
Q12008
Q12009
Q12010
Q12011
Q12012
Q12013

13. • For any questions or comments on this report please
contact Holly Marshall, Head of Corporate
Affairs, Aldermore
• Holly.marshall@aldermore.co.uk
• www.aldermore.co.uk
Contact
13