Written evidence from the Department for Business, Energy and Industrial Strategy (SBP0016)

Executive Summary

• The written evidence provided here focuses on the four specific lines of the committee’s inquiry: Improving productivity; Management capability: Scale-Up; and Fair treatment. It sets out the known evidence and highlights some of the key policy responses being taken forward to improve SME growth and productivity as part of the Government’s Industrial Strategy.
• The Long Tail Productivity Review, announced in Industrial Strategy will build on government’s understanding of the practises driving the performance of low productivity businesses. It will look into how public and private firm-level interventions can support growth and improve productivity for the ‘long tail’ of low productivity firms, and the market in which interventions operate. We will announce the further policies we intend to take forward following this review in autumn 2018.

Improving Productivity

Evidence

1. The UK has a productivity gap with its main competitors within the G7. This gap is particularly felt by micro and small companies which tend to be less productive than larger firms.

2. Recent analysis by the Bank of England[1] and OECD[2][3] suggests that while top firms (leaders) have been pulling ahead of the middle of the pack (followers), a bigger factor driving this trend is the bottom firms (laggards) falling further behind the middle. This effect also appears to be more pronounced amongst services firms than in manufacturing.

3. Whereas growth in the globally most productive firms has remained strong, the gap between leaders and the rest has increased over time, possibly implying a slowdown in knowledge diffusion from leading firms to followers. Again, evidence presented by the Bank of England[4] suggests that this leader-laggard problem is more of an issue in the UK than elsewhere. A recent CBI Report also illustrates that a failure to adopt readily available technologies is a significant contributor to poor productivity.[5]

Policy Response

4. In the work undertaken by Sir Charlie Mayfield last year, as part of the Productivity Leadership Group, business management or business capability were seen as more important than R&D and technology diffusion in driving productivity. In essence, businesses must undergo a cultural shift through which managers become more self-aware and open to changing technology and processes. Government is providing up to £13m to a new industry-led initiative called Be the Business. Chaired by Sir Charlie Mayfield and backed by some of Britain’s most senior business leaders, Be the Business will help SMEs and managers understand the simple management changes they can make to boost their productivity through innovative online tools, campaigns and place-based pilots.

5. The Industrial Strategy commits to investment in R&D reaching 2.4 per cent of GDP by 2027, rising to 3 per cent of GDP in the longer term, placing us in the top quartile of OECD countries. We are investing in strategic innovation challenges through the ambitious new Industrial Strategy Challenge Fund, which will help deliver the Grand Challenges - in Mobility, AI, Clean Growth and Ageing Society - and support sector productivity, including through Sector Deals. The Industrial Strategy Challenge Fund brings together world class UK research with business investment to develop the technologies that will transform existing industries and create entirely new ones.

6. A new Future Sectors programme will focus on new and innovative businesses that are developing the technologies & business models of tomorrow to drive earning power and improvements in productivity across the sectors in which they take root. This includes a series of Future Sectors reviews, working closely with cohorts of innovative businesses to understand and address their barriers to further growth; and barriers to the wider adoption by businesses of all sizes across sectors of the innovations they are spearheading.

7. The government's Industrial Strategy also announced a new Business Basics Programme to trial innovative approaches to drive up the adoption of tried and tested technologies and business practices that can improve businesses’ productivity. The programme, which will launch in 2018, will test approaches to encourage SMEs to adopt technologies and practices such as new accountancy software or performance management systems. It will also provide us with a better understanding of the specific barriers currently stopping businesses from adopting particular classes of technology and how these can be overcome.

8. Barriers to the adoption will be explored further as part of the Long Tail Productivity Review.

Management Capability

Evidence

9. Recent research has estimated that around a quarter of the UK’s productivity gap with the United States could be explained by management deficiencies.[6] 

• Better management practices (e.g. effective monitoring, targets, incentives, operations) have been found to be significantly associated with higher productivity.[7]
• Poor management practices have been linked with weak product market competition and/or when firm management is inherited by a close  family member.[8]

10. The best firms in the UK have world-class managers, but evidence suggests that on average our managers are less well qualified than many of our overseas competitors and have substantial skills gaps:
• Nearly three-quarters of SMEs in England report a deficit in leadership and management skills[9].
• Better management is linked with managers with higher qualification levels.[10]
• In the UK only around 40% of UK managers are qualified at level 4 and above compared to around 80% in other professional occupations[11].

11. Organisations with more qualified management and a dedicated programme of management development have been shown to perform better and have more sophisticated and higher quality product and market strategies.[12]

12. Figures from the Chartered Management Institute (CMI) show that UK firms are not training managers effectively, which is having a significant impact on the overall success and productivity of small firms; less than a quarter (23%) of organisations rank as ‘good or very good’ on leadership and management training before or within three months of taking up a management position[13]. Good human-resource management skills are also essential to growing firms as they seek to bring in new staff and boost workforce productivity[14]; three quarters of businesses in England that reported a deficit in leadership and management skills may have suffered as a consequence[15].

13. There are a range of approaches available to help SMEs to improve their capability, particularly leadership and management, for example:

• Formal training and qualifications including MBAs.
• Informal, mentoring support and peer to peer support. The FSB has found that the main source of support that has contributed to the growth of small businesses has been peer networks[16].
• Consultancy - In 2012-13 SMEs spent over £400 million on consultancy and research services[17].
• Support provided by finance and professional services providers/bodies. These can be a strong source for extolling the merits of good leadership and management by raising awareness of and signposting businesses to support and training.  For example, the Goldman Sachs 10,000 Small Business programme provides high-quality, practical education and business support for leaders of high-growth small businesses and social enterprises across the country.
• Formal external business support provided through business support schemes, including financial, strategic, regulatory or marketing advice. Formal external business support can be crucial to moderately growing firms, with nearly 60 per cent of SMEs reporting improved sales and profitability and being helped to ensure survival[18].
• Incubators, Accelerators and Universities offer a variety or combination of housing/space, formal and informal support, access to networks, as well as investment and finance.

14. Many SMEs are missing out on an opportunity to improve their business, often as a result of unawareness of weakness in their management practices.[19]

Policy Response

15. As set out above, there is substantial private sector provision available to help firms to improve their leadership and management capability. In order to help businesses to navigate the market, BEIS provides funding of £12 million per annum to maintain a network of 38 local Growth Hubs (led and governed Local Enterprise Partnerships) across England. Growth Hubs play an important role in helping to simplify and coordinate the local business support landscape by providing a free and impartial local ‘single point of contact’ aimed at helping firms to understand their business support needs and improving awareness and take-up of training and business support services available from the public and private sector.

16. Management capability is a key theme to be explored through the Long Tail Productivity Review. The review will look to determine the importance of management skills to the productivity problem and consider whether there is a role for Government in coordinating or stimulating demand for private sector provision.

Scale Ups

Evidence

17. Evidence suggests that the most significant barrier for Scale Ups is their ability to traverse a series of ‘tipping points’.

• People management (e.g. recruitment and delegation)
• Strategy (e.g. moving from opportunism to targeting)
• Formalised systems (e.g. formal MI and CRM systems)
• New market entry (e.g. developing new products, exports)
• Get finance (e.g. switch from reliance on initial funders)
• Operational improvement (e.g. move towards best practice)

18. These tipping points occur when the business reaches a critical scale at which it needs to adopt a range of different approaches to managing its finances, people and technology differently if it is to grow significantly. For founder-led businesses this is the point at which the founder may come across a whole set of new requirements for which they may be unprepared, and will also require them to relinquish some direct control to others to run different functions of the business.

19. Success in overcoming the challenges faced at these points depends on a firm’s ability to use internal and external capabilities to plan, implement changes and overcome barriers.[20] 

20. Research indicates that increased use of external support can have a large impact on improving business skills and outcomes, including improvements in business planning, marketing, increased investment in skills and technology, new innovation and export activity, increased viability of new business starts.[21] Despite these benefits, the use of external information or business advice has been declining since 2010. In 2016, only 26% of UK SME employers had sought external advice or information in the previous 12 months.[22]

21. BEIS analysis[23] has identified a range of market failures contribute to the sub-optimal use of business support activities to build business capability and capacity:

• Most relate to the demand side:
• Incomplete Information – challenges diagnosing need and assessing the potential benefits of the vast range of help available
• Information asymmetry – those seeking external advice know less about the quality and impartiality than those providing advice
• Externalities – can be wider benefits from knowledge spillovers across business networks or from employees moving to different firms that aren’t taken into account in business decision making.
• Discounting – the discount rate of individuals is higher than socially optimal. Small business owners are typically time poor or face cash-flow issues leading them to overly discount the returns from advice which may occur over the long-term.
• Credit constraints – small firms may not be able access finance to fund business advice even if they would be willing to pay the market cost of support
• There are also issues on supply side:
• Suppliers face costs from incomplete information on the firms that would benefit from their advice
• Suppliers may lack the incentive to refer firms to alternative providers, leading to ‘product push’

Policy Response

22. As set out above, Growth Hubs play an important coordinating role in helping businesses to understand their business support needs and connect them to relevant and trusted sources of funding and business support from the public and private sector (e.g. universities, Goldman Sachs 10,000 SMEs etc).
23. Industrial Strategy announced that we are working with partners to pilot and evaluate the role that customer feedback and online ratings marketplaces could play in making it easier for SMEs to assess the quality of the advice available. This work will start in the first half of 2018.

Role of the Scale-Up Task Force

24. The Scale Up Taskforce was set up to explore what more the government, working alongside the private sector, could do to help businesses scale up.

25. The work of the Taskforce focused on three themes:

1. Finding the right business at the right time;
2. Creating a vibrant ecosystem that helps businesses to scale and improves access to growth opportunities; and,
3. Inspiring businesses to scale-up.

26. The Taskforce prioritised four areas for action in support of the Industrial Strategy: 

• Better use of government and privately held business data to identify and target the right businesses at the right time, enabling a more coordinated approach;
• Increased market access through international trade, improved government procurement and better supply chain support;
• Access to talent, particularly enhancing leadership and management skills; and
• An increased awareness, and more uptake of, capital growth and equity finance to help business owners invest in business growth. 

27. BEIS is continuing to work with the Taskforce in these areas.

Access to finance

28. The Industrial Strategy’s access to finance plan will unlock over £20bn of capital investment, over 10 years, to grow innovative firms: addressing gaps in late stage venture capital and ensuring we can retain internationally-mobile companies seeking to scale. The British Business Bank will lead on delivering a number of new and updated sources of finance to support SMEs:

• The British Patient Capital Fund, unlocking £7.5bn of investment to ensure businesses can access capital needed to scale-up, is in the first of three phases of development, expected to launch by the end of September 2018.
• The Bank’s Commercial Investment Programme will support developing clusters of angel investors outside of London to create new sources of finance for SMEs across the UK. A request for proposals will launch in Q1 18/19.
• The Bank will roll out Regional Managers by autumn 2018, ensuring SMEs and investors are made aware of investment opportunities across the UK.
• The Bank’s Enterprise Finance Guarantee has been extended to March 2022, expanding its support to up to £500m of loans a year for businesses to access debt finance.
• The Enterprise Investment Scheme incentivises investments in knowledge-intensive, low-capital SMEs. Legislation is currently being considered within Parliament on doubling the annual allowance, if it obtains Royal Assent by the close of March, the EIS expansion could be rolled out in April.

Exporting

29. Businesses that export account for 60 per cent of the UK’s annual productivity growth deliver stronger employment growth and pay higher wages than those that don’t. DiT will support businesses to access international markets, driving up exports by working with businesses to undertake a review of export strategy, reporting in Spring 2018. UKEF will introduce a new guarantee to banks to increase liquidity in the supply chain and improve exporter’s access to capital and will launch a targeted campaign to promote the support they offer exporters and overseas buyers as part of the wider GREAT campaign.

Local Industrial Strategies

30. Place has an important role to play in driving productivity. Local Industrial Strategies will help identify priorities to improve skills, increase innovation and enhance infrastructure and business growth. Local Industrial Strategies will be long-term, based on clear evidence, and aligned to the national Industrial Strategy. They will identify local strengths and challenges, future opportunities and the action needed to boost productivity, earning power and competitiveness. We will agree the first Local Industrial Strategies by March 2019.

Procurement

31. The Government is committed to 33% of central government procurement spend going to small and medium sized enterprises (SMEs), directly or via the supply chain, by 2022.

32. The Small Business Research Initiative (SBRI) is a cross-government programme, managed by Innovate UK, that enables small businesses to bid for government contracts to develop new cutting-edge products for the public sector. These have included, for example, a non-invasive breath test for early detection of lung-cancer and robotics technology that can enable people in the early stages of dementia to stay independent in their own homes. SBRI currently provides around £75m of contracts a year to businesses.

33. As mentioned below, late payment and supply chain practices are often cited as barriers to SMEs. Crown Commercial Services is the lead for overall public prompt payment. Measures in the Public Contracts Regulations provide for all non-devolved public sector contracting authorities to pay valid and undisputed invoices in no more than 30 days and for those terms to be reflected in subcontracts all the way down the supply chain. Under the regulations, annual reports have to be published online by contracting bodies on their payment performance.

Do existing concessions for small businesses serve to discourage growth? 

VAT -  registration threshold

34. The Office of Tax Simplification (OTS) report on routes to simplification for VAT, published on 7 November 2017, observed that the relatively high level of the threshold in the UK has a distortionary impact on business growth. This is because of the phenomenon of bunching where small businesses deliberately limit their turnover to remain below the threshold. The OTS recommended that the government should examine the current approach to the level and design of the VAT registration threshold.

35. At Autumn Budget 2017, the Chancellor recognised that the UK had by far the highest threshold in the OECD, and noted concerns about the cliff edge nature of the threshold. However he also noted that a high threshold has the benefit of keeping the majority of UK businesses out of VAT altogether. The Chancellor announced that the government would consult on whether the design of the threshold could better incentivise growth. This consultation is due to be published later this year.

Business Rates – Small business rates relief

36. To support businesses as they grow, ratepayers can keep their Small Business Rate Relief (SBRR) on their main property for 12 months if they start to occupy a second property. Ratepayers can still get SBRR on their main property after this if both the following apply:

• none of the other properties has a rateable value above £2,899
• the total rateable value of all the properties is less than £20,000 (£28,000 in London)

Fair Treatment

Late Payment

37. Late payment of invoices remains a significant issue in the UK, estimated at £14.2bn[24]. The level of late payment debt to small and medium sized businesses is down from £26.3bn in 2016. The Government is taking several steps to tackle late payment, both in the public and private sector. Policies aim to address the imbalance in market power between parties, increase transparency and encourage better payment practices through culture change.

38. Crown Commercial Service is responsible for prompt payment policy in the public sector, whilst BEIS is responsible for the policy in the private sector, including the Prompt Payment Code and the Payment Practices Reporting requirement. Measures to tackle late payment include:

• The Late Payment of Commercial Debts (Interest) Act 1998 which gives suppliers a right to statutory interest if not paid within the agreed period.
• A duty on the UK’s largest businesses, introduced in April 2017, to report on their payment performance. This increases transparency and provides small business suppliers with better information about the payment practices of large businesses with whom they intend to trade.
• In October 2017, BEIS published two consultations on payment practices within the construction sector, both closing on 19 January 2018. Responses are being used to assess the extent of the issues; and what further intervention is needed.
• The voluntary, industry-led, Prompt Payment Code promotes best practice principles in payment standards. The Code enables businesses to demonstrate to suppliers that they are committed to prompt payment and has over 2,000 signatories.
• The recently launched Small Business Commissioner (SBC) will help small businesses struggling with late payments. The Commissioner will play an important role in supporting small businesses resolve their payment disputes with larger businesses, providing advice, and help bring about culture change in payment practices.
• Through the Public Contracts Regulations 2015, public sector buyers must include 30-day payment terms in new public sector contracts, and require that this term be passed down the supply chain. Public sector buyers must also publish annually their payment performance. The Government’s Mystery Shopper service, introduced in 2011, investigates concerns raised by suppliers about poor procurement practice, including poor payment practice and late payment in public sector contracts. Since 2011 Mystery Shopper has received over 1300 cases.

How effective are measures in place to protect small businesses against systematic late payment practices of large companies?

39. In private sector contracts, the Government promotes payment terms of no more than 60 days through best-practice schemes such as the Prompt Payment Code. If a supplier thinks a Code signatory is breaching best-practice principles, they are encouraged to alert the Code Compliance Board who will investigate and take further action if required. We are looking into options to improve awareness of, and compliance with, the Code. In public sector contracts, the Mystery Shopper service provides a route for suppliers to report poor payment practice and late payment, including late payment through the supply chain. To date, in excess of £4m worth of late invoices have been unblocked by Mystery Shopper.

40. The statutory reporting measure, introduced last year, requires large UK private sector businesses to report biannually on their payment practices and performance. Businesses must publish this information on gov.uk, which is available for anyone to access. The duty applies to businesses’ first full financial year starting after 5 April 2017. It is a criminal offence if a business fails to publish a report or knowingly publishes a report which is false or misleading. Most businesses have a financial year which starts on either 1 January or 1 April, and therefore we expect the majority of first reports to be submitted from July to November 2018. To date, over 650 reports have been submitted. We expect to better assess the impact of this measure once there is a larger volume of reports to analyse and review.

41. This measure will highlight payment practices and make payment behaviour a reputational issue. We anticipate the public pressure through the open nature of the reports - enabling companies, suppliers and third parties to compare reports and publicise - will encourage businesses to improve their payment practices. Also the public display of good payment behaviour from companies could encourage others to seek to match the best.

42. The SBC launched its advice and information website (which any business can use) and complaints function on 20 December 2017. Since the Commissioner’s website launched, it has already attracted over 2,100 hits. It is too early to properly assess the effectiveness of the service. The Commissioner will produce an annual report which will highlight any significant issues that have arisen in the course of his work, and can make recommendations on how to address them. The SBC’s performance will also be periodically reviewed. The first statutory review will cover the period until 31 March 2020 and each subsequent review period will cover three years.

Are the powers of the Small Business Commissioner to police poor payment practices strong enough?

43. Responses to the consultation on the SBC highlighted that the service should seek to avoid duplications and improve awareness of existing services across the payment landscape[25]. There was a clear demand from small businesses for an intervention which builds the confidence and capability of small business to negotiate payment terms and help small businesses resolve payment disputes, in a way which preserves business relationships.

44. The SBC was not established to police businesses and the government considers that a punitive approach (involving compulsion or financial penalties) is not the right one to take if the Commissioner is to contribute to culture change in payment practices. Instead, the Commissioner is developing trust and building credibility with small and larger businesses alike.

45. The Commissioner can make legally non-binding determinations, which may include recommendations on resolving issues, or how to avoid them occurring in future. He can also publish a report about an enquiry into a complaint which can name the respondent - a key power of the Commissioner that will enable him to draw attention to poor as well as good practice.

8 March 2018