In this report, M Institute identifies four key areas where the judicious use of policy actions would benefit the working of the economy, without compromising any commitment to the use of market mechanisms.
These four areas cut across the seven key challenges facing business leaders in this segment, with the expected consequence of inaction usually causing problems in the area of growth. This makes them particularly important to address.
Challenge I: Access to capital
Growth needs money, and money looks for growth. But the two often don't find each other in the medium segment of the market.
A major factor affecting growth in medium organisations is access to capital. Growing a business needs capital. Not every medium organisation has difficulty in raising capital, particularly when the capital is needed for buildings and capital equipment. But capital is difficult to obtain when the driver for finance is growth or innovation which is not tied to capital expenditure. It is even more difficult when the track record of the organisation does not demonstrate a steep upward year-on-year growth curve. Yet it is these organisations that are delivering the most consistent growth performance in the UK economy.
Why is it hard to raise such growth finance? According to respondents to this research study, there are a number of reasons why.
One, UK banks appear to have a short-term view on lending which does not support the longer-term growth finance requirements of medium business. They are also risk-averse at the levels of finance sought by medium business.
UK banks seem to have a shorter horizon than European banks in this regard. The former measure their performance on transactions – the more, the better. They reward their staff, and make more money, if they can make two five year loans, than one ten year loan. The fact that the second loan is simply taken to finance the repayment of the first loan is ignored.
Two, private equity providers are perceived to have moved up-market so that their need for a return is such that companies have either to deliver a spectacular growth performance or give the investors a higher share of the business than they would like to. This is self-defeating for medium enterprise leaders who expect to be working to benefit themselves rather than somebody else. Business angels operate at a level of finance that is usually too low for medium organisations.
Three, there is a problem of imperfect knowledge that exacerbates the two previous points. While the credit rating for most large organisations is public knowledge, the credit rating of most medium organisations is completely unknown. Without undertaking extensive (i.e. expensive) due diligence, it is impossible to tell the difference between a fantastic prospect and a complete dud.
Policy actions
Government schemes for finance are currently aimed at start-up businesses and are irrelevant to medium business. In any case, very few medium organisations would expect, or even want, government funding.
What is needed is not funding, but ensuring that market conditions operate appropriately. In this regard, there are certain actions that can help remove the barriers that currently exist:
• Investigate why the longer-term financing model between banks and companies that exists on the Continent is not applied by UK banks
• Create a credit rating scheme for medium organisations. Currently, there are six major credit agencies that dominate the large enterprise segment of the market but with none playing in the medium business sector: clearly, there is an issue of scale involved. It may not be worthwhile for any one of the existing commercial credit rating agencies to push-start a scheme for medium organisations, but government could help remove the imperfect knowledge that currently exists between lenders / investors and borrowers.
• Investigate whether there is need in the UK for a funding agency that supports bank loans and other financing when the main use for the funding is to be innovative or enter new markets.
Getting credit ratings or having new loan support schemes will not solve growth and finance challenges among medium organisations. They will not even take away the need for due diligence on the part of the financier. But having a credit rating could mean that the conversation could happen at all. Having a support mechanism for innovation funding could mean that the conversation starts.
Challenge II: Regional development
The economic performance of medium organisations is as strong in a regional context as the largest companies are in a national context. As a result, the engagement of a medium enterprise with the growth drivers in a region is particularly important. Yet, we find a very low connection between regional strategies and medium enterprise.
Why is regional performance important?
Around the world, certain regions are performing so spectacularly that the entire country seems to be glowing green with growth. Yet, in the same country, other regions lag behind.
China is a case in point. In China's coastal regions, such as Dalian, Beijing, Shanghai and Zhejiang, per capita income is around US $5000 per year, a figure already surpassed by Guangzhou. But in the hinterland, incomes fall away to between $2000 and $1000, and lower. If we treat regions as countries, then nine of the top fifteen Asian countries are actually Chinese regions.
It is the strength of the regional economy which is the underlying reason why the World Competitiveness Centre at IMD now includes 8 regional economies, such as Zhejiang, Maharashtra and Sao Paulo, in its benchmarking of 61 countries for competitiveness.
The power in competitiveness studies comes from understanding what makes each region perform. In Zhejiang, it is the clustering of electronic components supply chain participants and PC makers. In southern India, it is IT services. In Ireland, it is customer relationship management. The fuel for growth is often inward investment into these regions, and (unsurprisingly) the money follows expertise and execution capability. While the inward investment is often done by large companies, the companies that benefit from such investment are the local medium-sized organisations that provide the skills, resources and energy to deliver on the demands of the companies making the inward investments. This issue also has cross-cutting significance on globalisation, inward investment and innovation.
It is in this context that the role of regional authorities is so important.
Regional authorities have to learn to be distinctive - they cannot be jacks-of-all-trades. This does not mean that every company wanting to succeed in Guangzhou needs to be an electronic component manufacturer. But it helps to have a strategy in components that companies in the region can fit their offerings into.
So what are the distinctives on offer from Britain's regional authorities, the RDAs? After all, these strategies can be really beneficial for Britain's mid-sized organisations to plug into, if they want to build their own growth strategies around the inward investment these strategies attract.
Here's the problem. How can you plug into a regional strategy from an RDA you have never come across?
This study found that only 14% of all businesses had any knowledge of the function of RDAs. This figure does not vary across size of business. What is likely to vary by size of organisation is the issues that they believe RDAs should be involved with.
From the data, it is apparent that Medium II organisations are more interested in their RDA stimulating new business in a region, while Medium I organisations cite employment opportunities and skills development as their preferred priorities.
Policy actions
We don’t need eye-candy brochures promoting a region’s natural beauty. Unsurprisingly, inward investment into a region is never driven by what the region looks like. Instead, investors seek expertise and execution capability. Consequently, regional development will really work for medium organisations if:
• RDAs are intentionally strategic in choosing the strengths of the region they will focus on, in their efforts to attract inward investment
• As RDAs are relatively unknown among British companies, they need to make a conscious effort to promote their regional strategies to organisations inside their region so that the latter can plug into their region’s competitive strategies.
Challenge III: Burden of regulation
The burden of regulation shows itself in three ways.
One, business carries the burden of much of the interchange between government and its citizens, whether processing tax, tax credits, maternity pay or even alimony payments. This represents an administrative cost on businesses for the privilege of being employers.
Two, there is a separate regulatory burden that comes from meeting government policies that relate to public safety, correction of market failures or the promotion of a fair business environment. This is usually referred to as the policy cost of regulation.
Finally, there is a cost borne by business that relates to the policy cost – this is the administrative cost of complying with policies: getting to know the policies, keeping records on policy issues, reporting on compliance, and costs relating to government inspection and enforcement.
Each of these costs represents separate strands of regulatory burden. Although it is important to understand the components of the burden of regulation, it is fair to state that, as far as business is concerned, all these costs are taken together when it considers the costs of regulation.
Regulatory costs
While there are no firm measures on the cost of regulation in the UK, estimates from the United States and the Netherlands suggests that the total cost of regulation is around 10-12% of GDP. On that basis, the Better Regulation Commission estimates that the cost of regulation was in the region of £100 billion per year in 2005, slightly more than the combined annual yield from VAT and fuel duty, and almost up to the level of the projected income tax yield for 2005/6.
Clearly, the issue is not a small one.
For individual enterprises, regulatory costs have resulted in 86% of businesses increasing the resources needed for handling regulation over a three year period, according to a CBI/Grant Thornton report in 2004.
If anything, the current perception is that the pace at which new regulation is being added is growing. This study finds that 69% of medium-sized businesses cited at least one issue where the regulatory burden had worsened, while only 24% could identify an issue where the regulatory burden had eased.
Employment legislation is a key area of focus when it comes to reducing the burden of regulation. However, opinion is divided on the best means of improving employment legislation, and company size was not the key driver of these differences. Respondents to the Enterprise 2005 study were offered four different options but no single option was selected by a majority of respondents. The most frequently preferred option, favoured by almost a third of businesses (31%), was a guarantee not to introduce any further legislation for a fixed period. Around a quarter (26%) expressed a desire for a reduction in current employment legislation and a further fifth (22%) expressed concerns regarding the ability to dismiss employees by favouring a simplification of the disciplinary procedure. There were no significant variations in response according to company size.
Differential impact
The Enterprise 2005 survey from the ICAEW found that the average annual cost of implementing new legislation per surveyed UK business was £13,464. For the purposes of this study, the figure was analysed by size of business. As could be expected, the burden of new legislation rises in correlation with company size. On average, large businesses spend £25,761 compared to £6,444 amongst small businesses, with medium-sized businesses falling broadly in the middle of this range (£15,327). There was little difference between the average spent by medium I and II firms (£13,852 versus. £17,564).
According to the Small Business Research Trust, businesses with over 50 employees need 43 hours per month to deal with regulatory issues, compared to 31 hours per month in organisations with 10-15 employees.
While the accepted wisdom is that regulation hurts small businesses the most, and this report does not seek to challenge that point of view, what is interesting to note in the SME context is that medium organisations face every single regulatory issue while small organisations face only a sub-set as they often do not meet the threshold of applicability. Also, small organisations are more likely to outsource their regulatory compliance to outside professionals such as accountants and payroll bureau providers who are better capable of handling those issues. Medium organisations tend to deal with regulatory issues themselves.
The challenge that leaders of medium business face is that the regulatory requirements they face are usually exactly the same as those faced by large businesses. There are certain industries where this situation is exacerbated by regulations relating to those industries. For example, medium businesses in travel and financial services report additional regulatory issues they have to comply with, which come from watchdog bodies associated with their industry.
While nobody wants to see less protection for consumers, it may be appropriate in a B2B context for some of the risks that regulation seeks to contain to be handled instead by the companies that are trading with each other. After all, the finance director of a company should be a rather more informed and sophisticated purchaser of a company’s goods and services than a consumer, and therefore should need less protection from regulation than the ordinary consumer.
Policy actions
We need to see three actions in the area of challenge relating to regulation:
• Steady performance by government in reducing the regulatory burden, on the lines of the Dutch model, where new regulation is considered only in the context of old regulations that can be scrapped.
• Simplification of the regulatory environment for medium organisations in particular, as they usually have to deal with regulatory issues on their own without the added infrastructure and manpower that larger organisation can use to deal with such issues.
• Reconsideration of the overall burden of regulation in those industries where there is additional regulation from an industry watchdog, such as in travel and financial services.
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