Extracts from the Smith Institute report, commissioned by SMMT, are shown below. Click through to download the full report, including case studies and detailed appendices.
A UK supply chain with growth ambitions
So what is the current nature of the UK’s automotive supply chain? The survey of 82 automotive firms completed between March and May 2012 for this study covered firms at all stages in the supply chain representing a combined turnover of more than £2.25 billion and operating from 224 locations globally. On average, for these firms, about 80% of their sales are in the automotive sector and 70% in the UK.
These firms had 36 direct supply contracts to UK-based car manufacturers. The most common UK based OEM purchasers were Jaguar Land Rover (55%) and Aston Martin (48%). About one third supply Ford, Nissan and Honda. A wide range of other purchasers were also identified (34%).
The suppliers are diversified. Only one in seven firms has 75% or more of its business with their main customer and more than 50% of all firms have 25% or less of their sales with the main customer. When firms supply more than 50% of the sales to their main customer this purchaser was often Jaguar Land Rover, Nissan, GKN, SAIC (China) or Honda.
More than 50% of automotive sector firms report that they increased their turnover in the last year.
Nearly 60% of automotive firms plan to grow in the future, one third rapidly. More than one third of firms aspires to grow by more than 25% in the future. Growing sales, achieving an appropriate profit margin on sales and diversifying their customer base were ranked as the most important business objectives by these automotive firms.
Will the UK’s ‘window of opportunity’ be missed?
So what is stopping the UK supply chain from expanding even more? Automotive firms report challenges in responding to the scale and rapid pace of changes in market demand, the costs of premises and technology and the availability of debt finance. These were identified as the most important issues affecting automotive firms’ ability to meet their main stated business objective – growth.
Following an era of business drifting away from the UK, a number of OEMs such as JLR and Nissan are doing significantly more business in the UK and have aggressive model ramp-up plans. How firms finance themselves and their growth fundamentally affects the speed at which they can grow in response to these and other opportunities.
So how do automotive firms finance themselves? Cash flow and debt are the main sources of finance. More than half of all businesses are using their cash flow alone (32%) or their cash flow plus debt to finance their businesses(23%). One quarter of firms use any form of equity finance as part of their financing approach, and this is relatively high given the aversion of SMEs to using equity. About 4% of all firms rely on funding from their parent firm.
Financial issues are very different between OEMs / Tier Ones and SMEs operating at Tier Two and below. An OEM will have access to international capital markets and the ability to undertake its own rights issues as well as carefully managing its currency exposure across its supply chain. More than 80% of cars produced by Nissan in the UK are exported. The relative cost advantage of sterling, which is expected by the OEMs to last for the next three to five years, is acknowledged as a benefit to UK-based operations.
For internationally mobile Tier One suppliers considering different locations the UK’s cost base and offer of any tax breaks or grants are compared to other competing locations.
For UK-based Tier Two and Three suppliers the financial issues relate to cashflow and the payment terms from OEMs and Tier One suppliers. Late payment affects their credit rating and pushes up the costs of credit insurance.
Internal cash (56%) is the most important source of finance for the majority of automotive firms followed by bank loans and overdrafts (20%) and factoring or invoice discounting (12%). Important secondary sources include bank finance (31%), asset finance (23%), finance from suppliers and customers (15%) and equity from Directors and Partners (12%).
Constrained finance continues to limit growth
Our survey found that, despite the growth in the sector, over the last year financial conditions across a range of measures have actually worsened for more than one quarter of automotive firms. Problems were most acute in securing finance for tooling investments. While, on average, the survey found that financial conditions had improved for 17% of firms, they had deteriorated for 26% of all automotive firms. So for about every two firms reporting an improvement in their financial conditions, three report a decline and seven stayed the same.
The greatest change was reported in the costs of new lines of borrowing. While one third of firms reported that these had improved, one third reported that these had worsened over the last year. More than one third of all firms (36%) reported that the availability of finance for investments in tooling had worsened in the last year (with only 8% reporting an improvement). About 27% of firms reported more expensive fees on existing borrowing including overdrafts and a worsening in the availability of new lines of borrowing. One quarter of firms reported a deterioration in the terms connected to existing borrowing.
In response to problems with finance availability, some OEMs have supported the cashflow of their smaller suppliers by paying invoices faster. In some ways OEMs are being forced into increasingly performing the role of banks by providing cash headroom for their suppliers and some upfront payments to help with tooling costs. This in turn affects the OEMs perspective about the role and commitment of banks to the UK’s automotive sector. Conversely, while an individual OEM’s capacity and willingness affects the cash headroom it will provide to its suppliers, some interviewees noted that OEMs (or perhaps Tier One suppliers) could and should fulfil this role more than they do currently.
There is little other evidence of any improvement in the availability of credit to businesses in the UK. The most recent data from the Bank of England report that the stock of lending to businesses decreased by around £9 billion in the three months to February 2012 as part of a more general reduction in financial flows. This results from both restrictions in the availability of finance (supply) and the willingness of companies to borrow (demand). The net monthly flow of lending in February was at its lowest in almost two years. While lending growth rates for SMEs had been stronger than for businesses overall during 2009, this probably reflected their relative lack of access to alternative sources of finance such as capital markets. Lending growth for all SMEs has been negative since late 2009 and has been below that for all corporations as a whole since March 2011. Furthermore, a recent survey by the Federation of Small Businesses found that more than three-quarters of the 3,000 companies surveyed rated credit availability as poor or very poor. More than 40% of applications for credit in the preceding three months were declined compared to just 10% in 2007. On their part, banks report that demand for credit from SMEs remains muted.
Concerns with low levels of lending to business have resulted in a number of initiatives over the last two years. Established in July 2010, the Business Finance Taskforce set out a range of actions ‘to help business thrive and grow’. Involving the main UK banks, the Taskforce has focused on making improvements in 17 areas. Critics suggest that the overall emphasis has beentoo much on demand side factors – how firms can put themselves in a better position to allow banks to invest in them – rather than also addressing the clear supply side problems at the same time.
A further step, finalised in February 2011, was Project Merlin which set gross lending targets for the banks. Under Project Merlin, the UK’s five biggest banks agreed to make £76 billion of credit available to SMEs, but these (gross) targets were missed by £1 billion. Critics highlight that as well as the targets not being met there was no definition of gross additional lending.
A recent Government response (to concerns about the cost of finance) is the new National Loan Guarantee Scheme (NLGS). This scheme aims to pass on a one percentage point reduction in the headline interest rate on loans to SMEs by the Government guaranteeing up to £20 billion worth of loans. However, critics point out that only £5 billion is available over the first six months, the scheme has no targets and it is not compulsory.
Given these evident problems in the availability of finance from banks, the recent Breedon Report (March 2012) examined the increased role that non-bank finance could play in financing the needs of firms, especially smaller firms. The report recommended a range of initiatives to introduce more competition into the supply of business finance as well as stimulating a demand for a broader range of finance from firms. This also reflects wider concerns about the level of competition in the UK business banking sector. The four largest banks provide about 85% of lending to SMEs and the state- owned RBS alone has about a 30% share in the commercial and corporate markets.
As well as issues with the availability of credit for the automotive sector the survey, detailed case studies and expert interviews for this report, found a number of specific financial issues constraining the growth potential of the UK automotive supply chain, especially its smaller and more medium sized firms. Resulting from the nature of the automotive supply chain, current financial conditions and characteristics of an SME supplier these include:
- The relationship between the banks and the automotive sector including a persistent personal guarantee culture.
- A gap in growth finance for firms.
- A particular problem in securing finance for tooling development costs.
- Payment terms across the supply chain and the use of supply chain finance.
- The nature and preferences of SME owner managers.