Tough trading conditions are forcing changes in the UK information technology sector, with further M&A and heightened credit risk emerging as key trends.
The UK technology sector is on the up, with growth in the digital sector outpacing GDP, according to the latest Tech Nation report. However, scratch beneath the surface and the already competitive market conditions of making and selling business and consumer electronics is getting tougher.
Competition in the information communications technology (ICT) market is fierce and costs are rising, while Brexit adds another layer of uncertainty. Across the IT distribution chain, companies large and small are under increasing pressure, with many looking to cut costs and expand their offering in order to survive.
Rising costs have been a particular feature of the UK IT sector, squeezing margins for consumer electronics and suppliers of information communications technology (ICT) and office products.
Prices of PCs, laptops and consumer goods, such mobile phones and tablets, have been under pressure in recent years with the increased cost of raw materials and shortages of major components. Semi-conductor and memory chips, for example, experienced historic price increases in 2017, although prices have recently fallen back with an increase in supply.
Such raw material and component increases are particularly challenging in the price sensitive consumer electronics market, where manufacturers are pushing distributors and retailers to absorb some of the costs. Inflationary increases and foreign exchange rates are also an issue in the ICT market (where large international and regional wholesale distributors supply large business, smaller distributors and retailers) as most IT products have to be imported and paid for in US dollars or Euros.
Following the UK’s vote to leave the EU and subsequent fall in the value of sterling, a number of manufacturers have raised prices. Microsoft increased the price of its laptop computers in the UK by more than 15% while Apple announced price increases of up to 25%. PC distributor Context said that the average prices of PCs and laptops in July and August 2017 were approximately one third higher than the same period of 2016. Given the uncertainty over Brexit, further volatility in foreign exchange rates can’t be ruled out.
The ICT and consumer electronics markets also face weaker demand, a reflection of sluggish UK economic growth and declining hardware sales. The increased sophistication of smartphones and increase in cloud computing has reduced demand for traditional IT hardware like PCs, while the market for mobile phones is close to saturation – some 78% of UK adults now own a smartphone, according to Ofcom.
According to Gartner, the first quarter of 2018 recorded the 14th consecutive quarter of decline in worldwide PC shipments, although shipments did increase in the second quarter of 2018. Even demand for tablets may have peaked, with global sales falling 10% in 2017, down 30% from the 2014 peak, according to Deloitte. Given the challenging market conditions, some manufacturers have exited the market – recent years have seen Philips withdraw from consumer goods, while Sony has stopped making PCs and Samsung quit the European laptop market. More recently, Toshiba revealed plans to sell its PC business to Sharp.
In the UK, sales are influenced by low levels of consumer confidence - UK consumer spending fell at the start of 2018 and again in July, according to Visa. Business confidence is also waning, reflected in falling business investment (which fell 0.4% in the first quarter of 2018, according to the ONS) and deferred IT spending by many organisations awaiting the outcome of Brexit negotiations. While global IT spending is rising, it actually fell 3% in the UK in 2017, reflecting uncertainty over Brexit and the impact of weak sterling, according to Gartner.
While demand for traditional IT hardware has slowed, there are exciting growth areas, such as cloud computing and smart technology. Cyber security is another growth area, where well publicised data breaches, tougher data protection laws and an overall reliance on IT systems by businesses are leading to increased demand for related consulting , procurement and solutions offering. According to Gartner, increased regulation will see worldwide cyber security spending rise 8% to US$96.3 billion in 2018.
Many large ICT companies are expanding beyond hardware into value added services, which have higher margins and more consistent revenues. In particular, large ICT firms are creating end-to-end propositions, which include the design, procurement, installation and management of IT systems for businesses. This trend was typified by Hewlett-Packard’s decision to split into two companies, with HP Inc. focussing on its PC and printer businesses, while Hewlett Packard Enterprise provides servers, software, network and cloud services.
Opportunities are, however, not without risks. Diversifying away from core operations can isolate your existing customer base, while building wider IT business solutions is capital intensive and requires investment in skilled staff. Innovation can also come at a cost - hurried manufacturing and a design flaw caused Samsung to recall its flagship Note 7 shortly after its launch in 2016, costing the company over US$5 billion.
The need to diversify beyond IT hardware has sparked a spate of mergers and acquisitions in the ICT sector. In 2017, US-based IT distributor Tech Data acquired Avnet’s Technology Solutions business for $2.6bn as it aims to expand its footprint and service offering. Earlier this year Ingram Micro UK acquired UK-based IT infrastructure company Legrand, having purchased outsourced IT services provider Comms-care in 2016.
M&A is also being driven by consolidation, as distributors and office products companies need to increase scale and purchasing power to generate increased margin. It can also be a simpler way of bring ing a new service offering that you currently do not possess, though this can bring with it integration risk and leverage. The weakness of sterling relative to the US dollar is making UK IT companies an attractive target for private equity and foreign investors - HP Inc recently announced it is to acquire UK print services provider Apogee for £380 million.
Given market conditions, the risk of non-payment remains an ever-present-risk for UK IT companies. Low-value high-volume ‘box shifters’ are particularly vulnerable to a reduction in demand from consumers and business, as well as foreign exchange rate volatility. Margins in this niche are already depressed, and any further erosion will be difficult to sustain.
The technology sector is highly price sensitive and firms are under immense pressure to deliver the most up-to-date technology at short notice and at competitive prices. Office suppliers and distributors face growing competition from e-retailers. Last year Amazon launched Amazon Business, selling computers and other business supplies to UK companies. The sheer scale of Amazon’s purchasing power affords them a greater discount on products that smaller organisations are unable to compete with.
In response to tough trading conditions, vendors continue to rationalise their distribution partners in an effort to drive margin increases, as well as share an increased proportion of risk with distributors. A vendor that has too many distribution partners may see it’s product offering discounted heavily, as competing distributors challenge each other for market share. Companies that fail to adapt to the changing IT market will eventually be squeezed out, either through insolvency or acquisition. Given the thin margins and use of financing in the IT channel, a company that is unable to satisfy customers and/or vendors could very quickly find it is unable to service its debt.
Historically, insolvency rates in the IT sector have been relatively low, which is reflected in trade credit insurance premiums. However, the ICT sector has witnessed a number of high profile insolvencies in the past 12 months, with the failure of Maplin in February 2018 and Misco UK in October 2017. Given current trends, further insolvencies should be anticipated.
A high proportion of the ICT sector utilises trade credit insurance. From vendors to national and regional distributors and resellers. Due to the often low margin nature of this industry, and typically large trade debtor balances, credit insurance is seen as an important expense, as a single bad debt can materially impact a company’s financial health.
Many debtors in this industry rely on invoice finance and supply chain finance for their working capital. The hazard of falling sales volumes can dramatically impact financial flexibility, and we are seeing aggressive discounting and more risk taking by ICT companies in 2018 to generate revenue to simply cover their cost base.
Despite recent insolvencies, QBE takes a positive view of the UK IT sector. As a major provider of trade credit insurance to this industry, we have expertise and relationships with many of the key vendors, distributors and office suppliers. This continues to be an area where we see opportunities to grow, despite the challenges seen in 2018.