UK Technology is one of the country’s fastest growing sectors, with high levels of entrepreneurship, job creation and investment.
The industry is clearly punching above its weight. The UK is ranked fourth in the world for technology start-up investment and tech investment (at $6bn) was the highest in Europe in 2018, according to Tech Nation. Tech Unicorns, a term used for private start-up companies reaching a valuation of $1bn (£800m), topped 17 in 2019, up from 13 in 2018 and cements the UK as a premier destination for tech investment.
However, scratch beneath the surface and some areas of the industry are performing better than others. The recent lack-lustre performance of the UK economy and Brexit has weighed heavily on consumer electronics, I.T distributors and traditional office product suppliers, which already face intense price competition and squeezed margins.
The consumer electronics market faces some significant headwinds, with changing consumer habits, weakening demand and structural challenges.
Demand is subdued as consumers become more discerning and household incomes remain under pressure. Brexit may also be dampening consumer confidence and spending - average retail sales in the first half of 2019 rose by 0.5%, a record low according to the British Retail Consortium. At the same time, prices are under pressure from online retailers while costs have been rising with the increase in the living wage and more expensive imports due to falling value in sterling.
Mobile phone sales in particular, (the backbone of the consumer electronics market), are in decline. The smart phone market is saturated while a perceived lack of innovation has led many to retain devices for longer and switch to sim only deals. This has pushed retailers to assess their product offering, and drive renegotiation with airtime providers on the structure of contract mobile phone tariffs. At the same time, customers are now more likely to purchase their phones outright. Smartphone sales in Europe are forecast to fall by 5.3% this year, according to Gartner.
New consumer technologies – like virtual assistants, drones and virtual reality – have also failed to spur demand. The tablet and smart watch markets have seen a slowdown and plateaued. And while smart home technology is a promising growth market, the perceived complexity of products and concerns over data security and privacy have prevented the industry from truly taking off in the consumer space.
There are, however, some bright spots. The roll-out of the 5G network in 2020 is expected to boost smartphone sales as consumers upgrade handsets. The gaming sector is also expected to experience renewed growth, with ongoing demand for high-spec gaming PCs and the launch of new game consoles from Microsoft and Sony in 2020 – the first such releases in seven years.
B2B and office products
The slowdown in the UK economy and uncertainties surrounding the UK’s departure from the EU have affected demand in the commercial space, where Brexit concerns have led to deferred spend on IT upgrades. Margins for traditional ‘box shifters’ are being squeezed further, with an economic slowdown in the UK and Europe, as well as fierce competition and a softening of the personal computing market.
The underlying trend in the business hardware market is one of decline, despite a brief bounce in PC sales in the middle of 2019 prompted by Windows 10 upgrades. Microsoft’s Windows 7 will no longer be supported from January 2020, leading many organisations to a compulsory upgrade to hardware running Windows 10. Margins in the PC market have also been positively impacted by a shortage of Intel CPUs, while a further escalation in the trade war between the US and China could impact prices and future demand.
The traditional office products market is shrinking. This sector competes with online retailers like Amazon and is price sensitive and congested, with a shift towards contract business. Consolidation is likely to be key for this sector as M&A activity is expected to increase in the final quarter of 2019 and into 2020. While there is modest growth in hardware distribution, this sector remains extremely price sensitive and working capital intensive.
Other technology sub-sectors are, however, enjoying strong growth, including cyber security, Fintech and Artificial Intelligence (AI). UK investment in AI reached a record $1.3bn in 2018, having grown almost six fold from 2014 to 2018, while UK-based FinTech companies are predicting growth of 88% between 2018 and 2021.
Despite security concerns and integration challenges, Internet of Things (IoT) is another fast growing sector: Bain predicts the global IoT sector will grow to $520bn in 2021, more than double 2017.
Managed service providers, which provide and manage IT systems and services to business, also continue to perform strongly as businesses look to cut cost. The positive outlook for this sector is supported by mergers and acquisitions and interest from private equity investors.
Uncertainty around Brexit, in particular the threat of the UK crashing out without a deal on October 31, has a material effect on the UK technology industry.
The UK’s decision to leave the EU has caused considerable foreign exchange rate volatility, pushing up the cost of imports for UK ICT companies. For the price sensitive consumer goods and office products markets, passing on these higher costs is difficult, putting margins under additional pressure. For contract services, robust and variable pricing models are key to avoiding being locked into potentially loss-making contracts.
The threat of a no-deal Brexit, in particular, poses significant challenges for UK technology companies. According to the industry’s trade body, TechUK, ICT firms could experience issues when exporting and importing goods or providing services into the EU as well as potential disruption to supply chains. Of particular concern is the impact on free movement of people and the ability to access talent, as well compliance with cyber security and data protection regulations, which could hamper cross-border data transfer.
Uncertainty over the date and manner of Brexit is also putting supply chains and margins under pressure. Stockpiling ahead of the initial March 29 deadline proved costly for many ICT companies: Overstocking ties up working capital and increases the risk of insolvency, while demand naturally fell off in the second quarter with the unwinding of stock.
Outlook – Cloudy with some bouts of sunshine
Overall, insolvency rates are subdued within the technology industry, but tough trading conditions lie ahead for some subsectors. Brexit volatility and a global economic slowdown have already dented business confidence, which dropped to a 10-year low in the first quarter 2019.
Management data suggests many businesses in the distribution and office products sector are already struggling. Uncertainty over Brexit only adds to the pressure on these businesses, which are vulnerable to price increases, foreign exchange rate volatility and disruptions to supply chains. IT distributors focusing on low margin goods are under pressure from fierce competition and declining margins while consumer focussed industries continue to be challenged by Amazon.
Whilst insolvencies within the technology industry this year have been low, there have been some notable failures in the retail, construction and food and drink industries, which feature in the supply chains of many technology companies. Contract frustration, overstocking, and cash flow problems arising from supply chain risk are some of the biggest threats to business solvency.
All this said, parts of the technology sector are seeing growth and increased investments, such as managed service providers and the gaming industry. IoT, cloud service providers, analytics and data centres are also all performing well on the commercial side and seeing some of the highest levels of profitability.
QBE has the specialist expertise to navigate the Technology and Office Products sector and we continue to support the UK technology sector with large credit insurance lines. While distinct challenges lie ahead, our extensive contact with the market and supply chain enables QBE customers to stay informed, build revenue safely and stay protected against the unexpected.