KCP Blog

Austerity Chic?

Frugality is the new craze sweeping the nation; or at least it seems to be.

Asda CEO Andy Bond has reported a 40 per cent increase in sales of cooking ingredients, alongside a similar drop in the sale of certain ready meals. The Daily Telegraph is printing recipe ideas to help its readers make the most of their leftovers.

Elsewhere, waiting lists for allotments are growing, the University of Sheffield reportedly has formed a student knitting society and the website ‘Stitch & Bitch’ announces that such style icons as Geri Halliwell and Madonna are partial to a bit of “knit one, pearl one” during the long winter evenings.

Does this mark a step change in consumer spending patterns with “make do and mend” replacing “get out there and spend” as the mantra of the UK consumer?

Andy Bond seems to think so, for some consumers at least, rightly pointing out that the great depression of the 1930s and the Second World War had a long-term impact on the spending habits of our grandparents’ generation.

This hair shirtism may be a little overplayed. Apparently, Asda is still shifting plenty of champagne and olives, while one of the leftovers recipes in the Telegraph addresses the burning issue of what to do with those unwanted lobster shells. Don’t even ask the price of six balls of cashmere wool to knit a cardigan.

The question is an important one for companies and investors. Being close to your customer is a vital ingredient of business success and it becomes the imperative when many pre-conceived notions about current and future circumstances are being challenged on a daily basis.

One year ago, no-one would have expected consumers to be more concerned about the financial stability of their banks than the interest rate on their savings. A couple of banking collapses and government bail-outs later and the world, and bank advertising, look very different.

Similar, though less dramatic, challenges face many industries, from the automotive sector through to fashion. The challenge is to understand your customers and their needs before perhaps even they do, and be there with the right product, at the right price, in the right place.

This has never been easy, and is becoming more difficult by the day. However, when the economy does turn the corner, there will be significant rewards for the businesses that have managed it.

Is spending really going to save us?

It’s pretty much accepted now that the UK economy is headed for tough times. Even Alastair Darling, whose glasses must be so rosy that he has trouble telling red from green, expects negative economic growth in 2009, with all the misery of business failures and redundancies that this will bring.

The policy response to this impending recession is straight out of the Keynesian macroeconomic textbook; a combination of fiscal stimulus aimed at restoring the vigour of the UK consumer, bullying the banks to resume lending to homebuyers, consumers and businesses at the heady levels of 2007, and accelerated government spending. All of the above to be financed on the nation’s credit card.

It is questionable whether the prescription is strong enough to have any effect on the ailing UK economy. I also wonder whether the prescription is the right one.

The UK economy is in the grip of a huge hangover. After years of living the high life on borrowed money, the bill has arrived and the ‘morning after the night before’ isn’t proving to be very pleasant. A ‘hair of the dog’ to defer the pain is an attractive option but will it just make the final reckoning even more painful?

In the last few years, the UK has been consuming more than it earns. Consumer debt has mushroomed and the housing market has blown up into a big bubble on the back of cheap interest rates, increasing income multiples and loans to value of up to 125 per cent. The UK savings rate has been declining over the same period.

As UK savers have not provided the banks with the deposits to lend out in this credit explosion, the banks have looked to the wholesale money markets to fill the gap between deposits taken and loans advanced. A significant proportion of this funding came from overseas, particularly those countries providing us with the commodities and manufactured goods on which we’ve been splurging with our credit cards.

These chaps have decided that they don’t like what they see in the UK economy and want their cash back. As a result, UK banks can’t borrow on the wholesale money markets (and hence can’t lend – despite the protestations of the government) and sterling has collapsed as this ‘hot’ money is exchanged out of sterling into other ‘safer’ currencies.

In this context, rather than behaving like a junkie desperately in search of one last ‘hit’ of debt, would it not be better to go ‘cold turkey’, face reality and move to a position where, as a country, we consume what we can actually afford to pay for? An increase in savings rates will slowly restore the banks’ balance sheets so they can begin lending again (although not at the over-heated levels of the last couple of years). The recent fall in the pound will actually improve the competitiveness of UK manufacturing, both in the UK and abroad.

Government spending aimed at helping UK companies recruit and train staff to develop products attractive to export markets, along with a reduction in payroll taxes to reduce the cost to businesses of keeping people in employment, strikes me as being a better prescription for the patient than one last fix of the rampant consumption that put us here in the first place.

In Search of a Silver Lining ...?

“The bigger the boom, the bigger the bust,” so the saying goes; it’s 18 years since the UK economy last recorded negative growth so the boom looks pretty big in retrospect. The bust has so far lived up to this billing with banking bailouts, stock market crashes and a housing market in freefall.

The ‘real economy’ has yet to exhibit more than minor symptoms of this heart attack in the financial system. However, despite the promises of old-style Keynesian pump priming from government, and aggressive interest rate cuts around the world, it seems unlikely that the textbook symptoms of increased unemployment, business bankruptcies, negative housing equity and mortgage repossessions will be avoided.

These symptoms represent a very real and personal cost for many people and I doubt that anyone is looking forward to 2009 without at least some sense of foreboding.

The road ahead is shrouded in black, recessionary, storm clouds; is it possible to detect even the slightest silver lining?

One glimmer, however indistinct, might come from a most unlikely source: the private equity industry.

Private equity investors have only just been overtaken by investment banking bosses as top of the list in the corporate bad boy stakes. So bad has the PR image of the industry become that the daughter of one of my colleagues has taken to telling her friends that her father is a tax inspector to avoid social embarrassment.

Private equity is, in essence, very simple: the idea is to buy shares in a company and then sell them at a later date for a profit. During a boom, the plan, if not its execution, is relatively simple. Buy a company, usually using significant levels of bank debt, and use the profits of the company to pay down that debt before selling the company into a rising market, making attractive returns for the shareholders.

Recent events mean that bank debt is no longer available at anywhere near previous levels, and there are not many stock market bulls to be found these days.

A new plan is needed, and this needs to focus on growing the value of the company from the inside, rather than relying upon leverage and constantly rising stock markets to drive value.

The industry will need to back management teams with the vision and ability to grow their companies, using some of the cash flow that would previously have been used to service bank debt to fund investment in new products, markets, machinery and skills.

If successful, this strategy will not only provide a good return on investment; it will also build sustainable businesses, creating employment and wealth for many years to come.

Key to unlock investment in Midlands

Private equity house Key Capital Partners has launched a Birmingham office, specialising in businesses looking for "equity gap" funding.   

When will the rollercoaster hit the bottom? Dealmakers look to the second half of 2008

Dealmakers Forecast - September 2008

East of England Fall Short of the Equity Gap

Key Capital Partners come joint top of the private equity firms in the East of England.

Key capital at top of private equity

Cambridge News - 26th August 2008