Kenny McKay: Disruption is flushing out weaker players

You would be forgiven for thinking that the economy is teetering on a cliff edge. High profile business failures and restructuring cases are dominating headlines and painting a worrying picture for Yorkshire and the rest of the UK.

Kenny McKay, Heard of Restructuring, KPMG Yorkshire

While official statistics show a significant uptick in insolvency activity over the past quarter across the North, the annual figures are, in fact, relatively flat.

When you take a closure look, it is apparent that a handful of sectors account for most of cases and a clear theme emerges: there are large pockets of the economy that are still struggling to adapt to the impact of technology on their industry.

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These aren’t the notorious ‘zombie businesses’ hanging on to financial life support. Instead, they are more like ostriches, burying their head in the sand and ignoring the new reality that they are trading in and transformational effects of technology.

How has this happened? Since the financial crash, the economic recovery has provided low, but steady growth. A confluence of factors has enabled many businesses to limp on in poor health, namely: low interest rates; light banking covenants on corporate debt; and financial stakeholders less willing to enforce their positions.

Within this group these are businesses that have been operating with stiflingly low margins to compete for trade in the short term. Limited profits mean they have invested little in their operations, products or talent and often struggled to move with the times. There are also firms that have invested what little they have had into old business models.

The onward march of disruption is now starting to flush these businesses out – presenting them with a stark choice; evolve or face further financial pressure.

The problem is particularly prevalent in the retail sector. While the transition to online shopping is nothing new, we see that the move from bricks to clicks is biting particularly hard right now. A lack of investment in store estates and decline in footfall means that the pressure is as acute as ever for those operating out of non-prime shopping sites.

Conversely, the casual dining sector has seen some over-ambitious growth and investment plans come undone, scuppered by an overestimation of demand. Expensive fit outs in recent years have proved to be a heavy financial burden as delivery services shift orders online. It has created an interesting dynamic where brands manage the full cost of a physical site, but serve customers online out of kitchens that weren’t built to handle the takeaway trade.

Essentially, it is a story of too much capacity and online sales nibbling away at the model. Some chains in London may get by, thanks to the volume of the consumer market there. For Yorkshire, operators will struggle unless they are situated in good city centre or affluent town spots.

What we see coming around the corner is not too dissimilar. Technology disruption will reach out to other sectors. Not least to car forecourts and on the high street in the shape of estate agents. Both are highly fragmented sectors that are facing their own pressure as technology reshapes distribution channels and customer behaviour.

For the former, there is confusion over the future of diesel, a wider trend of soft consumer spending and foreboding questions over the commitment of some car marques to the traditional dealership model. For the latter, pure internet players with few fixed overhead costs are taking the real estate market into a whole new era.

The message is clear. If investment is cut back, standing still is not an option. Without a compelling and current business model, firms won’t be able to compete on service or price and ends up at a significant disadvantage.

At its heart, this takes a shift in mentality. Of course, businesses need to make sure they make the best of what they have got, be as profitable as they can be and reduce profit leakage. Encouragingly, we’ve seen local management teams develop a better understanding of cash and liquidity in recent years. They have helped foster a good cash-conscious culture that has helped ease distress in the region.

But, stripping out costs, managing cashflow and tweaking processes can only get a business so far. The most successful turnaround cases we have seen are those where management teams think strategically and radically reshape their business model to suit the current environment.

Sometimes it takes a tough question to make that mental transition - would the market miss your business if it didn’t survive? Unfortunately, many wouldn’t pass that test. Disruption is not optional, it is happening and the lesson needs to be learnt quickly. There are some testing times ahead for businesses in our region.