The UK Productivity Conundrum; Eight Insights for UK plc

• How to measure productivity?
• The employed population
• The role of the service sector
• The role of the Internet
• The rise of challenger brands
• Management influences
• Conclusions

How to measure productivity?

In general, labour productivity is the ratio between a measure of output volume (gross domestic product or gross value added) and a measure of input used (the total number of hours worked or total employment).

For our analysis, we use the following UK Office for National Statistics (ONS) definition (3).

Productivity = output per worker i.e. Gross Value Added  / Total Number of Hours Worked (by those employed).

Gross value added (GVA) is the same as gross domestic product (GDP) minus taxes on products plus subsidies on products. We use the ‘Chained’ definition to eliminate the effect of inflation.

We also use time series data with 2007 indexed as 100 to match Figure 2.

Thus, for productivity to improve, this means that output must rise ahead of hours worked. Or more must be produced in the same or fewer hours. Let’s investigate further.

Reasons behind UK productivity decline

Figure 3 shows first, that total hours worked failed to keep pace with the trend line between 2008-2014. The decline between 2008-2014 reflects the fall-out from the banking crisis. Between 2007 and 2009 some half a million lost their jobs when many firms down-sized, went out of business (and/or were taken over). Some notables in financial services include Northern Rock, Bradford and Bingley and Lehman Brothers.  However, total hours worked is now back on the long-term trend line mirroring population growth. Nevertheless, the number of hours worked has failed to ‘grow output’ or it has held up despite the fact there is less to do. Both options suggest some time is ‘wasted’ or ‘inefficient’.

Second, total output (Chained GVA) grew strongly between 2000-2007. It also fell sharply at the height of the banking crisis, yet continues to under-perform the trend line. Thus this also appears a compelling reason for the productivity decline. Let’s investigate both of these factors further.  Starting with the supply-side.

The growth of single owner businesses and part-time employees depress output

Since 2008 the number of single owner businesses and part-time employees grew above the trend line (Figure 4).

However, according to the Annual Business Survey, the ONS’s annual tracker, small firms produce less than large firms (Figure 5). Overall, therefore, it seems that a shift in the mix to less productive firms has depressed overall UK productivity. Further, as Figure 5 also shows, even the productivity of the largest firms fell during the heights of the financial crisis. This  suggests that even switching some workers to part-time contracts, failed to maintain productivity. Of course, both part-time and full-time workers still require the same training.

Further, looking at the ‘W’ shape of Figure 5 suggests that firms of all sizes have ‘bounced-back’ from the worst of the recession. With output at between £43-52,000 per worker, figures match those a decade earlier. It therefore appears that both employers and workers appear to have swallowed a new pill to keep businesses fully functional, flexible and to benefit quickly from an economic recovery.

The service sector is a key growth driver (Figure 6)

The UK service sector currently accounts for 80% of output and hours worked (2018). This is an increase of 7% points in output and hours worked since 2000 (from 73%). Further, in the 7 years to 2007 the increase was 4% points, yet in the last 11 years, just +3% points. While the service sector continues to grow ahead of the rest of the economy, growth remains below the pre-2007 trend line. As Government has focused on ‘belt-tightening’ since 2008, and Brexit since 2015, it is unsurprising, that spending remains depressed. But what’s going on in the different sectors?

Under-performing and over-performing service sectors

Closer inspection of the performance of individual service sectors reveals six laggards: wholesale/retail, finance/insurance, recreation/culture, hotels/catering, transport/storage, and the public sector (Figure 7).  All six continue to perform below the historic trend line.  Performance changes may be due to lower levels of expenditure and/or trading down to lower value, margin, or non-essential services. This seems reasonable given several sectors appear more ‘discretionary’. A decline in transport could also be explained by an increase in ‘stay-at-home’ entertainment.

Two sectors are yet to show a marked change of trajectory post the financial collapse. First, the finance sector which grew very rapidly to 2007 (with historical evidence pointing to uneconomic over-lending as the reason). ). Yet the sector still trails the pack. This seems due to a combination of low interest rates, low consumer confidence, and the rise of challenger banks (offering better value, and perhaps an opportunity for revenge). Second, the public sector; while resilient post ‘crash’, public sector GVA declined from 26 to 22% of the service economy from 2000-2017. However, hours worked remained c. 28% throughout the period. Thus output per hour has fallen and remains subdued.

Over-performing service sectors

Conversely, some service sectors have over-performed: services businesses (including rental, building and employment services), real estate, IT (including media and telephony), and other services (includes scientific, technical, law, accounting, advertising and consulting professions)  (Figure 8). However, growth for all but two remains below the historic trend line. Growing most strongly, are IT (reflecting many new markets and growing customer penetration), and service businesses.  Some services businesses, such as employment, advertising, consulting, and media firms, were highly responsive to changes in the economic environment. They quickly laid off staff or reduced hours or salaries, and vice versa, to maintain competitiveness and profitability. Many are also highly reliant on people, particularly well-educated people, to deliver services. Also on personal relationships to drive demand, rather than mass marketing, and the Internet.

The growth of online is the elephant in the room

Since 2007 the UK has experienced major sociological shifts, ‘belt-tightening’ societal pressure, and the rise of online channels. The financial crisis of 2008 also seems to coincide with a tipping point in the rise of the Internet. In 2000, just 27% of the UK population had Internet access, and fast speeds were non-existent. In 2007, 75% of the population had Internet access, and 50% received broadband at an average speed of 4.6 Mb/second. The first iPhone also launched in 2007. Yet today UK Internet penetration is over 90%, and average download speeds are 45-47 Mb/second (4). The first iPhone also launched in 2007 yet today 80% own a smartphone.

Aided also by the growing number of comparison sites, there is an increasing and high propensity for customers to compare and hunt lower prices (up to 30% less) online.

Thus online purchasing has grown significantly from just 3.4% of retail sales in 2007 to nearly 18% in mid 2018. Further looking at trends (Figure 9), overall retail sales since 2007 remain below the overall output trend line. And retail sales excluding online sales, even further below the trend line. The pattern of decline is almost a mirror image of the growth in Internet users.

The arrival of Black Friday

The convenience and financial benefits of shopping online enabled by increasing broadband and mobile penetration continue to drive online sales growth at the expense of ‘bricks and mortar’ retailers. Black Friday appeared in the UK in 2009 championed by etailers such as Amazon, eBay, and others. It was also spurred by Asda in 2013. However in 2015 Asda de-clined to participate, announcing that their customers preferred year-round deals rather than a single day of discounting. Reading between the lines, this suggests the event had little effect on Asda’s bottom line. Perhaps merely serving to bring forward demand. Conversely, etailers have experienced significant sales and growth.

The rise of online challenger brands

The UK branch of Amazon EU alone amassed £21 billion sales in 2017, +80% over 3 years (and equivalent to £7.5m per employee). However, as this Amazon business is based in Luxembourg these sums are largely removed from the UK’s accounts.

While the wholesale/retail sector only accounts for a 10-11% of total output, other sectors such as real estate, hotels/catering, recreation, transport, and finance /insurance markets, also have burgeoning online sectors. And the last decade or so has seen online challenger brands enter and grow share in other markets too. Examples include Rightmove in real estate, Booking.com in travel/hotels, a myriad of flight search engines, Confused.com and ComparetheMarket.com in finance and insurance, and uswitch.com in energy.

The growth of online therefore appears to coincide with the removal of a significant chunk of income from the UK economy.

Significant growth in online advertising

Figures were first recorded for digital advertising expenditure in 2005. In 2005 spending was just under £600m (some 5% total advertising expenditure). In 2007 digital advertising spend was 9% of the total, and by 2017, 28% of the total (£5.7bn). This is a growth index of 474 vs. 2007 (Figure 10).

While online advertising potentially influences all purchases, growth better correlates with online sales rather than total output (Figure 10). While online advertising potentially drives income, it is also a cost, and only adds to profits if extra income generated exceeds extra costs. It remains to be seen whether this level of online advertising is sustainable (6-8% income) and grows margins.

What we do know however, is that a very great proportion of online advertising income is also due to US owned Google and Facebook – both based in Ireland. Google Ireland’s turnover is £27.5bn (£9.2m/employee) and Facebook Ireland’s turnover is £16bn (£4m/employee). Again this suggests a significant chunk of UK advertising output has shifted offshore.

Structured management practices enhance productivity

Now let’s return to the role of internal business influences on productivity (Figure 11). In 2016, the ONS surveyed management practices among 25,000 firms. The so-called ‘management practice’ score is an aggregate of several measures including practices relating to continuous improvement and employment management – such as those relating to promotions, performance reviews, training and managing under-performance. In the questions, a score of 1 is assigned to the most structured management practice and 0 the least.  The mean score across all organisations was 0.49. Their analysis found a statistically significant correlation between management practices and labour productivity, with an increase in management score of 0.1 associated with a 9.6% increase in productivity.

The analysis also shows a statistically significant relationship between management practices, the size of a firm, and productivity.  Further analysis also reveals that family firms have lower management practice scores and productivity than non-family or foreign-owned firms. Management scores are also higher for the real estate, service business, and other services (scientific and technical) businesses. A higher incidence of degree-level staff is also associated with a higher management practice score and greater productivity.

Does time spent online at work affect productivity? 

Finally, we explore the effect of hours spent online at work to see if this has any bearing on productivity (Figure 12). Since 2007 the number of hours spent online at work (or in education) doubled from 3.3 hours (10% total in 2007) to 6.6 hours (20% total in 2017) (6).

While we cannot precisely quantify productivity in those hours, some research raises questions. Asked whether ‘I feel more productive without the Internet’, 10% of adults 16+, and 15% of those aged 18-34 answered ‘yes’ (6). Recent announcements that Wetherspoons, and Lush Cosmetics, are closing their social media accounts, also confirms (at least for them) that the marketing time-costs fail to outweigh the benefits. And if marketers are failing to realise benefits, it raises the question are you?

Marketing Inspiration

1. It appears that there are many supply and demand side-factors that depress UK productivity. Including competition from other nations.
2. While the financial crisis spurred many new businesses, the smallest are least productive, and have most to learn. They should seek help from the UK’s world-leading academic, marketing, creative and consulting community.
3. The financial crisis of 2008 also depressed customer confidence and purchasing. However, marketing deals with changing attitudes and perceptions. And basic marketing communication principles suggest that businesses and customers will buy and invest to secure benefits, rather than to avoid disbenefits. To drive demand, all should therefore promote positive messages. The national campaign starts here.
4. Further technological and societal change is inevitable. And with online sales accounting for c.20% total, expect further growth. Marketing’s answer to the UK productivity crisis is to invest more in understanding the social and behavioural causes and effects, and inspiring products and services that deliver benefits.
5. Off-line players face threats from low price online players and disintermediation. So choose to join and beat them. Or lose out. Winning requires improved customer value propositions or world-efficient supply and production capabilities.
6. Digital promotion is here to stay. Though online advertisers should carefully measure returns. And remember that the marketing mix also includes off-line media with very high reach and impact.
7. Declining public sector productivity is a threat to the whole economy, as income comes from private sources. The challenge is to deliver more for less, facilitate world-class organisations and reduce income loss from UK shores.
8. The openness of the UK economy, high Internet and smartphone penetration, and fast broadband, fuels customer and business agility, and innovation. However, the Internet also brings distractions that appear to dilute UK productivity. Addressing this starts with awareness of the issue. So remember the story of the emperor’s new clothes.

References

(1) Patterson, Peter, Deputy Chief Economist, Office for National Statistics, The Productivity Conundrum, Explanations and Preliminary Analysis, 2012

(2) Organisation for Economic Development (OECD)

(3) Camus, Dawn, Editor, The ONS Productivity Handbook – A Statistical Overview and Guide, 2007

(4) UK Fixed Line Broadband Performance (Residential), OFCOM, November 2017

(5) Management and Expectations Survey, Office of National Statistics and Economic Statistics Centre of Excellence (ESCoE), 2016

(6) Communications Market Report, OFCOM, August 2018

Thanks to the analysts at the Office of National Statistics for answering our questions and helping with our analysis. Also to my colleagues at The Marketing Directors, Chris West, and Tim Arnold. To anyone wishing to build on this analysis, please do. We’re happy to share our datasets and insights to help you.