Costs rise across the services sector, as investment plans are cut

Costs per person employed in the services sector grew at an accelerated pace over the last quarter, far above the long-run average, according to the CBI’s latest quarterly Service Sector Survey.

Despite this, selling prices only rose modestly over the last three months, and are expected to rise more slowly in the next three months. Services firms reported a further decline in profitability that is set to accelerate in the three months to November.

Sentiment within the service sector was mixed. Rising optimism among business & professional services firms contrasted with a sharp decline for consumer services firms. Consumer services firms also reported that business volumes were broadly stable, having fallen steadily since December 2023, but volumes are expected to fall slightly in the three months to November.

In contrast, business & professional services firms reported that volumes were broadly unchanged in the quarter to August and are expected to grow at a robust pace in the three months to November. As a result, business volumes across the entire services sector were stable in the three months to August but are expected to rise over the next three months.

Headcount was broadly unchanged across the services sector in the three months to August. Employment is expected to be unchanged again in the quarter to November.

Plans for investment over the year ahead have softened compared with May. Across the sector, firms expect to cut capital expenditure on vehicles, plant & machinery, and land & buildings. Investment in training & retraining is set to be unchanged, but is set to rise modestly for IT. The cost of finance remains a big constraint to capital expenditure, despite having fallen a little from its peak this time last year. Inadequate net returns and shortages of internal finance are also slightly above-average constraints.

Alpesh Paleja, CBI Interim Deputy Chief Economist, said: 

“Cost pressures are continuing to squeeze profitability among services firms. And with interest rates only just starting to come down, this remains a significant drag on investment plans.

“Coupled with middling business conditions, this does not paint a picture of a sector that is thriving. Services firms could do with a major boost to confidence. Delivering certainty about the tax and regulatory environment could really help to address that shortfall.

“By publishing a long-term UK Business Tax Roadmap that delivers a simpler, more digitised and proportionate tax system – one with competitiveness at its heart – the government could take a major stride in delivering the confidence businesses and investors are looking for.”

The survey, based on the responses of 236 services firms, found: 

Business & Professional Services  

• Optimism about the general business situation improved for a third successive quarter (+9%, from +12% in May).
• Business volumes were broadly unchanged in the three months to August, following a decline in the quarter to July (+2% from -6%). Volumes are expected to rise robustly in the three months ahead (+19%).
• Growth in total costs per person employed remained elevated in the quarter to August (+47% from +45% in May). Although growth in costs per person has slowed over the past year, it remains historically strong, with the balance standing well above the long-run average (+30%). Cost growth is set to ease slightly but remain elevated next quarter (+42%).
• Average selling prices rose modestly in the three months to August (+8% from +10% in May). Firms expect prices to be broadly unchanged over the next three months (+2%).
• Headcount rose moderately for the second consecutive quarter (+7% from +17% in May). Headcount is expected to rise at a faster pace in the quarter ahead (+17%).

Consumer services 

• Optimism about the general business situation deteriorated for the fourth consecutive quarter (-19% from -21% in May).
• Business volumes were broadly unchanged in the quarter to August (+1%), marking the first time that volumes didn’t fall since December 2023. However, consumer services firms expect volumes to fall marginally in the three months to November (-4%).
• Costs growth accelerated in the three months to August (+64% from +51% in May), standing above the long-run average (+39%). Firms expect costs growth to decelerate next quarter (+43%, equivalent to the long-run average).
• Average selling price inflation rose moderately in the three months to August (+11%) unchanged from May and slower than the long-run average (+14%). Nevertheless, average selling price growth is expected to pick up slightly next quarter (+17%).
• Employment fell amongst consumer services firms in the three months to August (-9%, equivalent to July). Numbers employed are expected to fall at a faster pace in the three months to November (-33%).