Service sector profitability takes a hit - CBI

Business volumes in the services sector expanded at a steady pace in the three months to August, however strong cost pressures hit profitability, according to the latest quarterly CBI Services Sector Survey.

The business and professional services sector – which includes accountancy, legal and marketing firms – saw growth in business volumes ease and the pace is set to slow further in the three months to November. However, after a sharp decline in the three months to May, business volumes picked up a little in the consumer services sector – which includes hotels, bars, restaurants, travel and leisure firms. Demand for consumer services is expected to increase a little further next quarter.

Other indicators painted a mixed picture. Profitability in both sub-sectors failed to improve, being flat for business & professional services and falling for a second successive quarter in consumer services.

Cost pressures remained elevated in both sub-sectors, with costs growth in business & professional services edging higher and remaining far above average in consumer services, despite easing last quarter. Rising costs continue to feed into selling prices with heightened inflation in both sub-sectors. Next quarter, prices are expected to remain stable in business and professional services, but to rise at an accelerating rate in consumer services.

Sentiment in the services sector varied, with business & professional services firms’ optimism about the general business situation falling at the fastest pace since November 2016, while consumer services saw a modest improvement in sentiment. The trend is similar for plans for business expansion with consumer services slightly more optimistic about their prospects in the year ahead compared with three months ago, whilst business & professional services firms are neutral about their outlook. Nevertheless, employment growth remained robust in both sub-sectors, with similar levels of growth expected in the quarter ahead.

The broader economic outlook remains fairly subdued, with UK GDP growth held back by weak household income growth and the impact of Brexit uncertainty on investment. For more detail, see our June economic forecast.

Rain Newton-Smith, CBI Chief Economist, said:

“Although consumer services growth inched up last quarter, overall services sector growth was fairly muted. And with cost pressures rising, services firms are not seeing any improvement in their bottom lines.

“The underlying challenges facing the sector are not going away any time soon. Demand growth is expected to remain subdued next quarter and firms seem hesitant over the prospects for expanding their businesses in the year ahead. They still plan to take on new workers next quarter, but the confidence to invest significantly more is lacking.

“Above all, the Government and Brussels need to get on with finalising a Withdrawal Agreement, putting pen put to paper on a jobs-first transition period and finally, agreeing a new relationship between the UK and the EU that puts people’s livelihoods above politics.”

Meanwhile, investment intentions were close to long-run averages and remain skewed towards IT, although plans for spending on IT in consumer services is set to be the weakest since February 2015.

Key findings

Business and professional services:

• Optimism regarding the general business situation fell (-4%, from +14% in May) at the fastest pace since November 2016 (-19%). Firms were neutral about their expected business expansion in the year ahead (+1%, up from -9%)
• Growth in business volumes (+14%) slowed, down from +25% in May. Growth is expected to weaken further in the three months to November (+6%), falling below average (+10%)
• Profits were flat (+1%) – a combination of slower volumes growth and stronger costs growth – and are expected to barely change over the next quarter (-1%)
• Growth in total costs per person edged higher (+45% from +38% in May), and cost growth is expected to be broadly steady next quarter (+48%)
• Average selling prices rose at a steady pace (+9%, down from +10% in May), but are expected to be flat in the three months to November (+2%)
• Numbers employed (+11%) grew at a steady pace, and are expected to rise further next quarter (+13%)
• Investment intentions are mixed – firms expect to keep spending unchanged on land and buildings (-2%) and cut back on investment in vehicles, plant and machinery unchanged (+5%). Meanwhile, investment on IT is expected to increase (+22%), albeit at a slower pace than last quarter (+27%).

Consumer services:

• Optimism about the general business situation improved (+7%) – rising after a fall in May (-11%) – as did firms’ expectations for business expansion in the year ahead (+5%, up from -10% in May)
• Growth in business volumes bounced back (+7%) from the previous quarter’s decline (-12%), and is expected to be steady in the three months to November (+6%)
• Profitability fell for the second consecutive quarter (-18%), but is expected to be flat next quarter (-3%).
• Growth in total costs per person eased (+51%, down from +61%) but continues to expand at a pace above the long-run average (+37%). Growth is expected to ease further in the three months to November (+44%)
• Average selling price growth eased somewhat (+20%) from the previous quarter (+26%) but remains above the long-run average (+14%). Nevertheless, growth is expected to pick up next quarter (+26%)
• Employment growth accelerated (+20%) on the previous quarter (+10%), with a similar level of growth expected next quarter (+18%)
• Investment intentions in IT remain positive (+9%), but at their lowest level since February 2015 (-3%). However, firms expect to cut back on spending on land and buildings (-8%) and to leave investment in vehicles, plant and machinery unchanged (0%).

Notes to Editors:

The Service Sector Survey was conducted between 27^th July and 13^th August 2018. 131 Business and Professional Service firms and 76 Consumer Service firms replied.

A ‘balance’ is the difference between the weighted percentage of firms answering that output is “up” and the percentage answering “down” (for example, if 30% of firms say that output is up, 60% that it is unchanged, and 10% that it is down, the balance statistic is +20%).