26 May 2017

  |  CBI Scotland

Update

Cost pressures strengthening across the service sector

Demand in the services sector was flat in the three months to May, while rising costs caused profitability to decline, according to the CBI’s latest quarterly Service Sector Survey.

Cost pressures strengthening across the service sector

Business and professional services firms – which include accountancy, legal and marketing firms – reported that volumes were relatively unchanged for the fourth consecutive quarter. Consumer services – which include hotels, bars, restaurants, travel and leisure - saw growth in volumes slow.

This pattern is expected to reverse next in the three months to August, when business and professional services expect volumes to pick up. However, volumes for the consumer sector are expected to fall at the fastest pace since August 2012.

Cost pressures are building in both sub-sectors. In business and professional services, total costs per person rose at the fastest rate in three years and are expected to rise at a similar pace over the next three months. In consumer services, costs surged at the fastest pace since August 2008 in the last quarter and are expected to grow at a similar pace next quarter – the strongest expectations since August 2006.

Business and professional services firms reported that average selling price inflation eased modestly over the last three months, although it remained above the long-run average. In consumer services, average selling prices rose at the fastest pace since November 2014.

Notwithstanding higher prices, profitability declined in both sub-sectors in the three months to May. However, mirroring the divergence in demand prospects, profitability is expected to improve next quarter in business and professional services, and to decline further in consumer services. Similarly, optimism among business and professional improved for the first time since November 2015, with a more modest improvement in sentiment reported by consumer services firms.

Rain Newton-Smith, CBI Chief Economist, said:

“Rising inflation is squeezing household incomes, which is hitting demand in the consumer services sector. At the same time, cost pressures are building across the board, painting a difficult picture for services firms.”  

Despite these pressures, services firms expect to hire more workers and to continue to invest. Firms in business and professional services cut back on employment over the last quarter, but expect to increase headcount over the next three months. While employment growth slowed in consumer services, firms are expecting a slight pick-up next quarter. 

Capital expenditure is expected to increase over the year ahead in both sub-sectors. Investment among consumer services firms will be increasingly driven by the need to replace old equipment and improve efficiency, while the need to expand capacity and provide new services have become more important motivations for business and professional services firms.

Key findings:

Business and professional services

  • Optimism about the business situation improved (+14%) for the first time since November 2015
  • The volume of business was flat for the fourth quarter running (-3%), with 22% of firms reporting they were up compared with the previous quarter, and 25% saying they were down – the lowest since February 2013. Volumes are expected to rise over the coming quarter (+22%) – the strongest expectations since November 2015
  • Average selling price inflation eased over the quarter to May – with a balance of +9%, above the long-run average of -7%. Price inflation is expected to pick up again over the next three months (+16%)
  • Total costs per person rose at the fastest pace since May 2014 (+42%, up from +34% in the previous quarter)
  • 24% of firms said the overall profitability of business was up on the previous quarter, and 30% said it was down, giving a balance of -6%. But firms expect profits growth to resume next quarter (+12%)
  • 20% of businesses said numbers employed were up on three months ago, and 27% said they were down, giving a balance of -7% - the fastest decline since February 2010
  • Investment intentions for the year ahead improved for land and buildings (+13%) and IT (+33%). Business and professional services expect growth on vehicles, plant and machinery to be flat (0%).
  • The motivations for capital expenditure were broad-based, including:
    • Increase efficiency/speed (+41%) – the lowest since August 2008
    • Replacement (+40%) – the lowest since February 2001
    • Capacity expansion (+35%) – the highest since August 2016
    • The provision of new services (+25%) – the highest since February 2015
  • 63% of firms said they expected to expand their business over the year ahead, and 34% said they did not, giving a balance of +29%, the strongest balance since February 2014.

Consumer services

  • Optimism about the business situation improved slightly (+7%) – with 20% of firms saying they were more optimistic than three months ago, and 13% saying they were less optimistic
  • 31% of firms reported a rise in business volumes, compared with 19% saying they were down in the last three months, giving a balance of  +12% (down from +33%). Volumes are expected to fall next quarter (-9%) – the weakest expectations since August 2012
  • Average selling prices rose at the fastest pace since November 2014 (+29%). Firms expect prices to rise at a similar pace next quarter (+31%).
  • Growth in costs per person increased significantly (+60%, from +32% in the previous quarter) – the quickest pace of growth since August 2008. Costs are expected to rise at broadly the same pace over the next three months (+61%) – the strongest expectations since August 2006
  • Profitability declined for the fifth consecutive quarter in May (-7%), and is expected to fall again next quarter (-13%)
  • Growth in numbers employed eased (+13% from +25%) – the slowest growth since August 2014, but is expected to pick up in the next three months (+19%)
  • Capital expenditure is expected to increase across all three categories over the coming 12 months – land and buildings (+11%), IT (+30%) and vehicles, plant and machinery (+8%).
  • Replacement was the main reason being cited by firms for boosting capital expenditure over the next year (74%).
  • 27% of firms said they expected to expand their business, and 68% said they did not, giving a balance of -41%, the weakest balance since February 2009.