The UK attracted more venture capital investments than any other European country in 2018 (Source: TechNation 2018). Scaleups in the London area delivered 56% annual growth rates, the fastest in the world.
Yet, a study by CMC Partners, of 117 businesses within a 50-mile radius of London, each with annual revenues less than £10m and delivering traditional IT services, found that revenue CAGR in the last 3 years was a mere 2.3% with EBITDA growth in the same period generating a CAGR of -9%. Equally profoundly EBITDA (as a percentage of revenue) was 4% in the same period.
These are surprising results. the FTSE Techmark 100 grew at a CAGR of 7.3%, while the retail price index grew 2.9%, in the same 3-year period, as a broad comparisons. These traditional IT service businesses are clearly far away from the scorching scaleup growth rates of new tech businesses in the same area.
So what explains this data? There are many plausible strategic and operational reasons.
1. The services might be undifferentiated
This occurs when customers are unable to adequately distinguish what one supplier has on offer from another. Such perceived commoditisation forces service providers to compete on price which shrinks margins and makes revenue growth challenging. Our qualitative assessment of our study sample showed infrastructure services, bespoke application development and customer support services as being common in the companies’ portfolios – all examples of mature offerings that are increasingly suffering from price competition.
2. SME companies typically lack scale economies
This is driven by size and is often caused when your total costs are spread over lower volumes resulting in unit costs exceeding unit margins. This situation is rectified by increasing revenues (while controlling costs and prices, of course). Many companies in our study might potentially be lacking economies of scale based on the stage of their lifecycle. As such companies grow in revenue (and/or) margins they should be able to overcome this issue.
3. There might not be structured planning and disciplined execution
SME businesses need focus as their growth strategy to stay committed to an agreed direction and achieve a set of planned milestones before changing course. This requires expertise and governance of decision making. Many privately-owned businesses might be lacking in professional management expertise and experience of scaling business operations.
4. Sales and service delivery skills might be inadequate
SME businesses often do not have (or cannot afford) an experienced sales lead, with the business owner directly selling and leading delivery. This hinders scaling the business.
5. Services might not be wholly relevant anymore and the customers might be seeking alternatives
This could be due to the increasing need to support the digital transformation objectives of businesses, resulting in demand for cloud-based products, cloud-based service delivery, very high-efficiency and throughput of services and risk-share or pay-as-you-go business models. Many SMEs in delivering IT services through traditional on-premise structures might find it difficult to change and not be able to meet such client expectations.
6. Lack of capital to adequately invest in the business
SME businesses often suffer from working capital shortages caused by delays in paying cycles and mismatches between cash inflows and outflows. Raising debt capital from banks requires appropriate collateral. Equity capital is both expensive and hard to come by if the business is not in a high growth segment.
7.The market for IT services might be over supplied
This sample included companies in a 50-mile radius of London. When supply exceeds demand there is more intense competition often leading to falling prices for services.
Political climate including Brexit uncertainties within the broader market could have certainly contributed to the sluggish outcomes – especially as businesses curtailed investments and delayed strategic decisions.
These are hypothetical causes for underperformance of the average firm in our study sample. Our work with the SME sector has demonstrated that, in fact, a combination of the above reasons is more likely than any one being dominant.
The Key to unlocking SME Business Growth
A comprehensive strategic audit of the business is a good starting point to identify such potential business performance issues.
CMC Partners has built a track record of improving business performance of its clients over the last 30 years. Call 01844 319286, complete the form below or email firstname.lastname@example.org to book your free and confidential meeting.