UK’s post-Brexit economy hinges on SME innovation

If Brexit leads to new tariffs, it is not just the UK’s 6,700 large manufacturing companies that will be impacted, but also the country’s 264,000-plus manufacturing SMEs, and that poses significant dangers for the UK economy.

According to a recent survey by the Chartered Institute of Procurement and Supply (CIPS), nearly half (46%) of EU businesses that work with UK suppliers are in the process of finding local replacements.

If global supply chain managers are planning to re-shore all or part of their supply chains back to Europe to avoid Brexit tariffs then the impact could be quite significant on the UK’s SMEs.

Yet the opportunities are also huge. The CBI estimates that strengthening supply chains could add £30bn to the UK economy by 2025. The CIPS survey also shows that the move to sever supply chain ties between the UK and the EU could go the other direction, with 32% of UK businesses who use EU suppliers now looking for British replacements.

But are UK SMEs ready to pursue potential new business opportunities in advanced industries post-Brexit?

Innovation

A key aspect to look at is the barriers faced by SMEs to innovating. While the scientific output of the UK is world-leading, many British companies, especially SMEs, still don’t utilise the latest technological know-how, and as a result, the UK has a long tail of un-productive firms hindering supply chain competitiveness.

According to the Bank of England, around 1% of companies have seen productivity growth of approximately 6% a year – but one-third have seen no increase since 2000.

SMEs also have an intrinsic ‘innovation fear’, because an unsuccessful investment of their limited resources in an innovative project can greatly affect their financial performance and even jeopardise their survival.

As a result, many SMEs are unable to update production processes and undertake the development of new products. The smaller the company is, the harder it is to innovate or capitalise on its innovations.

In the US, for example, it is estimated that only around 2% of small firms conduct R&D, compared to 14% of large firms. The lack of involvement of SMEs in R&D and innovation might represent a risk to competitiveness in advanced manufacturing sectors that require continuous innovation and long-term investment horizons.

Integrating SMEs into the national system of innovation

In the UK there are not many avenues open for SMEs to engage with R&D and innovation. Most SMEs do not have the time, capacity or funds to partner with universities or research and technology organisations.

The loss of EU research and innovation funding post-Brexit could further hurt SME engagement in R&D and innovation if no mechanism is put in place to replace it.

A recent report commissioned by the UK National Academies (Academy of Medical Sciences, British Academy, Royal Academy of Engineering and the Royal Society) found that while EU funding accounts for a small proportion of total UK business expenditure on R&D, it comprises 17% of the R&D for UK SMEs, who have received more than £650m between 2007 and 2013.

Moreover, there is a worrying dip in investment by UK manufacturers as reported in EEF’s annual Investment Monitor report.

Companies are split on making future investments, with some seeing opportunities from Brexit, while others are holding off on new investments until there is clarity on the Brexit deal.

Delaying investments, such as in automation, has the follow-on consequence of also delaying productivity growth. This is worrying.

The UK’s future success in growing its advanced manufacturing economy relies on all companies that are part of the supply chain being incorporated into the national system of research and innovation.

SMEs are the backbone of the UK manufacturing sector, as well as the economy as a whole, with SMEs making-up 99.5% of all manufacturing businesses in the country. Supporting small business innovation is critical, therefore, for ensuring the future success of UK manufacturing.

What can be done?

The situation is not about to change in a hurry without some serious intervention and support to increase the capability of UK SMEs, particularly in tradable sectors that would be most affected by Brexit.

Some of our overseas manufacturing competitor countries, such as Japan and Germany, have long recognised the barriers to SME innovation and have established systems to overcome some of these constraints.

Foreign examples of supporting SME innovation

Japan has a regional network of 60 Kohsetsushi centres, some of which have been operating for more than 100 years. These focus solely on providing testing and research services for industrial SMEs.

There are hundreds more centres like these in other areas, such as agriculture and health. In 2014, these centres received a combined funding of more than $1.6bn and hosted around 7,000 researchers – all working to help SMEs innovate.

In Germany, there are the well-known 69 Fraunhofer institutes and research units with their 24,000 staff and €2.2bn annual funding, but there are also other institutions that support innovation of SMEs.

These include the German Federation of Industrial Research Associations (AiF), which has been operating for more than 60 years and encompasses 100 industrial research associations serving approximately 50,000 businesses, mostly SMEs. In 2014, the AiF disbursed about €500m of public funding.

These institutions help SMEs develop their internal innovation capacity by providing a number of technical services, such as:

• Access to high-quality equipment and laboratories that SMEs could not otherwise afford
• Technical advice
• Analysis and testing services to ensure product quality and compliance with international standards
• Workforce training required for the introduction of new equipment or new technologies in existing equipment
• Commissioned research
• Access to innovation funds

Support in the UK

The Catapult Centres in the UK fill an important gap in the innovation system, but they still lack the scale and geographical coverage found in similar institutions in other countries.

Recent independent evaluations have found that the Catapult centres cannot by themselves fulfil all the functions required to support SME industrial innovation.

Other initiatives need to be appropriately assessed in order to understand what has worked and what has not in the past. Perhaps more importantly, the effect on UK SMEs of the unexpected closure of the Manufacturing Advisory Service in 2016, as part of the government austerity programme, also needs to be properly understood.

And because barriers faced by manufacturing SMEs to innovate are diverse – from skills and infrastructure to R&D and finance – no single programme will be able to address them all. Instead, what international experience tells us is that the particular needs of SMEs have to be systematically accounted for across all relevant policy interventions.

A country’s innovation performance is defined by not only its ability to generate new knowledge but also, critically, by the ability of existing firms to quickly absorb and apply this new knowledge to upgrade, diversify and gain competitive advantage.

Positive action to nurture UK SME innovation, and address gaps in the institutional support infrastructure in the UK, is therefore necessary and vital for the nation’s future industrial success.